Want to Buy Foreign Bonds Directly? Good Luck

Want to Buy Foreign Bonds Directly? Good Luck

  by Jarbes Lima – Economist and ex-financial analyst of Banco do Brasil

The yields on debt issued by governments overseas trump what you can get from U.S. debt. But you need to be a millionaire to tap that market.

I often advocate buying individual bonds rather than mutual funds. Assembling your own portfolio of bonds is easy to do, especially if you're dealing with relatively simple and safe bonds (that rules out junk bonds, some mortgage securities and other esoteric debt instruments).

If you buy bonds directly, you know you'll get your principal back when an issue matures, assuming the borrower of your money doesn't go bust. You'll save on management fees, and you won't have to worry about some fund manager misusing derivatives. It's easy to buy government bonds through Treasury Direct, and you can buy municipal and corporate bonds through such brokerages as Fidelity and Charles Schwab.

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Lately I've received several inquiries about buying individual foreign bonds. That's not entirely surprising because foreign government debt has done far better this year than U.S. Treasury bonds, which have performed terribly. Clearly, many investors think this may be a good time to replace Treasuries with bonds from such prosperous nations as Australia or Japan, or just about any nation in Western Europe.

That's a fine idea -- if you happen to be a millionaire or a professional fund manager. Here's the background:

So far this year, bonds from most developed nations have produced positive returns -- some as high as 8%, according to FTSE Global Bond Indexes. Most foreign currencies have appreciated or stayed stable against the dollar, so currency translation has been either a positive or not meaningful with regard to returns of foreign debt.

Bonds from emerging nations, which took a beating last year as fears rose that some nations might default on their debt during the financial crisis, have rebounded with a vengeance. According to Morningstar, the average developing-markets bond fund has gained 23% so far this year. In either case, foreign bonds shine compared with U.S. debt: The benchmark ten-year Treasury has lost more than 10% on a total-return basis.

Meanwhile, most foreign governments are paying more than Uncle Sam does. In the first week of August, for example, Australia's ten-year government bonds yielded 5.7%. Brazil recently sold new government bonds due in 2037 at a yield of 6.5%. The ten-year Treasury yields 3.7%.

As evidence that the recession is over continues to mount, concerns are growing that U.S. bond yields will continue their recent ascent. Because bond prices move inversely with yields, that would mean further declines in Treasury prices. That prospect is reason enough to go light on long-term Treasuries until their yields surpass 4%, or perhaps even 4.5%.

You can get 6% or better in high-grade U.S. corporate bonds or bonds issued in dollars by a foreign company. But even a global issuer with the stature of an AstraZeneca or a Deutsche Bank can't manufacture money. A government can. Moody's says that global economies have slowly started to heal and that it sees signs of stabilization among "sovereign issuers" that it had feared might default during the financial crisis.

I have  friends at Fidelity and Schwab, so I went researching for Brazilian and Aussie bonds. I found that you cannot find listings for such bonds on the brokerages' Web sites. However, if you're a customer, you can speak to a trader who specializes in foreign debt. But there's this catch: Schwab requires you to buy bonds worth a minimum of 100,000 units of the relevant currency. So, if you're buying a bond from the euro zone, you have to buy 100,000 euros' worth (roughly $140,000). If you're buying Brazilian debt, you need to buy at least 100,000 reais' worth ($55,000).

The Fidelity rep told me I'd have to order $100,000 worth of bonds, at a minimum, "and then we'll try to go get 'em; there's no guarantee." His explanation: Demand is low, and the spread between bid and asked price would be too wide on an order smaller than that. I wasn't joking about being a millionaire.

A big problem is that the New York Stock Exchange doesn't list foreign government bonds. Some nations' official Web sites -- look at the Irish Treasury site -- name local brokerages that sell government bonds. But then you'll face all kinds of fees and commissions, plus the tax hassles of investing via an offshore account.

EverBank, a St. Louis company known for FDIC-insured certificates of deposit denominated in foreign currencies, has a brokerage arm that offers foreign bonds. The minimum account is $20,000; however, the selection is limited. On December an Everbank rep could offer just two bonds from Australia and Brazil. One was a three-year Brazilian issue from a Dutch-owned bank that's classified triple-A by several bond raters. The current yield of 9.25% was tempting, but the bond didn't offer government backing. The other security was a five-year Australian government bond, priced to yield 5.5%. Obviously, EverBank doesn't want to keep too much inventory for its own accounts. Can't say I necessarily blame it.

Fidelity's bond guy suggested that I take a look at exchange-traded funds. For example, iShares JPMorgan USD Emerging Markets Bond Fund (symbol EMB) contains, as its name suggests, bonds from places such as Brazil, Russia and Turkey. Its expenses, at 0.60%, are low. But the current yield, based on the latest monthly distribution, is only 5.5%, which diminishes the fund's appeal considerably.

The iShares S&P Citigroup International Treasury Bond Fund (IGOV) has low expenses of 0.35%, but it hews to an index that forces it to include Japanese, German and other low-yielding bonds. The fund is so new that we don't yet know its yield, but it will be tiny. It may be a nice tool for diversification, but as an income investment, it's mediocre.

And besides, the point of this column is to get away from funds. Perhaps one day all of the world's electronic-securities markets will unite. Then the borders between our insular bond market and everyone else's will disappear. But that's not the case today.

·         Got a question? E-mail me directly at jarbes@usa.com. Want to be heard? Leave a reader comment below.