Do you want to buy foreign bonds directly? Much luck – I often advocate buying individual bonds rather than mutual funds. Building your own bond portfolio is easy, especially for relatively easy and safe bonds (which excludes junk bonds, some mortgage-backed securities, and other esoteric debt instruments).
When you buy bonds outright, you know you’ll get your principal back when an issue matures, provided the borrower of your money doesn’t go bankrupt. You save management fees and don’t have to worry about a fund manager abusing derivatives. It’s easy to buy government bonds through Treasure Direct, and you can buy municipal and corporate bonds through brokers like Fidelity and Charles Schwab.
Recently I have received several requests to buy individual foreign bonds. This is not entirely surprising given that foreign sovereign debt has fared much better than the dreadful US Treasuries this year. Obviously, many investors believe that now is the right time to swap government bonds for bonds from countries as wealthy as Australia or Japan or pretty much any other country in Western Europe.
It’s a good idea if you are a millionaire or a professional wealth manager. Here’s the context:
Bonds from most developed markets have posted positive returns so far this year, some as much as 8%, according to the FTSE World Bond Indices. Most foreign currencies appreciated or remained flat against the dollar, resulting in currency translation positive or insignificant relative to foreign debt yields.
Emerging market debt, which suffered a setback last year amid growing fears that some countries might default during the financial crisis, rebounded strongly. According to Morningstar, the average bond fund in emerging markets is up 23% year-to-date. In any case, foreign bonds shine against US bonds: the benchmark 10-year government bond fell by more than 10% in terms of total return.
Most foreign governments now pay more than Uncle Sam. For example, in the first week of August, Australian 10-year government bonds returned 5.7%. Brazil recently sold new government bonds maturing in 2037 at a yield of 6.5%. The 10-year Treasury yield is 3.7%.
As signs mount that the recession is over, fears are mounting that US bond yields will continue their recent rise. As bond prices move inversely with yields, this would mean further declines in government bond prices. This prospect is reason enough to short long-dated Treasuries until their yields exceed 4% or even 4.5%.
You can earn 6% or more on high quality US corporate bonds or bonds issued in dollars by a foreign company. But even a global issuer of the stature of AstraZeneca or Deutsche Bank can’t make money. A government can. According to Moody’s, global economies have slowly started to recover and it sees signs of stabilization among “sovereign issuers” which have feared could default during the financial crisis.
I have accounts with Fidelity and Schwab, so I chose Brazilian and Australian bonds. I have noticed that you cannot find any listings for such bonds on broker websites. However, if you are a client, you can contact a broker who specializes in foreign debt. But there’s a catch: Schwab requires you to buy bonds worth at least 100,000 units of the relevant currency. So if you buy a Eurozone bond, you need to buy it for €100,000 (about $140,000). When buying Brazilian debt, you must buy at least 100,000 reais ($55,000).
The Fidelity rep told me I would have to ask for at least $100,000 in bonds, “and then we’ll try to pursue them, there’s no guarantee.” His explanation: Demand is weak and the spread between supply and asking price would be too big for a lower order. I didn’t joke about being a millionaire.
A big problem is that the New York Stock Exchange does not list foreign government bonds. Some countries’ official websites (see Irish Treasury website) list local brokers selling government bonds. But then you have to deal with all kinds of fees and commissions, as well as the tax burden of investing through an offshore account.
EverBank, a St. Louis company known for its FDIC-insured foreign currency certificates of deposit, has a brokerage arm that offers foreign bonds. Minimum account is $20,000; However, the choice is limited. On August 5, an Everbank representative could only offer two bonds from Australia and Brazil. One of these was a three-year Brazilian issue from a Dutch bank, which was triple-A rated by multiple bond reviewers. The current yield of 9.25% was tempting, but the bond offered no government support. The other security was a five-year Australian government bond yielding 5.5%. Obviously, EverBank doesn’t want to hold too many balances for their own accounts. I can’t say I necessarily blame him.
Fidelity’s bond agent suggested I take a look at exchange-traded funds. For example, the iShares JPMorgan USD Emerging Markets Bond Fund (Ticker EMB), as the name suggests, contains bonds from countries such as Brazil, Russia and Turkey. Your expenses are small at 0.60%. However, the current yield, based on the last monthly distribution, is only 5.5%, which significantly reduces the fund’s attractiveness.
The iShares S&P Citigroup International Treasury Bond Fund (IGOV) has a low expense of 0.35% but relies on an index that forces it to absorb Japanese, German and other low-yielding bonds. The fund is so new that we don’t yet know how it will perform, but it will be tiny. It can be a good diversification tool, but as an income investment it’s mediocre.
And besides, the purpose of this column is to get off the tills. Maybe one day all the electronic exchanges in the world will come together. Then the boundaries between our island bond market and everyone else’s will disappear. But that is not the case today.