We have identified a five year new issue Morgan Stanley (MS) "step up" bond linked to Russia that will yield 9.25 the first two years, 9.50 the next two, and 9.75 the last year (averaging 9.43% to maturity.) The high yield and medium length maturity of this ruble bond, when considered with its solid A-/A rating, compares very favorably with other high yielding instruments in our Foreign and World Fixed Income holdings. We believe the dollar's longer term weakening trend against many world currencies remains a major concern for investors seeking protection against its devaluation and a further erosion of its buying power, and we view this as an opportune time to diversify into the Russian economy, which continues to show remarkably good growth potential in spite of the recent financial turmoil.
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 near 1%, the Ten Year hovering around 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.
Here at Durig Capital, 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 this superior yielding Morgan Stanley Russian ruble issue as This Week's Best Bond.
Russia has undergone significant changes since the collapse of the Soviet Union, moving from a globally-isolated, centrally-planned economy to a more market-based and globally-integrated economy. Economic reforms in the 1990s privatized most industries, with notable exceptions in the energy and defense-related sectors. The Russian export industry consists primarily of natural gas to the eurozone, is the world's second largest exporter of oil, and is the third largest exporter of steel and primary aluminum. This reliance on commodity exports makes Russia vulnerable to boom and bust cycles following the highly volatile swings in global commodity prices, and provides reason for the higher correlation of its currency to oil prices.
The economy had averaged 7% growth since the 1998 Russian financial crisis, resulting in a doubling of real disposable incomes and the emergence of a middle class. The Russian economy, however, was one of the hardest hit by the 2008-09 global economic crisis as oil prices plummeted and the foreign credits that Russian banks and firms relied on dried up. The economic decline bottomed out in mid-2009 and the economy began to grow in the first quarter of 2010. Growth for 2011 was 4.8%, and unemployment was at 6.6%. Capital markets are relatively small but growing and are dominated by energy companies.
Russia's competitive flat income tax rate and low corporate tax rates support innovation, although private enterprises also must cope with "informal taxes" such as bureaucratic hassling and corruption. Other taxes include a value-added tax (VAT) and a regional property tax. Overall tax revenue as a percentage of GDP was 34.1 percent. In the most recent year, total government expenditures, including consumption and transfer payments, increased slightly to 34.1 percent of GDP. The state maintains a strong presence in such key sectors as energy and mining. Public debt is at under 10 percent of GDP in 2011, while inflation is 3.8%.
|Country||Debt to GDP||2011 GDP growth||Unemployment Rate|
|Russia||9.9 %||4.8 %||6.6%|
|United States||over 100 %||3.0 %||8.2 %|
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
|U.S. Treasury||U.S. Dollar|
|Morgan Stanley||U.S. Dollar|
|Morgan Stanley||Russian Ruble|
This Morgan Stanley ruble linked note indicates a yield pickup of over 8% compared to similar maturity U.S. Treasuries, and a yield that is nearly 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 4.6% annually relative to the ruble, 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 4.6% annually, that much appreciation of the ruble would likely result in a better than 14% annual return.
Please compare this Morgan Stanley Russian ruble bond to other offshore bank income investment opportunities, that include JP Morgan (JPM)'s Russian ruble bond, Bank of America (BAC) or Lloyds Bank (LYG) Brazilian real bonds, or UBS (UBS) Mexican peso bonds, all of similar or shorter maturities.
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 Russian ruble.
The currency risk of the Russian ruble could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to the Russian economy. Russia's long-term challenges include a shrinking workforce, a high level of corruption, difficulty in accessing capital for smaller, non-energy companies, and poor infrastructure in need of large investments. Higher oil prices, which buoyed Russian growth in the first quarter of 2011, could help Russia reduce the budget deficit inherited from the lean years of 2008-09.
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 Russian ruble 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 Russian ruble 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 lose its domineering status as the world's reserve currency and collapse against a basket of other stronger currencies.
While acknowledging that every investment vehicle involves varying elements of risk, we believe that this recent strengthening of the U.S. dollar relative to the Russian ruble represents an extremely attractive opportunity for initiating a moderately longer term exposure to the Russian economy with a well respected issuer, at a very attractive yield. A continued demand for Russia's abundant supply of oil and natural gas will likely result in a continued strengthening and expansion of their economy, which in turn is likely to result in the strengthening of the ruble currency, which we believe is one of the currencies more highly correlated to the price of oil. Therefore, we view the ruble currency risk of this prominent emerging market as an unusual and significant opportunity that we have highly recommended our clients take in their continued effort to diversify away from overweighted U.S. dollar based assets, and it is why we are adding it to our Foreign and World Fixed Income holdings.
Coupon: 9.25 (steps up in later years)
Yield to Maturity: 9.43%
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.