(Bloomberg) -- Pacific Investment Management Co. doesn’t hold Puerto Rico debt in its tax-free funds, and the company predicts that a lack of improvement in the island’s finances may increase volatility in other municipal securities.

Puerto Rico’s economy is shrinking and the commonwealth has relied on deficit financing to balance recurring budget gaps. Its general obligations, whose yields rose to record highs last month, are rated one step above junk. The island’s debt lost value the past four months, the longest slide since 2011, Standard & Poor’s data show.

“We’re not here to beat up on Puerto Rico,” Joe Deane, head of munis for Pimco in New York, said in a telephone interview. “But it’s important for people to understand out there that as a municipal group our exposure to the island is zero, and we intend to stay there for the foreseeable future.”

The Newport Beach, California-based company, which managed $1.97 trillion as of June 30, holds about $60 billion of munis across its funds. Pimco has had no allocation to Puerto Rico in its tax-exempt funds for six months, Deane said.

Should Governor Alejandro Garcia Padilla, 42, who took office in January, be unable to turn around the island’s economy and end budget gaps, yields on Puerto Rico debt would jump further, Deane said.

Struggle Scenario

“If Puerto Rico were to continue to struggle in here, you probably won’t see a tremendous amount of selling in Puerto Rico,” Deane said. Investors will instead turn to selling “more liquid, easy-to-trade stuff,” he said. “And that might be an opportunity to pick up some really cheap paper.”

The $553 million Pimco Municipal Bond Fund, which Deane manages, has earned about 0.8 percent in the past three months, beating 73 percent of its peers, data compiled by Bloomberg show.

“What they say is their decision, their call,” David Chafey, chairman of the island’s Government Development Bank, said today when asked about Pimco’s strategy in an interview at Bloomberg headquarters in New York. “We are clearly delivering on all the things that are expected of us in terms of being very fiscally responsible.”

Pimco’s $250 billion Total Return Fund, managed by Bill Gross, is the world’s largest bond fund. The asset manager is owned by Munich-based insurer Allianz SE.

The outlook for Puerto Rico’s finances and its debt has significance beyond the shores of the Caribbean island. About 77 percent of U.S. muni mutual funds hold its securities, which are tax-exempt in all states, according to Morningstar Inc.

Investors should buy munis that will be easier to sell to achieve earnings, Deane said in a report released today.

A key to choosing munis is the extent of a state’s or locality’s unfunded pension and health-care liabilities, Deane said.

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