This week, we looked to Aa3 rated UBS (NYSE:UBS) Mexican peso denominated bonds, maturing in June of 2015, to achieve a 7% return for our clients that are seeking more income from their investments than the paltry yields found in similar U.S. debt instruments. Guillaume Solomon, a London-based analyst at French banking giant Société Générale (OTCPK:SCGLF), views the Mexican peso as “fundamentally cheap” and well positioned to take advantage of the positive short-term dynamics in the U.S. economy. Given the recently improving outlook for the U.S. economy versus that of Europe, we agree that the outlook in Latin America, particularly in Mexico, is much more favorable than in the eurozone, and it is why we have gone south of the border for This Week’s Best Bond.
Corporate Bond linked to Mexican Peso
UBS AG (Jersey Branch) has 10.25% coupon bonds denominated in the Mexican peso that mature in 42 months and currently have a yield to maturity of about 7%. This debt instrument represents over twice the yield to maturity of similar UBS AG bonds denominated in U.S. dollars, while offering an exposure to Mexico’s economy and the peso. This three and a half year bond offers diversification into a country that has experienced a greater economic rebound than the United States after 2008 and is poised to grow a healthy 3.25% in 2012. While the Mexican peso has a “high sensitivity” to the economic woes of the United States, we believe there are strong fundamentals underpinning for the peso. Mexico’s central bank currently holds significant foreign reserves, amounting to 20 percent of gross domestic product versus foreign reserves totaling 7 percent of GDP in 2008. Public debt levels are in check, and even amid weakened U.S. demand, Mexican manufactured products have gained ground, accounting for 12.4 percent of total U.S. imports versus 11 percent in 2009. So, while the peso has declined over 15% since last July due to storms on various fronts (namely European), we view the higher yield that this bond offers a great opportunity to reduce U.S. dollar devaluation risk by diversify away from an overweighted U.S. dollar based assets.
Wealth Preservation and U.S. Dollar Concerns
Global equity and commodity markets appear content to end the year with no consistent or clear direction, and wealth preservation remains a top priority for many people. Declining equity and property prices, ultra-low interest rates, minimal pay raises, elevated inflation, ineffective politicians, potentially increased taxes, and the Fed’s constant printing of more money in what may be an effort to not only backstop the U.S. economy but also that of Europe, have all precipitated into a widespread erosion of wealth that will likely continue until the aforementioned conditions begin to change.
Headlines last week indicate that European banks are more than eager to accept ECB emergency refinance funding amid continuing liquidity concerns. Flooding the banking system with cheap (fiat) money and is, of course, the central bank’s traditional “fix” to any looming credit crunch. It’s okay if a dose or two from the ECB doesn’t provide enough juice to the European financial system with cheap euros, as there’s evidently a virtual wellspring of U.S. drugs (i.e., cheap dollars) that’s ready, willing and able to backstop the euro. So, the financial system itself is poised to survive. Where certain sovereign political systems, politicians, economies, and their fiat currencies end up look to be another matter. But as long as the global economy survives, what significance is, can be, should be, or will be placed on the cost to any one individual, or nation?
We are continuing with our efforts to protect our clients' assets against the persistent erosion of wealth resulting from inflation rates that remain significantly higher than the extremely low, but “safe,” yields currently available with banksters and in U.S. Treasuries. By scouring the globe in search of sound investments, in the strongest global economies, we strive to offer the best possible high yield instruments that we think offers both a high income stream and the possibility of positively accruing money in spite of broad economic uncertainties.
The economy of Mexico is 13th largest in the world in nominal terms and 11th by purchasing power parity, according to the World Bank, and the United Nations reports that Mexico's standard of living - including health, education and per capita income - is now higher than Russia, China and India. As an export oriented economy in the trillion dollar class, it remains integrally correlated to the U.S. economy because of its prominent role at 80% of exports trading partner. However, Mexico’s last reported debt to GDP ratio stood at 42.7% and the U.S. ratio just passed 100%, while unemployment was about 4.97% compared to 8.6% for the U.S. Inflation rates for Mexico were recently reported at 3.65%, down from over 4% at the end of 2010.
