Global Investing

GUEST BLOG: Is Your Global Bond Fund Riskier than You Thought?

This is a guest post from Douglas J. Peebles, Head of Fixed Income at AllianceBernstein. The piece reflects his own opinion and is not endorsed by Reuters. The views expressed  do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.


Global bond funds continue to attract strong inflows as near-zero interest rates lead many investors to look abroad for assets with attractive yields. As we’ve argued before, global bonds provide many important benefits, but it’s crucial that investors select the right type of fund.

Not all global bond funds are cut from the same cloth. One key consideration that investors often overlook is the extent to which the fund elects to hedge its currency exposure. When a domestic currency depreciates – as it did for US-dollar–based investors during most of the period between 2002 and 2008 – foreign currency exposure can help boost returns from holding global bonds.

This is fine while the good times last. But it’s important to understand that currencies are extremely volatile – much more so than bonds – and adverse movements in currencies can quickly swamp the income and price gains generated from holding global bonds. As such, for investors looking at their global bond allocations as a hedge for their equity risk, choosing not to hedge against currency swings could have disastrous results.

Take 2008, for example.  That year, bonds rallied strongly across the developed world, providing valuable diversification for investors smarting from heavy losses in their equity portfolios…if investors were hedging the currency exposure in their global bond allocations. Those who didn’t got a lot more volatility than they had bargained for, and—depending on their base currency—may have been faced with significant losses in their bond portfolios as well as in their stock portfolios.

Certain danger: Extreme investing in Africa

The Arab Spring, for all its democratic and political virtues,  put a big economic dent in the side of participating North African countries, particularly when it came to attracting foreign investment in 2011.

According to a recent UNCTAD report:

Sub-Saharan Africa drew FDI not only to its natural resources, but also to its emerging consumer markets as the growth outlook remained positive. Political uncertainty in North Africa deterred investment in that region.

So far, so logical. Except that simply can’t be all there is to it.

Why? Because plenty of African countries marred by political uncertainty have succeeded in attracting inward FDI.

In Brazil, rate cuts but no economic recovery

Brazil’s central bank meets today and almost certainly will announce another half point cut in interest rates, the eighth consecutive reduction since last August. But so far there is little sign that its rate-cutting spree – the longest and most aggressive  in the developing world – is having much success in resuscitating the economy.

HSBC’s closely watched emerging markets index (EMI), released this week, shows Brazil as one of the weak links in the EM growth picture,  with sharp declines in manufacturing and export orders in the second quarter.

The government is expected to soon revise down its 4.5 percent growth projection for 2012; the central bank has already done so.  Industrial output is down, and automobile production has slumped 9 percent in the first half of 2012. Nor  it seems are record low interest rates encouraging the middle classes to take on more debt — the number of Brazilians seeking new credit fell 7.4 percent in the first half of this year, the biggest fall on record, according to credit research firm Seresa Experian.

Investors hungover after wine binge

During this depression, it would appear that investors are no longer finding solace in turning to the bottle.

Fine wines are being hit hard by the global downturn, with the Liv-ex Fine Wine 100 index down 7.4 percent on the year, according to July’s Cellar Watch Market Report.

The Liv-ex Bordeaux 500 was down by 3.4 percent month-on-month - an especially disappointing showing given that the market is usually energised in June by new Bordeaux releases.

Lipper: Getting serious about giving

“Wouldn’t you rather your donations achieve a lot rather than a little? Then you’ll need to get serious and proactive. If you do it wrong, you can easily waste your entire donation.”

Caroline Fiennes is not one to pull her punches when talking about charitable giving, but the more I talk to her, or read her new book – ‘It Ain’t What You Give It’s The Way That You Give It’ – the more it becomes apparent that her philosophy is not all that different from that of a professional fund manager.

No self-respecting fund manager would invest in a company just because they were asked to. A fund manager will choose to invest (or disinvest) because they believe it will help their fund perform well and that the investment fits within their investment objectives. Fiennes, who advises companies and individuals on their giving, advocates a similar approach for any donor: be clear about your objective and find organisations that have done a good job of achieving this, not just the ones that market themselves well.

Next week: Call and response?

The Greek vote next Sunday now stands front and centre of pretty much all investment thinking, but the problem is that it may still be days and weeks before we get a true picture of what’s happened, whether a government can be formed and what their stance will be. If the new parliament cannot clearly back the existing bailout, even after a bout of  horse-trading, then a game of chicken with Europe ensues.  Eurogroup meets again on Thursday and there’s a German/French/Italy/Spain summit on Friday.  But G20 leaders gather in Mexico as all this is unfolding, so they will certainly be quorate if some sort of global response is required to any initial market shock. What’s more, the FOMC is meeting Tuesday and Wednesday should Bernanke feel the US needs urgent insulation from the fallout regardless of broader action. But it’s certainly not beyond the bounds of reason that coordinated central bank action materializes next week if markets do indeed go skewways after the Greek poll. They have all clearly been consulting on the issue lately via telephone and bilaterals. And the assumption of more QE is there among investors. Three quarters of the 260+ funds polled by BoAMerrill Lynch this month expect another ECB LTRO by the end of Q3 and almost a half expecting more Fed QE over the same time.

And maybe it is this assumption of massive policy response that’s preventing markets capitulating outright. Money is gradually going to ground, but it’s not yet thrown in the towel completely as you can see from major equity indices, volatility gauges and interbank spreads etc. And there are a lot of headwinds everywhere over the next six months, the US election, fiscal cliff, end of operation twist stateside – and that’s in one of the few major western economies that was generating any significant growth this year. In other words, there are no shortage of arguments for another monetary boost. A heavy econ data slate during the week will also reveal just how much the world economy has run into sand this quarter. The standouts are the flash PMIs for June, the US Philly Fed index for June and UK jobs and inflation numbers.

