4 Ways to Protect Your Capital (Think Debt and Bond ETFs)

In late 2007 when I starting writing about dividend investing I had two primary motives in mind: 1. Put myself in a position where there is some public accountability. 2. Interact with knowledgeable investors and expose myself to new ideas. In response to a recent post “How Much Money Will You Need For Retirement?“, two readers introduced me to a concept that hadn’t considered up to that point.

First, some background. As a result of massive and growing deficits in The United States and our willingness to print enormous sums money meet our increasing obligations, many have called for the collapse of the U.S. dollar. Tim Hanson in a recent article quoted the following:

• Swiss banker Dr. Konrad Hummler wrote “It’s time to take advantage of the recovery of the U.S. dollar to get one’s currency diversification in order.” (i.e. get out of dollars)

• Warren Buffett wrote in the NY Times “Fiscally, we are in uncharted territory” and concluded that “Unchecked greenback emissions will certainly cause the purchasing power of currency to melt. The dollar’s destiny lies with Congress.”

• Bill Gross of Pacific Investment Management Co. (PIMCO), which manages the biggest bond fund in the world, advises investors to sell dollar investments ‘before the central banks and sovereign wealth funds do’.

• Commodities specialist Jim Rogers announces his new favorite currency — the Chinese yuan.

I have long recognized the importance of holding international investments. In addition, to international funds held outside my income portfolio, I hold individual dividend stocks with large global presences such as: The Coca-Cola Company (KO) – Analysis, Johnson & Johnson (JNJ) – Analysis, The Procter & Gamble Company (PG) – Analysis, McDonald’s Corporation (MCD) – Analysis and Wal-Mart Stores, Inc. (WMT) – Analysis.

However, when it comes to debt I am 100% invested in U.S. debt funds. In response to the article referenced in the opening paragraph, two readers who read it on Seeking Alpha left some intriguing comments as follows in part:

Mad Hedge Fund Trader said “A number of readers have asked me to come up with a safe, high yielding investment in which to hide out in case the equity markets swoon again. That means they are looking for a security that offers a high fixed return, denominated in a strong currency that will benefit from future upgrades that will boost the principal over time. All of that is another name for the Invesco PowerShares Emerging Market Sovereign Debt ETF (PCY). The fund [...] pays a handy 6.42% dividend. This beats the daylights out of the nine basis points you currently earn for cash, the 3.40% yield on 10 year Treasuries, and still exceeds the 6.42% dividend on the iShares Investment Grade Bond ETN (LQD), which buys predominantly single “A” US corporates. The big difference here is that foreign bonds are issued in strong foreign currencies instead of weak dollars, and have a rosy future of further credit upgrades to look forward to.

Old Trader added “TEI and GIM are a couple of other foreign debt funds to consider. Templeton Emerging Markets Income Fund (TEI) is primarily emerging markets, Templeton Global Income Fund (GIM) is global sovereign…both are run by Templeton. “

You can read their full comments and others here.

Up to this point I had assumed that non-U.S. debt would have the same variability as non-U.S. dividends, which I deemed as unacceptable for my income portfolio. I ran some quick numbers on PCY’s dividend comparing it to LQD. Surprisingly, its standard deviation from 11/07 to 9/09 was 0.01489 compared to 0.02817 for LQD over the same period (Yahoo data + iShares to fill in some LQD blanks). LQD is one of my core bond holdings, but it is quickly approaching full allocation, so I’ve been looking for some other alternatives. A higher yield and lower standard deviation on its dividend makes PCY worth looking into. I also plan to spend some time looking at TEI and GIM.

Full Disclosure: Long KO, JNJ, PG, MCD, WMT, LQD. See a list of all my income holdings here.

Comments

[buyitcheap:]

If we are truly deflationary, wouldn't owning zeroes, possibly municipal issues, make a lot of sense?

Oct 01 08:16 AM

[Windwood Tr...:]

We may be deflationary but the fact that the $US printing presses are going full bore shows me that an investment in comparatively stable foreign debt will be basically a USD short with good income to boot.


On Oct 01 08:16 AM buyitcheap wrote:

> If we are truly deflationary, wouldn't owning zeroes, possibly municipal
> issues, make a lot of sense?

