Playing the global bond market is not for neophytes. But investors who understand the movement of currencies and who keep abreast of political and economic events around the world might want to consider purchasing overseas bonds. Despite the global rise in long-term interest rates, some of them have provided handsome returns this year thanks to the decline in the dollar. And some analysts see further opportunities in the world's battered debt markets. "If you do your homework, you can enhance a portfolio without added risk," says Gary Evans, a senior vice-president at Baring Securities in New York.
That's not so simple, of course. This arena has long been dominated by professionals because it's so difficult to manage currency risk along with the interest-rate and credit risk that go hand in hand with bond investing. Nonetheless, for investors with resources who aren't easily intimidated, getting involved is becoming easier. Many large brokerages and private banks that trade international bonds have minimums of around $100,000 for retail investors. But several firms are now selling smaller quantities of bonds and have dropped the minimum to as low as $5,000 in one case.
SQUEEZE PLAY. The main factor to consider is foreign exchange movements. This year, they have worked in favor of U.S. investors as the dollar has fallen against the yen and major European currencies. If you had bought bonds denominated in those currencies, the gains (13.2% for the yen, 10.7% for the mark, for example) would have more than compensated for the decline in the bonds' price due to rising yields
Granted, this has been an unusual year in the international capital markets. So you wouldn't want to jump into foreign bonds now if you think that the dollar will strengthen. But if you're willing to bet that the dollar will drop further, you might squeeze out some additional currency appreciation. And you will benefit from higher yields. While government bond yields in the U.S. have risen an average of 1.5 percentage points this year, yields shot up 2.2 points in New Zealand and 1.8 points in Switzerland, one reason these bonds are so attractive now, says Edison Lee, an analyst with Friedberg Mercantile Group in Toronto.
Friedberg's U.S. arm in New York (212 943-5300) recently started offering individual investors a choice of 30 foreign bonds, most of which are AAA-rated government issues in major currencies such as marks, Swiss francs, or British pounds, with less than five years to maturity. The firm's analysts choose bonds expected to benefit from currency fluctuations and interest-rate declines. The minimum investment is $5,000, and some bonds can be purchased for under $1,000. The firm will also manage a global bond portfolio for a minimum of $80,000.
Friedberg, like all bond traders, makes its money off the spread between the bid and the asked price. Its spreads--which are close to 1% for less liquid bonds--are sometimes more than institutional buyers would pay for larger quantities of the same bonds. Among other firms that sell choice bonds to individuals, Merrill Lynch dropped its minimum for international bond trades from $50,000 to $25,000 about two years ago, and it now sells some Canadian bonds in lots as small as $10,000.
REAL YIELDS. If you're just getting started buying foreign bonds, you would do well to stick with government debt so you don't have to worry about credit risk. Buy countries with the highest "real yield," which is the nominal yield minus the inflation rate, says Arthur Micheletti, chief economist and investment strategist for Bailard, Biehl & Kaiser. The bond dealer should be able to provide this information. Finally, buy bonds from several countries.
Conventional wisdom still has it that individuals should leave foreign bond buying to the professionals, in part because they hedge to control currency risk. Yet ironically, such strategies prevented many global bond mutual funds from benefiting from the dollar's fall, while they all suffered from rising interest rates. Global bond funds are the worst-performing bond-fund category this year, with a 6.13% decline in average total return through Aug. 19, according to Morningstar Mutual Funds.
Mutual-fund contrarians might see this as an opportune time to buy into
the battered international group. And if you really want to go against the prevailing view, you can try purchasing the bonds yourself.