As to the lack of response to last weekend’s Spanish bank bailout, it was weird in many ways that anyone really expected a major rally on this just six days ahead of a Greek vote which could throw the whole bloc into chaos.  Even if you thought the Spanish bailout was good, and it was certainly a necessary if not sufficient step, you would still not return to Spanish debt until the next couple of weeks of events had cleared. So, in that respect, it’s unlikely the market made any real judgement on it either way. The subsequent credit rating cuts from Moody’s have not helped and yields have spiked to the 7% level flashing red lights. But it’s hard to see how any exposed frontline euro market, from Spain to Italy and Ireland to Portugal, can really stabilise ahead of the weekend.  One fear on the Spanish rescue was of private investors’ subordination to EU/IMF creditors in any workout of Spanish debt. But even that too may have been overstated when it comes to the sovereign. For a start, the interest rate charged on the funds means a massive saving for Madrid compared with prevailing market rates and, as Barclays argued, actually increases the overall pie available for any workout, with a possible increase in projected recovery rates compared with the pre-bailout setup.  If that was the big concern, then the subsequent rise in Spanish yields most likely is more Greek than Spanish in origin.

The ETF ‘Death List’

Our colleagues at Lipper have put together some eye-catching data on developments in the ETF industry. You can read the slides here.

Most intriguing is the idea of a slumbering cohort of 241 exchange-traded funds forming what Lipper calls a ‘Death List’; ETFs which are more than three years old, but which have failed to drive assets up to the 100 million euro-mark.

Detlef Glow, Lipper’s head of Research for EMEA, notes these funds might well be thought to be under review by their promoters, but he hasn’t spotted any particular trend towards consolidation. Why?

Investors face a battle for clarity

How are we looking? Fluid, very fluid!

In a classic case of call and response, the latest twist of the euro saga has seen the crisis escalate sharply in Spain and Italy (with the attempted cleanup of Bankia the latest trigger for a surge in government borrowing rates in both) only to see the European Commission today invoke major policy responses including the proposed use of the new European Stability Mechanism (ESM) to directly recapitalize euro banks, a single banking union, a euro-wide deposit protection system and even pushing back Spanish budget deadlines by a year.

It seems clear from this that they see Spain and Italy – which seem to be trading in tandem regardless of their differences – as the battleground for the survival of the euro. The gauntlet is down for next month’s summit, though the absence of a roadmap to Eurobonds per se will disappoint and markets are not going to sit quietly for a month. Moreover, the Grexit vigil has another fortnight to run before any clarity and the latest polls are not going in the direction other euro governments had hoped, with anti-bailout parties still in the lead. And we can only assume Ireland votes in favour of the now notional fiscal pact tomorrow as per opinion polls, though there’s always an outside chance of an upset.

So, seeing ahead even a month seems like an impossible task. A week ahead, however, points the spotlight firmly at the ECBs meeting on Wednesday and the chance the central bank eases again in some form to try and buy time for other developments to work through. But it will also be a moment of potential conflict, with its role in the Spanish bank bailout fraught with disagreements to date. Despite a two-day London market holiday, the week will be dominated by central banks at large – the BoE meeting and Bernanke’s testimony on Thursday being the other highlights. Is there a chance they act together again? And Italian/Spanish/French bond auctions next week certainly look precarious in the current environment.

Where will the FDI flow?

For years the four mighty BRIC nations have grabbed increasing shares of world investment flows. But the coming years may not be so kind.  These countries bring up the bottom of the Economic Freedom Index (EFI) for 2012. Compiled by Washington D.C.-based think-tank The Heritage Foundation the EFI measures 10 freedoms —  from property rights to entrepreneurship – and according to a note out today from RBS economists, there is a strong positive link between a country’s EFI score and the amount of FDI (foreign direct investment) it can secure. So the more “free” a country, the more FDI inflows it can expect to receive — that’s what an RBS analysis of 2002-2008 investment flows shows.

So back to the BRICs. Or BRICS if you add in South Africa (part of the political grouping though not yet included in the BRIC investment concept used by fund managers). The following graphic shows Russia languishing at the bottom of the EFI, China just above Russia and India third from bottom.  Brazil is sixth from bottom while South Africa ranks two places higher.

At the other end of the spectrum is tiny Singapore. Its EFI score is double that of Russia and between 2002-2008 it attracted FDI equivalent to 50 percent of its economy. Russia in contrast saw negative net FDI (outflows exceeded inflows)

Research Radar: Very 20th century

Wednesday’s market commentaries are loaded with the buzz around another technical UK recession in Q1 (the first time Britain has suffered what many see as a ‘double-dip’ since the 1970s); guessing about Wednesday’s FOMC outcome; and the European Commission letting Hungary off the hook about its controversial constitutional changes. In aggregate, and probably due to the looming FOMC,  markets are fairly stable – world equities, including euro stocks, emerging markets and even Britain’s FTSE are all higher. The US dollar, Treasuries,  volatility gauges, gold and even peripheral euro government bond yields are all down a bit.

Following is a selection of some of Wednesday’s interesting research ideas:

- Barclays’ Barry Knapp reckons US and world equities face a dilemma from the endless distortion to multiples and risk premia from monetary intervention and QE that is artifically lowering the risk-free rate akin to the “financial repression” of the 1950s — no one is sure now if equity is cheap or bonds just very expensive. He concludes that best thing for equities in the medium to long term is to avoid further QE but the problem is that stocks will almost certainly suffer in the short run if the Fed takes QE3 off the table. What’s more, Wednesday’s FOMC could be problem for markets initally if the Fed frets about the growth outlook, but a worsening of the economy might bring QE3 sooner than similar bouts in 2010 and 2011.