International Bonds

Bonds are not something I know much about — and they scare me because they appear to have so little upside. But as I’ve looked at them I realize there is a huge amount of diversity there and I need that. Maybe later I’ll look at corporate/junk – but today is international.

I have zero interest in buying individual bonds. So this is one area where it is worth buying some sort of fund and paying the expense fees to have someone else manage them. I also have less than zero interest in buying “developed” country bonds — US Treasuries, UK gilts, Eurozone, Japanese. They are all dreck.

Nor do I have any interest in buying bonds from other countries that are denominated in those above currencies. Those sorts of bonds (eg dollar-denominated Brazil bonds) are THE cause of all the emerging market crises (defaults, hyperinflation, commodity price swings, dependence on commodity exports to get foreign exchange, etc) of the 1970’s-1990’s that have given emerging markets a bad reputation — and the only beneficiary of those bond issuances were/are the big international trade finance banks (and the governments that issue those currencies).

Fortunately, it does appear that emerging markets really did learn lessons. “Foreign-currency” bonds now represent only 1/3 of the outstanding bonds from those countries. They are now funding themselves using local currencies — which also means they are mostly funding themselves via the savings of their own people. That is really a huge stabilizing force since, as Alexander Hamilton observed, that is one of the major actions that ensures that a government is financially responsible to its own people rather than to foreign entities.

Further, some of those countries are now truly fiscally responsible – unlike the US/etc. Many of them run fiscal surpluses over the course of the economic cycle — are spending less as a % of the economy — and have far lower total debt burdens. The list of “most-indebted” governments is now top-heavy with Europe, Japan – with the US advancing quickly into that sewer. While many “risky” countries have public debt levels that we haven’t seen here for decades. Not to say that all is peaches-and-cream. But it does mean that the “safest” government bond yields are in places we might not feel “safe” in — and bonds (esp sovereign-level credit) add major stability/income to a portfolio.

There are two exchange-traded fund options that fit the above criteria — EMLC, ELD — and a few closed-end fund options.

EMLC — Passively follows a “local-currency” index. Forget it. This means that over time, the ETF will end up loading itself down with the most-indebted just as stock indexes load themselves with the big-cap.

ELD — Actively managed. Says its investment policy focuses on issuer responsibility and such. However, still too new for me to say “OK. I trust you”. So far so good though. Currently diversified well but only in emerging markets — and not going out in duration (4.7 years) reaching for extra yield and risking principal. Will probably yield about 5% — but like most ETF’s won’t pay it except at the end of the year. For now — wait and watch. Potentially very good.

GIM — Closed-end fund. I like CEF’s for bonds because they don’t have to sell underlying bonds simply because investors panic and need liquidity for themselves. Rather, sometimes the CEF just sells at a discount. Unfortunately, right now it is at a 6% premium. EXCELLENT portfolio. Diversified across continents, among emerging markets and solid developed markets (Australia, Sweden, etc), and also makes currency bets (eg currently short the euro/yen in order to fund a carry-trade into other Asian/European bonds). Has a long history and monthly distributions. Duration – 5.4 years; Yld – 5.1%. I don’t like it at its current premium — but this is a perfect fund to put in a GTC order at 6-10% below the current price – or a real stink-bid at 12-15% below — and wait/pray for a flash crash/panic. And if it doesn’t fill in the next 60 days, then just renew the GTC order when it expires. For example, on the day of the May 6 flash crash, GIM traded in a range of $9.97 – $5.00 – the following day traded between $9.40-$8.95 – and recovered back to its then NAV ($9.80) within one week. Pretty good for a sovereign bond fund but the only way to do this is via a low GTC bid because the potential window is so narrow/unpredictable.

There are a couple of CEF’s that I would look at if/after a market crash happens because they are leveraged and hence could get into their own internal margin-call problems which take awhile to work out. And ETF’s probably have better upside after a crash simply because they will own bonds at “forced-liquidation” prices then. But for now, I’ll just put that as something to monitor in the event of some serious financial crisis like late 2008.

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