Oct 01 10:01 AM

[TLassen:]

"Swiss banker Dr. Konrad Hummler wrote “It’s time to take advantage of the recovery of the U.S. dollar to get one’s currency diversification in order.” (i.e. get out of dollars)"

Correct me if I am wrong but I believe Mr Hummler actually expressed the following in his speech.:

"Wegelin & Co., Switzerland’s oldest bank, is telling wealthy clients to sell their U.S. assets, or switch banks, because of concerns new rules will saddle investors with tax obligations in the world’s biggest economy. U.S. proposals to extend reporting requirements for banks whose clients buy American stocks and bonds coupled with estate tax liabilities that may be inherited by the heirs of people who have such holdings prompted the advice from the St. Gallen, Switzerland-based bank, said Managing Partner Konrad Hummler"

in regards to 'getting out of the dollar" (that's all relative to where you live) As a Canadian resident it is in my interest to buy the US dollar now in anticipation of an USD recovery. Most of my new US equity purchases will be hedged. As the US economy improves (and it will, never bet against the US!) it will mean an increase in the USD relative to our currency and provide maybe as much 10-20 % hedge in equity values.

Oct 01 12:39 PM

[market mojo:]

Regarding PCY. Here is part of its profile from Yahoo.

"The fund normally invests at least 80% of total assets in emerging markets U.S. dollar-denominated government bonds."

Doesn't this mean that the fund is 80% dollar correlated? If so it doesn't seem to be a good fund for dollar diversification.

Oct 01 03:56 PM

[Old Trader:]

Dividends,

Thanks for the acknowledgement! I've owned GIM for a number of years, and my initial reason for buying it (aside from a monthly dividend) was because I felt the dollar was in a long term downtrend (a fact which doesn't seem to have changed any), and the purchase was basically a currency hedge.

TEI is a much more recent addition, and my thinking there was a) an additional "short" on the dollar, and b) taking advantage of the fact that I think emerging markets will outperform the developed ones, at least in the mid-term, while avoiding (hopefully) some of the volatility of holding emerging market equities.

Oct 01 06:09 PM

[Dollar Pimp:]

It's true you need to be careful with emerging market bond funds since most EM bonds are denominated in dollars. Sometimes it takes a bit of digging to find out exactly what your currency exposure is. For instance GIM, which is also mentioned here, is about 40% exposed to the dollar, which makes it more dollar neutral than a bearish dollar play. I like the FEO closed end fund; it's 50% exposed to the dollar (again dollar neutral) and invests in both EM bonds and stocks.


On Oct 01 03:56 PM market mojo wrote:

> Regarding PCY. Here is part of its profile from Yahoo.
>
> "The fund normally invests at least 80% of total assets in emerging
> markets U.S. dollar-denominated government bonds."
>
> Doesn't this mean that the fund is 80% dollar correlated? If so it
> doesn't seem to be a good fund for dollar diversification.

Oct 01 07:06 PM

[Old Trader:]

mojo,

That would be my take as well. Usually, its pretty easy to learn if any fund investing in foreign securities of any type is hedged, currency-wise, and if so, to what extent. Of course, if one is buying into a foreign equity fund, the option of buying "US dollar denominated" assets isn't available.


On Oct 01 03:56 PM market mojo wrote:

> Regarding PCY. Here is part of its profile from Yahoo.
>
> "The fund normally invests at least 80% of total assets in emerging
> markets U.S. dollar-denominated government bonds."
>
> Doesn't this mean that the fund is 80% dollar correlated? If so it
> doesn't seem to be a good fund for dollar diversification.

Oct 01 08:52 PM

[biomedlives:]

Note that, unlike many closed end income funds, GIM does not use leverage.

Oct 01 09:39 PM

[Bob Mayo:]

Ugg. PCY and EMB are in dollars. GIM and TIE are more than two thirds in dollars or euros. CEW is the only thing I can find denominated in a variety of emerging market currencies, but it is a currency fund not a bond fund.

Templeton and Merk also have hard currency funds, but with >1% expenses.

Anybody have suggestions for emerging market bond funds in local currency?

Oct 01 10:36 PM

[Dollar Pimp:]

I think Pimco offers an EM bond mutual fund denominated in EM currencies - Emerging Market Local Bond?


On Oct 01 10:36 PM Bob Mayo wrote:

> Ugg. PCY and EMB are in dollars. GIM and TIE are more than two thirds
> in dollars or euros. CEW is the only thing I can find denominated
> in a variety of emerging market currencies, but it is a currency
> fund not a bond fund.
>
> Templeton and Merk also have hard currency funds, but with >1% expenses.
>
>
> Anybody have suggestions for emerging market bond funds in local
> currency?

Oct 02 05:58 PM

[bynd2009:]

Based on its current price (around $9.30), GIM is paying 5.4% dividend, a monthly payment of 0.042/share. Before investing in it, make sure you have the risk tolerance! It lost close to 40% of share value when all the markets crashed Sept08-Mar09 but has nicely recovered since then. May be a good idea to buy etfs like FXE and CYB (it is an etf for Chinese Yuan but also an apt acronym for covering the behind!!)

Oct 03 11:56 PM