Opportunity only knocks once. Had I picked up some Italian or Spanish 10-year bonds a year ago when they were yielding 5% I’d be one happy camper today. They now yield closer to 3%, so I’d have a capital gain (bond prices rise as yields drop) and pocketed a nice coupon along the way. (See graph below). But is it too late to get into global bonds? We hear all the time about diversifying portfolios to spread risk and take advantage of opportunities, but is this a good time to do so?
I asked James Dutkiewicz—who manages the global fixed-income mandates at Sentry Investments—this very question. “There’s no magic bullet, Pat,” he replied. “It’s not as attractive as it was a year ago, but isn’t that true of every market?” His point was well made. I could have bought U.S. or Canadian equities and made out like a bandit too.
But the diversification argument still holds. The Canadian bond market, like stocks, is narrow with limited choice. Looking for tech stocks? Good luck. Same with healthcare, gaming and others. Sure, some sectors (energy or finance) still offer choice, but that creates concentration risk.
A narrow mindset also limits opportunity. Some pension mandates restrict investments to North America. In the post-Lehman era, bond players have been excessively risk averse, bidding up issues offering even a modicum of stability. Curiously, this results in a less-than-dynamic market. When uranium firm Cameco faced mine floods a few years ago and again after the Fukushima-Daiichi nuclear disaster, its stock cratered, but the bonds dropped only a buck. As Dutkiewicz remarks, domestic bond investors don’t punish companies the way equity investors do.
The same holds for provincial bonds. Ontario racks up deficits and debt equivalent to the worst offenders in the global financial crisis, but easily sells debt issues into the market.
Dutkiewicz believes there are many ways to slice and dice a risk approach to this asset class. Credit quality, as with any bond investment, is one relatively easily quantifiable parameter. He sees greater risk and opportunity when factoring in currency or liquidity. A year ago, when investors in emerging-market debt were heading to the exits, the liquidity window closed quickly.
The key to success in managing these risks is to maintain strong working relationships around the globe. That provides critical local market knowledge and assures bids when a liquidity crisis looms. It allows access to unique companies and products. There’s an amazing breadth of diversity in emerging and developed markets. Even within a single currency, local knowledge provides answers to questions like duration risk for German versus Irish or French bonds.
Investors might rightly consider an ETF to invest in global bonds. This addresses, at least in part, liquidity. It’s not intuitive, but buying a global bond ETF also requires close monitoring. Do you buy a currency-hedged ETF and forfeit potential gains? Or do you bear potential currency risk by choosing not to hedge?
Global bond mutual funds have higher costs than ETFs, with MERs ranging as high as 3%. Hopefully that gets you a relationship that helps avoid global investing pitfalls while providing decent returns.
For now, James likes Latin America and European financials. He thinks Chinese high-yield instruments have seen their run but is shifting his attention to investment-grade bonds in China. Among sectors he’s looking at global energy issuers. He’s avoiding the ‘Fragile Five’— Turkey, Indonesia, South Africa, Brazil and India. All have seen sharp currency depreciation versus the U.S. dollar and are struggling with rising current account deficits.
James believes there’s still value in some markets if you know where to look. A year ago, everyone was forecasting higher interest rates. They were wrong. When looking at the negative real return of holding cash investors should stay invested. “Everyone would like this to be the fifth inning in the game . . . but even if it’s the eighth it looks like we’re heading for extra innings.”
Opportunity is knocking. Not breaking down the door, but knocking.
Pat Bolland is a veteran financial broadcaster currently with Sun News Network. His Twitter feed is @patbolland.