This week we look at medium term, A- rated investment grade, Morgan Stanley debt denominated in Brazilian Real and its 10.85% yields to quench the thirst of those needing or seeking higher fixed income returns without the need to throw caution to the wind.
Corporate Bond linked to the Brazilian Real
Morgan Stanley (MS) has issued debt, denominated in the Brazilian real, which currently has a yield of about 10.75% for 62 months. The very high yield of this five year Brazil bond, when considered with its solid "A-" rating and favorable positioning within the U.S. financial system, offers an extremely favorable reward to relatively low risk position. As the European debt crisis continues to slowly work towards a resolution, the dollar's longer term weakening trend against many of the world currencies also appears to be returning, and it remains a major concern for investors seeking protection against its devaluation and the continued erosion of its buying power. In our ongoing effort to address the concerns of our clients in protecting their existing wealth from the destruction caused by the persistent devaluation of the dollar, we believe this short to medium term Morgan Stanley Brazil bond represents this week's best opportunity to add the higher yields of one the world's best emerging economies to our Foreign and World Fixed Income holdings at a reasonable exchange rate.
Wealth Preservation Concerns
Wealth preservation continues to be one of the biggest concerns among our clients. In other words, the focus for many people is not necessarily towards making more money, but to preserve the wealth they have already accumulated by taking what we call "intelligent risks" to achieve reasonable returns that can simply outpace moderately rising inflation. With U.S. Five Year treasury yields stuck below 1%, the Ten Year below 2%, and with energy commodities (up over 6% year over year) threatening to push the CPI average back over 3% (the food index already at 4.4%), a certain degree of wealth destruction is virtually assured within these otherwise commonly considered "safe" U.S. government notes.
Giving additional credence to Sam Zell's warning last year that Americans should brace for a disastrous 25 percent decline in the standard of living should the U.S. dollar's reign as the global reserve currency ever end, the Wall Street Journal reported last summer that the Congressional Budget Office "anticipates that the trade-weighted exchange value of the U.S. dollar will decline at a moderate pace over the next 10 years". It should be noted that already there are major efforts underway to further undermine the need for U.S. dollars (or for any other currency) to be the "global reserve currency." Last October, the first gold contracts denominated in the Chinese Renminbi (also known informally as "yuan") came to the Hong Kong market. A month later, China and Russia decided to renounce the U.S. dollar and resort to using their own currencies for bilateral trade. In December, China and Japan agreed to take steps to facilitate the yen-yuan currency exchange, and just last month India agreed to pay Iran in gold for oil in a move to switch away from the dollar in bilateral trade.
Regardless of whether it's the result of new and greater or simply buffed and retreaded austerity pledges, the flight to safety evoked by the every evolving European debt crisis, which recently strengthened the U.S. dollar, appears to have reached either a state of callous indifference or a state of "dry heaves" where just nothing much of value moves. Consequently, the dollar appears to be happy to returning to its longer term decline relative to most other major global currencies, perhaps including even the euro.
We are continuing in the effort to protect our client's assets against the persistent destruction associated with an ever increasing supply of U.S. dollars by scouring the globe in search of sound investments in a basket of the strongest global currencies, and it is why we have chosen Morgan Stanley's very high yield, medium term Brazil bond as This Week's Best Bond.
By far the largest and most populous country in South America, Brazil continues to pursue industrial and agricultural growth and development of its interior. Exploiting vast natural resources and a large labor pool, it has large and well-developed agricultural, mining, manufacturing, and service sectors. It is the world's largest producer of coffee, sugar and orange juice and the second-largest exporter of iron-ore and soybeans. Brazil's offshore oil fields have turned it into a net crude exporter, helping it expand its presence in world markets, and its economy outweighs that of all other South American countries. Currently, Brazil is the world's 11th largest oil producer.
Brazil's economy slowed sharply last year, but remained among the world's best at near 3%. Despite concern about the impact of slower Chinese growth, Brazil recently moved up to be the world's sixth-largest economy and is expected to continue growing about 3 1/2 percent in 2012. This fundamentally solid economic growth underscores the importance of emerging markets, if it should even still be regarded as emerging, as the developed world continues to struggle with a sluggish rebound from the global economic slowdown and the European debt crisis.
Despite continued price pressures in Latin America's largest economy, the Brazilian Central Bank suddenly shifted course late last year to cut interest rates because of concerns about global economic growth. Given that the inflation rate in Brazil has slowed to below 6% and is projected to pace closer to 5 ¼% for 2012, the rate cut appears warranted. The government's official inflation target remains around 4.5%.
