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Where Government Bonds Still Yield 5%
Smart Money ^ | 06/30/2012 | JACK HOUGH

Posted on 06/30/2012 3:09:05 PM PDT by SeekAndFind

Investors who find Treasury yields too meager can choose from a long menu of meatier government bond yields abroad.

But finding the right combination of risk and return is getting trickier.

Most investors hold a sizable chunk of government debt in their bond portfolios, for safety more than the income the bonds generate. Not long ago, that slice consisted of one kind of bond: U.S. Treasurys.

But the relationship between yields and risk in government bonds has taken an odd turn. As a result, even cautious investors should consider branching out from the U.S. to places like Australia and Mexico.

Among the factors that determine the credit-worthiness of governments are how much they owe, the size and growth rates of the economies they oversee and the inflation rate. While heavy debtors might be expected to offer higher yields, as in the corporate-bond world, this isn't always the case with government bonds.

Central banks in the U.S. and Japan, in an effort to boost economic growth, have bought bonds aggressively to reduce yields, which move in the opposite direction of prices.

As a result, bond yields in these countries are artificially low now, says Shane Shepherd, head of fixed-income research at Research Affiliates, an investment firm in Newport Beach, Calif. The 10-year Treasury yield is just under the latest annual inflation rate of 1.7%.

Treasurys remain a top choice for investors who value short-term safety over long-term growth because they carry negligible risk of default, says Erik Weisman, a portfolio manager at fund company MFS Investment Management.

But investors who are seeking higher yields without a lot of extra risk should look to the likes of Australia and New Zealand, Mr. Weisman says. Both countries have manageable debt levels and potential for healthy economic growth, and their currencies are likely to hold their value a key consideration for foreign-bond buyers, Mr. Weisman says. Australia and New Zealand 10-year bonds yield 3.0% and 3.3%, respectively.

For investors who want higher yields and don't mind additional risk, Ian Kelson, head of global fixed income for $555 billion asset manager T. Rowe Price Group (TROW: 62.96, 2.22, 3.65%), says Mexico is his favorite market because its 10-year bond yield of 5.5% is safely higher than its inflation rate and it has good growth potential. He also likes South Africa, whose 10-year yield is 7.2%.

For similar reasons, Krishna Memani, director of fixed income at $173 billion money manager OppenheimerFunds, also likes Mexico, along with Brazil (with a 10-year yield of 10.2%) and Indonesia (6.5%).

For his part, MFS's Mr. Weisman thinks Mexico, South Africa and Turkey (8.6%) offer good value.

Some caveats are in order. Bonds in nations like Mexico and Indonesia, even government ones, can be volatile. "Those yields aren't high for nothing," says Tina Vandersteel, portfolio manager at GMO, which oversees $105 billion.

And for all the talk on Wall Street about global investing, it isn't especially easy for U.S. customers to buy foreign government bonds directly. For example, Charles Schwab doesn't list them with other bonds on its website. Customers must call in and request them, at which point a broker will get prices from outside dealers.

Fees are assessed case by case, and while there isn't a minimum purchase, "we have a hard time finding securities for customers who want to spend less than $100,000," says James Grady, vice president of fixed-income trading.

Jacksonville, Fla.-based EverBank, known for its foreign-currency certificates of deposit, also specializes in foreign government bonds through its brokerage arm. The minimum purchase is $20,000 and fees are typically 0.75% of purchase amounts up to $100,000, 0.5% for amounts up to $500,000 and 0.375% for larger amounts, says Frank Trotter, president of EverBank Direct, which oversees the brokerage business. Investors can choose from 14 countries, but neither Turkey nor Indonesia is among them.

Mutual funds offer an easy path to diversified foreign bond exposure, and fund managers are experienced enough to go beyond government bonds into attractive corporate issues, too. But beware high fees. Many such funds have sales charges of 4% to 5% and continuing fees of more than 1% a year, a high price to pay for the privilege of collecting an extra point or two per year in yield.

T. Rowe Price charges 0.83% for its International Bond fund, which focuses on developed markets and yields 1.7%, and 0.94% a year for its Emerging Markets Bond fund, which yields 5.8%. Fidelity International Bond, launched in May, costs 0.75% a year.

Index funds are even cheaper, but most weight countries by bond market size, favoring heavy debtors. SPDR Barclays Capital International Treasury Bond (BWX: 59.13, 0.71, 1.22%) costs 0.5% of assets per year. Vanguard Group, known for its low-fee funds, says it plans to launch Total International Bond Index later this year.

More options might be on the way. Research Affiliates and Citigroup (C: 27.41, 1.02, 3.87%) earlier this year launched Citi RAFI bond indexes, which weight countries by economic size, land area, energy use and population, rather than outstanding debt. Relative to other indexes, they tend to underweight the U.S. and Japan and overweight countries like Australia and Canada. Discussions are under way to launch mutual funds based on the indexes for U.S. investors, says Mr. Shepherd at Research Affiliates.

Such approaches could help investors diversify smartly. Remember: A credit-card issuer wouldn't charge the lowest rates to customers who carry the most debt. Treasury holders should think likewise by shifting a portion of their funds to countries where debt levels are lower and yields are higher.

TOPICS: Business/Economy
KEYWORDS: bonds; government; investing

1 posted on 06/30/2012 3:09:15 PM PDT by SeekAndFind
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To: SeekAndFind

Besides the currency exchange risk of foreign bonds, bonds in general carry inflation risk. With all the excessive printing of money, inflation is certain to rear it’s ugly head when economy recovers. Buyers be aware.

2 posted on 06/30/2012 3:15:18 PM PDT by entropy12 (Hate is the most insidious emotion, it will rot your gut from the inside.)
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To: SeekAndFind

You can find state munis on the secondary markets here in the USA for 4 & 5 percent. Buy them in your own state & they are double tax free.

3 posted on 06/30/2012 3:22:52 PM PDT by LongWayHome
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To: entropy12

RE: currency exchange risk of foreign bonds

For me, I look at the FISCAL and DEBT fundamentals of a country to determine whether the future of a currency is STRONGER or WEAKER.

Consider this — America’s debt to GDP ratio has now approached 100%. Australia’s is a mere 22% and there is strong clamor on both sides of the political fence to SHRINK that.

I would not be surprised to see the Aussie strengthen vs the USD ( which it has the past few years ).

4 posted on 06/30/2012 3:29:59 PM PDT by SeekAndFind (bOTRT)
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To: SeekAndFind

I am assuming you are correct on 22% Australian debt. Next question, and just as pertinent is, in which direction is the country headed, and how prominent is the currency in world markets. US dollar is still the reserve currency.

But I am in full agreement that US currency is being debased by the day. Which is why I am focusing on asset based securities, and staying out of cash and bonds as much as possible. Reits, Chemicals & Energy are favored by me.

5 posted on 06/30/2012 4:59:24 PM PDT by entropy12 (Hate is the most insidious emotion, it will rot your gut from the inside.)
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To: LongWayHome
find state munis on the secondary markets here in the USA for 4 & 5 percent

Be sure to check ratings of muni bonds. Do not buy bonds of cities/counties/states in deep financial mess. Such as city of Stockton ans state of CA.
6 posted on 06/30/2012 5:03:07 PM PDT by entropy12 (Hate is the most insidious emotion, it will rot your gut from the inside.)
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To: entropy12

Yes, and look at the state’s general obligation bonds. And, believe it or not, look at the high tax blue states: they always just keep raising taxes.

7 posted on 06/30/2012 5:28:03 PM PDT by LongWayHome
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