As prospects for economic recovery and rising interest rates in the U.S., Canada, Germany, Britain and most of northern Europe make your clients’ existing bond holdings look vulnerable to large price declines, you should be on the hunt for global sovereign bonds to sustain mid-single digit yields. For instance, bond markets in Asia, Africa and the Far East are thriving. However, bagging returns in global bonds requires accurate picking; shotgun tactics won’t do.
The U.S. and Canadian bond boom is over. In January, the U.S. Treasury 30-year bond posted a 5% loss, according to Bloomberg LP, while the Canadian DEX universe bond index, which has a 60% weighting in government bonds and a 40% weighting in corporate bonds, turned in a 0.79% loss. With yields below inflation rates, government issues are due to become orphans wanted only by life insurance companies and pension funds in order to match their liabilities.
Clients who invest in fixed-income and want to sustain yield have no choice but to accept the credit risk in bond markets in which interest rates are higher. With the exception of bonds issued by global multi-sovereign entities, such as the World Bank – whose bonds are guaranteed by its member countries and carry AAA credit ratings that indicate no default risk and, hence, trade at only small premiums to U.S. Treasury issues of similar term – high-yield, single-nation sovereign-bond issues can be perilous.
Nevertheless, money is flowing into global debt markets that were ignored for the past five years. The Barclays capital emerging markets tradable USD sovereign bond index, which tracks debt issued in U.S. dollars and, thus, eliminates currency variations, turned in a 12.67% gain for the 12 months ended Jan. 31. The gain helped to pull up the index’s three-year average annual return to 11.12% and the five-year average annual return to 7.86%. That has made emerging-markets sovereigns one of the best-performing asset groups and the hottest of all bond fund categories for those periods.
The prospect of sustaining yields by taking on default risk in distant places has played tricks with investors’ memories. Fixed-income markets appear to have forgiven Iceland for its missteps in 2008, when the country’s absurdly overextended banks – some were lending at 100 times capital – defaulted on US$85 billion in bonds that were held mostly by institutions outside of Iceland. The country’s currency, the krona, went into a tailspin.
But after five years of austerity, Iceland is back in the good graces of the bond market. New York-based Moody’s Investors Service Inc. now rates Iceland’s sovereign debt at Baa3, the lowest level of investment-grade. An Iceland krona-denominated sovereign bond due Oct. 22, 2026 – sold at par when issued on Feb. 8, 2013 – was recently priced at US$105.20 to yield 6.5% to maturity. In comparison, a Government of Canada 8% issue due June 1, 2027, was recently priced at $168.64 to yield 2.33% to maturity.
@page_break@The appetite of investors – mainly institutions – for global debt they formerly had scorned is evident in last year’s top African issue, a US$750-million 10-year bond from Zambia launched in late September. Small by Canadian and U.S. standards, Fitch Ratings Inc. and Standard & Poor’s Financial Services LLC (both based in New York) rated the bond as “junk” with a B+ rating. Nevertheless, Reuters reported that the bond was oversubscribed by an astonishing 15 times. In aftermarket trading, this bond’s yield fell to 5.2% just a day after it was issued with a price to yield 5.625% to maturity. The Zambia bond was both the largest issue from sub-Saharan Africa and the lowest coupon issue since the global meltdown in 2008.
Prospects for timely payment of interest and return on capital depend on the issuing country’s fortunes. And Zambia’s are hitched to the global recovery, as copper comprises 77% of Zambia’s exports. If the global recovery stumbles or China’s construction boom goes into a tailspin, the Zambia bond’s prospects would be in doubt.
“Emerging-markets bonds are an attractive place to be right now,” says Jack Ablin, executive vice president and chief investment officer with BMO Harris Private Bank in Chicago. “The thesis is that interest rates are higher than those in the developed world. Moreover, for bonds issued in native currencies that appear cheap in relation to the [British] pound [sterling], the U.S. dollar and the euro, you have both the prospect for a rising currency and falling interest rates working in your favour.”
Those principles also work for the Russian Federation, where midterm rates for maturities from five to 15 years range from 4% to 5.5%. Russia is seen as a stable emerging market. However, investors seem to have forgotten that Russia defaulted on bonds issued by its internal regions and it devalued the ruble in August 1998.
That said, not all portfolio managers are ready to take on global bonds as a substitute for the familiar senior bonds of Canada, the U.S., Britain and Germany.
“I would not buy into these global high-yield bonds right now,” says Marc Stern, vice president and head of discretionary wealth management with Industrial Alliance Securities Inc. in Montreal. “Some of these emerging markets don’t have enough history to assure me that the interest will be paid promptly when [it’s] due and that capital will be returned at maturity. The high yields of global bonds can mask their underlying risks.”
Other perils include lack of liquidity in secondary markets for many issues that are too small or too obscure to trade, as well as lack of reliable economic information from some issuing nations. Says Stern: “These are bonds you have to be prepared to hold to maturity.”
Buying global debt – whether investment-grade, state-guaranteed bonds in Germany or junk bonds from emerging markets – takes not only research and caution but continuous monitoring. Far from sight should not be far from mind. That may be a platitude, but it is essential to keeping safe in a market known for its perils.
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