This week we look at a newly issued five-year Morgan Stanley (MS) Kangaroo (Australian dollar) bond that will yield 9.0% the first year, and then switch to a floating rate yield (the 3 month LIBOR rate plus 5%) in years 2 through 5. The high yield and medium-length maturity of this Aussie dollar 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 U.S. 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 increase our exposure to one of world's better performing currencies and fundamentally strongest economies.
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 US Five Year treasury yields still 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" US government notes.
In the continuing effort to protect our clients' assets against the persistent destruction associated with an ever increasing supply of US dollars, we have chosen this highly attractive Morgan Stanley Australian Dollar issue as This Week's Best Bond.
Australia's abundant and diverse natural resources include extensive reserves of coal, iron ore, copper, gold, natural gas, uranium, and renewable energy sources. It also has a large services sector and is a significant exporter of natural resources, energy, and food. The key tenets of Australia's trade policy include support for open trade and the successful culmination of the Doha Round of multilateral trade negotiations, particularly for agriculture and services.
While many large advanced economies have been struggling with growing debt burdens that result from years of heavy government spending, Australia's gross public debt stands at less than 25 percent of GDP. Unemployment, originally expected to reach 8-10%, peaked at 5.7% in late 2009 and fell to 5.0% in 2011. Budget deficits have been under control owing to prudent public finance management that recognizes limits on government. As a result of an improved economy (growing 2.7% in 2010 and 3% in 2011,) the budget deficit is expected to peak below 4.2% of GDP and the government could return to budget surpluses as early as 2015.
Earlier last month, the Reserve Bank of Australia trimmed the economy's growth forecast to 3.5 percent for the year ending June 2012 from the previous forecast of 4 percent. The annual rate of inflation in Australian appears to have recently fallen to about 2%, but is projected to rise by 0.7 percent. With inflation under control, the latest batch of data keeps the door open to further rate cuts. China's weaker-than-anticipated exports, as well as industrial production and retail sales data released last week, was generating uncertainty about the near-term outlook for Australian resource stocks, but offshore investors continue to see Australia as a safe haven with a stable growth outlook on the back of the strengthening resource boom.
Public debt to GDP
Australia in A$
A$ 20.3 billion
United States in USD
|102.8%||US$ 1.29 Trillion||1.474 Trillion||2.239 Trillion|
Stanford University has rated the Australian economy number #1 on its global Sovereign Fiscal Responsibility Index. This recognition helped highlight how much stronger Australia's financial condition is compared to #28 ranked (out of 34) United States, which came in only four points above a defaulted Iceland.
Australian dollars (AUD) per US dollar:
- 0.9559 (current)
- 0.9797 (2011)
- 1.0902 (2010)
- 1.2822 (2009)
- 1.2059 (2008)
- 1.2137 (2007)
- 1.3285 (2006)
About Morgan Stanley
After the Glass-Steagall Act of 1933 that 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, its 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.
This Morgan Stanley Australian dollar note offers a very sweet 9% first year yield, making it especially attractive to fixed income investors desiring a higher cash flow from their fixed income investments. While we expect that the coupon rate will reset to lower rates (possibly under 6% if the LIBOR rate remains near current levels) in later years, the overall average rate that we think this bond could potentially produce represents a remarkable improvement over similar maturity US Treasuries, and a yield that is significantly higher than that of similar Morgan Stanley bonds denominated in US dollars.
Furthermore, the floating rate feature of this issue would be a great benefit to bondholders should LIBOR rates and inflation (the inevitable result of proliferating dollars) rise much sooner than many pundits expect. Even if the Congressional Budget office is wrong and we have an appreciation of the dollar, as long as the currency appreciation averages less than 3% annually relative to the Aussie dollar, this bond is still likely outperform its US dollar counterpart.
The default risk is Morgan Stanley's ability to perform. Morgan Stanley is currently under review for a credit downgrade from major rating agencies, which could affect the flexibility of their balance sheet, their access to more favorable financing, and possibly the desirability of their existing debt. However, given last year's great results and their improved balance sheet, it is our opinion that the default risk for this short-term bond is minimal relative to the currency risk of the Australian dollar.
The currency risk of the Australian dollar could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to the Australian economy. Australia's economy is heavily dependent upon its strong commodity export, which could be affected adversely with diminishing demand from China.
We view these bonds as having currency risks similar to other offshore bank bonds that we have recently written about, such as 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 about three to five year fixed maturities.
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 US $10,000.
We hope NOT to see any further destruction of wealth resulting from a constant decline in the US dollar relative other global currencies as forecast by the Congressional Budget Office, and we acknowledge that a strengthening of the US dollar would directly reduce the total returns of this Australian dollar denominated bond.
On the other hand, should the US dollar continue on the long-term path of devaluation that it has been on, this alone could add quite significantly to the already positively accruing returns of this bond, not to mention the possible stellar returns that would result should the US dollar ever lose its domineering status as the world's reserve currency and collapse against a basket of other stronger currencies.
A continued demand for Australia's abundant natural resources will likely result in a continued strengthening and expansion of their economy, which in turn is likely to result in the strengthening of the Aussie dollar, which we believe is one of the strongest global currencies.
Therefore, we are recommended this new issue Morgan Stanley foreign currency bond for our clients looking for both greater cash flow and diversification away from overweighted US dollar based assets, and this is why we are adding it to our Foreign and World Fixed Income holdings.
Coupon: 9.00 (first year, floats at 3 mo. LIBOR plus % in later years)
Yield to Maturity: VAR (6.32% indicated average YTM)
Additional disclosure: Some Durig Capital clients currently own these bonds.