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International diversification in the fixed income area is important for enhancing the efficient frontier of the balanced and /or fixed income portfolios. Needless to say, two of the important risks worth mentioning in international bond investments are currency and default risks. Currency risk can simplistically be defined as the risk that US dollar moves strongly against the currency. Historically, countries with current account deficits have shown high level of volatilities, as their currencies are very sensitive to short-term movements. In this regard, looking at countries' FX reserves as well as their current account situations could be helpful in understanding their proneness to the currency shocks. Furthermore, recent past performance of the currency could also help understand its next possible direction.

Similarly, in order to have an evaluation for the Default risk, the below table shows the S&P LT Local Debt ratings. Finally, a measure for the local real rate is estimating by subtracting the CPI rate from the Central Bank rate.

The conclusion drawn from the data in the below table can be summarized as :

    • In terms of real yield in local currencies, the most interesting debt markets are those of Brazil, Hungary, China, South Africa and Norway. On the other hand; the yields of US, Germany and Russia seem to be eaten up by the inflationary pressures.
    • Furthermore, in terms of appreciation against USD since January 2009; Norwegian (24.4%); South African (38.09%) and Brazilian (39.18%) currencies have appreciated significantly since 2009. If one believes in mean reversion, these currencies could lose some of these gains in the near future.
    • Poland: While not being particularly strong in any one measure, it has some balanced macroeconomics
    • In sum, the most interesting debt markets for international fixed income investment for a USD based investors are: a) Poland (for Eastern European risk); b) Brazil (for BRICs risk); c) Norway (for commodity based economy and /or European Economic Risk)

Comparative Overview of Some Selected Sovereign Debt Issuers (Data Source: Bloomberg)

Measure

Figures as of March 29, 2001 Intraday

Brazil

Russia

China

Poland

Turkey

South Africa

Hungary

USA

Germany

Norway

Central Bank Rate (2011E)

12.25%

8.50%

6.50%

4.50%

7.00%

6.00%

5.25%

0.25%

1.00%

2.75%

CPI (yoy %) (2011 Estimate)

5.50%

9.05%

4.55%

3.60%

6.30%

4.70%

3.80%

2.30%

2.20%

1.80%

Real Rate (Estimate)

6.75%

-0.55%

1.95%

0.90%

0.70%

1.30%

1.45%

-2.1%

-1.20%

0.95%

Real GDP Growth-2011 Estimates

4.10%

4.35%

9.50%

4.00%

4.55%

3.50%

2.80%

3.10%

2.60%

2.60%

Current Account (% of GDP)-Estimate

-2.80%

3.70%

5.00%

-3.63%

-6.90%

-4.00%

-0.70%

-3.4%

5.30%

13.80%

Change of Local Currency against USD since Jan '09

39.18%

2.80%

4.05%

4.53%

-1.49%

38.09%

-0.21%

0%

0.70%

24.40%

Currency Depreciation Risk vs USD (Subjective Evaluation)

Medium

Low

Low

Medium

High

High

High

N/A

Low

Medium

Unemployment

6.70%

6.90%

4.20%

11.50%

11.25%

24.80%

10.00%

8.80%

7.20%

3.50%

Credit Rating (Local LT Debt Rating by S&P)

BBB+

BBB+

AA-

A

BB+

A

BBB-

AAA

AAA

AAA

Global Reserves ($bn)

316.2

448.8

2,847.3

86.3

85.8

37.3

44.4

48.0

37.3

50.2

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Which International Bond Market Delivers Real Yield ?