Fixed income markets are heating up

Emerging fixed income markets are yielding higher rates these days.

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by Special to MoneySense
August 29th, 2013

Online only.

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I am quite upbeat on the prospects for capital markets over the next few years. This optimism is based on a firm belief that the world’s central banks will continue to keep global monetary policy very easy until the unemployment rate in their various domains drops to an acceptable level. The first solid indication of this came from new Bank of England Governor Mark Carney who has now targeted an unemployment rate of 7% before slowing the quantitative easing policy. Despite the U.S. Federal Reserve making noises that they will slow the level of QE they will be keeping a beady eye on the unemployment rate, which they are targeting at 6.5% and will not do anything that might push unemployment higher, unless galloping inflation rears its ugly head. This is unlikely with the amount of excess capacity in the global economy. Once again one needs to look at what central bankers do, not what they say. Europe is just starting to stabilize and Mario Draghi will certainly continue to support the banking system throughout Europe and is clearly aware of the continental unemployment problem, the European Central Bank is nowhere near tightening and the Bank of Japan is still easing.

All of this is good news for investors. The excess liquidity that central banks hope will fuel employment markets will also fuel securities markets and that means one can expect markets to behave reasonably well over the foreseeable future. Bond markets are not excluded from this equation and emerging market fixed income markets are yielding much higher rates than those available in the developed world. Many of these markets depend upon foreign investors to keep them liquid and they can be very volatile, in times of uncertainty, but under the current benign conditions I believe it is a reasonable bet from a risk/reward viewpoint to enter these foreign waters.

As with all investments, timing is everything and the timing is now right for investors to move into this sector. The sector fell in June as investors panicked when the U.S. Fed Chairman indicated that the Fed might start tapering its QE program. However after the weak holders had left the field the funds stabilized and since I believe so strongly that the central banks will hold their ground and not tighten, the June selloff  has presented us with a buying opportunity.

How does one invest in such arcane markets, one might ask. Once again the answer is through ETFs. There are a number of issues and they address different sub sectors. The most popular funds are BRICS funds which as the name suggests include bonds from Brazil, Russia, China, India and South Africa. There are other more broadly based funds that include countries such as Mexico, Turkey, The Philippines among others. Interest rates in these countries are at least 4% higher than in the U.S. or Europe and the credit quality of most of these countries is investment grade, plus the holdings of the larger ETFs are so widely distributed that unless one had a major financial crisis, similar to the Asian crisis in 1995 or the financial meltdown in 2008, one’s investment should weather most isolated storms. I clearly do not see an imminent disaster.

Be careful of what it is you purchase however as some companies will provide a hedged or an unhedged product. My view is that, at the moment, one should take the unhedged product, otherwise the cost of the hedging will offset the carry advantage one obtains through the interest rate differential and all one gains is a risk position in the foreign bond market price moves. Carry, which is the difference in the interest rate earned abroad as opposed to what would be available in Canada, is an important part of this investment and should not be hedged away.—Malcolm Gilroy

Malcolm is a seasoned executive in the financial services industry, having held senior management positions in North America, Europe and Africa including as a technical adviser for Nigeria at the IFC. He’s currently working as a consultant.
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