Stanford University has rated the Brazilian economy number #10 on its global Sovereign Fiscal Responsibility Index, a placement significantly above #28 ranked (out of 34) United States.
About Morgan Stanley
After the Glass-Steagall Act of 1933 which separated commercial banking from securities underwriting, Morgan Stanley opened for business after separating from J.P. Morgan. When the global financial crisis of 2008 brought down rivals Bears Sterns and Lehman Brothers, Morgan Stanley secured a $9 Billion capital investment from Mitsubishi UFJ (MUFG.) The firm also helped the U.S. Treasury navigate the crisis at mortgage providers Fannie Mae and Freddie Mac. In 2009, James Gorman helped create the largest wealth management platform in the world when he led the merger and integration of Morgan Stanley's retail brokerage operations and Citibank's Smith Barney brokerage unit. The wealth management platform is a very good annuitized income, lower risk business. The Morgan Stanley Smith Barney joint venture is now a global leader with more than 18,000 financial advisors and $ 1.5 trillion in client assets.
Morgan Stanley delivered strong full year results, reporting fourth quarter net revenues at $5.7 Billion and full year net revenues for 2011 at $32.4 Billion. The Global Wealth Management Group delivered net revenues of $13.4 billion, with global fee-based asset flows of $42.5 billion and net new assets of $35.8 billion, the highest for both since the inception of the Morgan Stanley Smith Barney joint venture (MSSB). The year's pre-tax margin improved to 10% from 9% a year ago. Asset Management reported net revenues of $1.9 billion, with assets under management or supervision of $287 billion and positive net flows of $25.8 billion. In strategic actions that further strengthen Morgan Stanley's capital and liquidity, their Series B Preferred Stock held by MUFG was converted into common stock, and several outstanding strategic and legacy issues were resolved, including a settlement with MBIA.
5 Year Bond Yield
|US Treasury||US Dollar|
|Morgan Stanley||US Dollar|
A-, A2, A
|Morgan Stanley||Brazilian Real|
A-, A2, A
This Morgan Stanley Brazil bond indicates a yield pickup of about 10% when compared to similar maturity U.S. Treasuries, and a yield that is well over double that of similar Morgan Stanley bonds denominated in U.S. dollars. Even if the Congressional Budget office is wrong and we have strong appreciation in the dollar, as long as the currency appreciation averages less than 6% annually relative to the Real, this bond would still outperform its U.S. dollar counterpart. However, if the CBO is correct, and should the U.S. currency decline instead of gain that same 6% annually, that much appreciation of the Real would likely result in a better than 16.85% annual return.
The default risk is Morgan Stanley's ability to perform. Given last year's great results, their improved balance sheet, and the positive outlook for Morgan Stanley, it is our opinion that the default risk for this short term bond is minimal relative to the currency risk of the Brazilian real.
The currency risk of the Brazilian real could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to the Brazilian economy.
Accessibility and Liquidity
Morgan Stanley currently has over $415 billion of outstanding debt, mainly denominated in U.S. dollars. 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 Morgan Stanley Brazilian real linked notes. Many times broker/dealers require an institutional sized single bond purchase. However, with a broker and advisor'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.
We hope NOT to see any further destruction of wealth resulting from a constant decline in the U.S. dollar relative other global currencies as forecast by the Congressional Budget Office, and we acknowledge that a strengthening of the U.S. dollar would directly reduce the total returns of this Brazilian real denominated bond. On the other hand, should the U.S. dollar continue on the long term path of devaluation that it has been on, this alone could add quite significantly to the already highly positive accruing returns of this bond, not to mention the possible stellar returns that would result should the U.S. dollar ever loose its domineering status as the world's reserve currency and collapse against a basket of other stronger currencies.
Considering Brazil's prominent position as the leading emerging market economy, stable political system, and solid growth prospects in spite of broader global slowdowns, we view the gaining of over twice the yield as an incredibly compelling reason for choosing Morgan Stanley's Brazilian real bond over their similar U.S. dollar bond. The combination of a remarkably high yield, a protection against the further loss of wealth that would result should the U.S. dollar continue to weaken against the real, and a diversification away from heavily overweighted U.S. dollar based assets into one of the world's top emerging markets is why we have chosen to add this 62 month Morgan Stanly bond linked to the Brazilian Real to our Foreign and World Fixed Income holdings.
Yield to Maturity: 10.857%
Disclosure: Some Durig Capital clients currently own these bonds. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.