The Case for Buying Foreign Bonds from Low-Deficit Countries → Washingtons Blog
The Case for Buying Foreign Bonds from Low-Deficit Countries - Washingtons Blog

Friday, March 26, 2010

The Case for Buying Foreign Bonds from Low-Deficit Countries


Bill Gross is recommending that investors buy the debt of low-deficit countries. Via Business Week:

As Pacific Investment Management Co.’s Gross, manager of the world’s biggest bond fund, said yesterday in an interview with Tom Keene on Bloomberg Radio that [U.S.] “bonds have seen their best days.” Pimco, which announced in December that it would offer stock funds, is advising investors to buy the debt of countries such as Germany and Canada that have low deficits and higher- yielding corporate securities.

Similarly, the Mad Hedge Fund Trader writes:

I am constantly asked where to find safe places to park cash by investors understandably unhappy with the risk/reward currently offered by the markets. Any reach for yield now carries substantial principal risk, the kind we saw, oh say, in the summer of 2007.

I have had great luck steering people into the Invesco PowerShares Emerging Market Sovereign Debt ETF (PCY) for the last nine months, which is invested primarily in the debt of Asian and Latin American government entities, and sports a generous 6.44% yield. This beats the daylights out of the one basis point you currently earn for cash, the 3.76% yield on 10 year Treasuries, and still exceeds the 4.70% yield on the iShares Investment Grade Bond ETN (LQD), which buys predominantly single “BBB”, or better, US corporates.

The big difference here is that PCY has a much rosier future of credit upgrades to look forward to than other alternatives. It turns out that many emerging markets have little or no debt, because until recently, investors thought their credit quality was too poor. No doubt a history of defaults in the region going back to 1820 is in the backs of their minds.

You would think that a sovereign debt fund would be the last place to safely park your money in the middle of a debt crisis, but you’d be wrong. PCY has minimal holdings in the Land of Sophocles and Plato, and very little in the other European PIIGS. In fact, the crisis has accelerated the differentiation of credit qualities, separating the wheat from the chaff, and sending bonds issues by financially responsible countries to decent premiums, while punishing the bad boys with huge discounts. It seems this fund has a decent set of managers at the helm.

With US government bond issuance going through the roof, the shoe is now on the other foot.
It should be noted that both Gross and the Hedge Trader are rather bullish on the U.S. economy. For example, one of the main reasons that Gross is now bearish on U.S. treasuries is because he is convinced the U.S. be hit with massive inflation. If he is wrong - and wrong deflation reins for a while longer - then U.S. treasuries may still recover.

As to foreign sovereign debt, Ferguson, Faber and Grice apparently don't think that any country is safe. If they are right, that could argue for gold.

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