While banking giant HSBC (HBC) announced plans to cut back on retail operations in the U.S. and cut 30,000 jobs worldwide, it said that it instead intends to focus on faster growing emerging markets like Brazil and Mexico, where the company is still hiring. Interestingly, Chinese tourism to Mexico increased 32.8% in 2011, and Japanese automaker Honda (NYSE:HMC) (which already has a plant in El Santo, Jalisco) plans to invest about 312 million dollars to build a new 100,000 vehicles per year capacity car plant near Jalisco. The Mexican Institute of Finance Executives, or IMEF, stated this week that Mexico’s economy will grow 3.25 percent in 2012 even though the economic problems in Europe and the United States remain unresolved.
UBS AG, a financial services firm, provides wealth management, asset management, and investment banking products and services to private, corporate, and institutional clients worldwide. The company is also involved in retail and commercial banking, and is Switzerland's largest bank. Based in Zurich, UBS AG was founded on 29 June 1998 only after the merger of Union Bank of Switzerland and Swiss Bank Corporation, but its many roots go back over 100 years to 1862. UBS AG currently operates in approximately 50 countries, and employs over 65,000 people.
Having achieved a significant reduction in residual risk exposure, UBS AG recently improved their Basel 2 tier 1 ratio to 18.4% and increased its tangible book value 11% quarter on quarter. It’s long term credit ratings are Aa3 at Moody’s, A for S&P, and A for Fitch.
UBS has forecast 2012 as another year of subtrend growth, and believes that there is a longer-term “climate change” in the current economic cycle. For conservative investors, they believe finding safe-haven assets that offer acceptable real returns will be more challenging that it was this past year. UBS's strategy is centered on its strong Global Asset Management business and a focused, less complex and less capital-intensive Investment Bank in Switzerland. Group CEO Sergio Ermotti recently stated that UBS has “chosen to substantially reduce the risk profile of the bank by exiting and downsizing businesses which do not add value to our client franchise or deliver unattractive risk-adjusted returns.”
The default risk is UBS AG’s ability to perform. Given their costs improvements, refocused efforts on building their strong Wealth Management franchise, and solid credit ratings, it is our opinion that the default risk is significantly less than the currency risk of the Mexican peso.
The currency risk could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to Mexico’s economy.
Per capita income in Mexico is roughly one-third that of the U.S., and income distribution remains highly unequal. The current Mexican administration continues to face many economic challenges, including improving the public education system, upgrading infrastructure, modernizing labor laws, and fostering private investment in the energy sector. Because of the dominance of exports to the US, its economy will remain correlated to that of the U.S.
Accessibility and Liquidity
UBS currently maintains over $160 billion of long term debt, in U.S. dollars, euros, Swiss francs and other currencies. Aside from owning various emerging market funds and ETFs that blend together various winners and losers into a mixed yield cocktail, the question arises as to how a retail investor might own or acquire individual, maturity definite UBS Mexican denominated bonds. Many times broker/dealers require an institutional sized single bond purchase. However, with a broker and adviser's assistance, it is possible for a number of retail clients to be combined together in order to make a larger institutional sized purchase. Previously, we have been able to facilitate purchases as low as U.S. $10,000.
The era of dollar devaluation, the indubitable result of relentless injections of “cheap” dollars into the financial markets, appears to be far from being over. Regardless of how opaque the economic “stimulus” reasoning is, or how it is presented to the average American taxpayer as being vital and necessary for our economy, a dependence on the global economy and perhaps the dollar’s dominate position as the reserve currency of the world seems to have precipitated the need for enough of these cheap dollars to stimulate the entire global economy. How many dollars are enough or how long it will take, isn’t defined. However, we believe that diversification into higher yielding corporate debt instruments denominated in various foreign currencies offer a savvy hedge against this abject devaluation of the U.S. dollar.
As a result, it is our opinion that this short term, higher yielding Mexican peso debenture, issued by a sound and well respected financial institution, provides an intelligent alternative to the U.S. dollar’s further devaluation and loss of buying power, which is why we have added it to our Foreign and World Fixed Income holdings.
- Coupon: 10.25%
- BB CUSIP: ED9562536
- Ratings: A1/A-
- Maturity: 6/08/2015
- Price: 110
- YTM: 7.0%
Disclosure: Some Durig Capital clients may currently own these bonds. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.