Looking Abroad for Income? Consider Brazil Bonds

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 |  About: iShares MSCI Brazil Capped ETF (EWZ)
by: Randy Durig

Investors should consider international bonds for the following reasons:

  • The US government politically seems to have less stability by the day.
  • In this low rate environment, people are often seeking higher interest rates.
  • It's current wisdom that through proper diversification you can reduce risk.
  • Many believe the US dollar currency could decline in value due to government spending.
  • Many other international debt issues have preformed far better than both the US government and US corporate debt.

Currently, we recommend that higher net worth individuals take a look at Brazil. Buy or get a quote here for international government and corporate bonds, including Brazil. Investors are often surprised at how easy it can be to buy/invest in foreign government and corporate securities.

Brazil Economy

Brazil, officially known as the Federate Republic of Brazil, is the largest country in South America. It is the fifth largest country by geographical area and the fifth most populous country in the world.

Brazil is the world's eighth largest economy by nominal GDP (gross domestic product) and the ninth in the world by PPP (purchasing power parity). Economic reforms have given the country new international recognition.

Brazil has moderately free markets and an inward-oriented economy. It's GDP surpasses $1.6 trillion, making it the eighth in the world and the second in the Americas (even ahead of Canada) in the World Bank ranking.

Judged by PPP, Brazil earns $1.9 trillion, making it the ninth largest economy in the world and the second largest in the Americas just behind the United States.

Brazil Government Debt

Brazil government bonds receive superb ratings (Aa3/ AAA).

Yield premiums for most nations' debts are in the 8.5% range. For Brazil, government debt is 6% higher than US Treasury debt for the same maturity. This is over three times higher for a comparable AAA rated debt.

The currency issues could, and will, affect future returns. Yet, with America debt exploding and the knowledge of many academic studies claiming to diversify a portion of your portfolio from US currency, risk could actually reduce for US citizens' portfolios that have an over-abundance of their assets in US dollars.

While working with other nations, some debt is more restrictive to US citizens than others, and Brazil has higher restrictions than some.

Brazil government bonds maturing in 2016 are yielding around 8.50-8.75%. Brazil's Real is their underlying currency, which has been recently one of the stronger currencies worldwide.

On March 23, the indication for Brazil government bonds ($250,000 face value, 12.50% coupon, maturing in 2016) was at 117.125 (8.66161 yield) using a spot rate of 1.788. These levels are often fluid and are subject to change (and, have changed), but it allows you to see how much higher Brazil debt compares to other country debt. The Brazil currency, the real, can and will affect the returns. We just can't predict or insure that this currency will cause a positive or negative result.

Brazil Restrictions

  • $250,000 minimum.
  • Must buy in US currency.

Buying in a single country does both increase your investment risk due to currency fluctuation and ownership of foreign debt, knowing that the volatility of each underling security is higher. But, if you properly build a diversified portfolio among several countries, utilizing government and corporate debt plus using the many currencies, the portfolio could actually reduce risk and add significant income.

The following is our belief: United States income investors should protect a portion of their portfolio from the possibility of a devaluing dollar and current political instability. In doing this, they can often attain a much higher income and less overall portfolio risk. Even though, a large negative is that the individual sovereign security, affected by both currency and country economic condition, increases volatility.

You might ask how can it be that more volatile individual securities reduce risk? This is because one would be adding the opposite of a crest and a trough to each other. Thus, in simple terms, they might just cancel out each other. Therefore, their entire portfolio might and often does have less total overall risk.

Currently, it is now our opinion that the future stability of the US dollar is at the highest risk for increased volatility; higher than I've ever seen in my 25-year career. It's due to the twin issues of overall US government increases in spending, that makes a very large corresponding debt even larger, and then add this great increase in political instability that seems to be growing every day. These two titanic shifts will, in my opinion, greatly increase the underling volatility of the dollar and most probably in a negative way.

Brazil on the Positive Side

According to the World Economic Forum, Brazil was the top country in upward evolution in BRIC economies in 2009, gaining eight positions among other countries while overcoming Russia for the first time and partially closing the competition gap with India and China. Important steps taken toward fiscal sustainability since the 1990s, including measures taken to liberalize and open the economy, have significantly boosted the country’s competitive fundamentals allowing for more private-sector development, which is helping to expand it's economy.

Brazil on the Negative Side

Ten Economic Freedoms of Brazil:
54.5 Business Freedom Avg 64.6 45.0 Investment Freedom Avg 49.0
69.2 Trade Freedom Avg. 74.2 50.0 Financial Freedom Avg 48.5
68.4 Fiscal Freedom Avg. 75.4 50.0 Property Rights Avg 43.8
50.3 Government Spending Avg. 65.0 35.0 Fdm. from Corruption Avg 40.5
75.8 Monetary Freedom Avg. 70.6 57.5 Labor Freedom Avg 62.1
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Brazil Statistics & Quick Facts

Population:

  • 192.0 million

GDP (PPP):

  • $2.0 trillion
  • 5.1% growth
  • 4.5% 5-year compound annual growth
  • $10,296 per capita

Unemployment:

  • 7.9%

Inflation (CPI):

  • 5.7%

FDI Inflow:

  • $45.1 billion

Brazil’s economic freedom score is 55.6, making it's economy the 113th freest in the 2010 Index. It's score is 1.1 points lower than last year as a result of declines in investment freedom and labor freedom. Brazil is ranked 21st out of 29 countries in the South and Central America/Caribbean region, and it's overall score is below the regional and world averages.

Conclusion

Brazil's dynamic growth, long term position as a major oil producer and their monetary management appear to tip the scale in favor of their socialistic tendencies; thus, helping the country have a higher degree of growth than most Latin American countries. An over 8% yield, or over 6 times the same comparable maturity in US debt, plus protection against a possible US decline in currency (but, at risk against a rising dollar) in this market appears doubly attractive for US investors.

Disclosure: No positions