Foreign T-Bills: The Simplest Strategy for Fixed-Income Investing

by: Roger Nusbaum

You probably heard about the investment fund in Florida that had to suspend withdrawals due to having too much allocated into SIVs. You might have heard about a public fund in Montana going through a similar ordeal. You may not have heard about the Norwegian brokerage that shut down for putting money from four different townships into similar vehicles.

One by-product from the tech wreck is that some people learned a lesson, and now know more about not allocating too much - like 50% - into one sector. Maybe this can be thought of as a back-to-basics for equities.

The current meltdown of complex fixed income products, connected to mortgages and CDOs levered up and "stress tested," could very likely lead to a simplification of fixed income investing even if just for individuals.

A few months ago, I mentioned Nassim Nicholas Taleb's suggestion of putting 90% of a portfolio in t-bills from various countries, and then letting it ride with the other 10%.

To take that idea in a different direction, there is no simpler strategy in fixed income investing than t-bills. This is also true of foreign t-bills (and notes). Accessing them can be more difficult, but the strategy is simple.

The ETF industry is starting to create funds that provide access to foreign fixed-income products. I believe that over the next couple of years there will be a lot more of these funds, as investor demand for this segment increases.

I have small positions for some clients in two year (now 18 month) sovereign debt from Norway, the U.K. or both. Foreign debt - individual issues as opposed to funds - are difficult for individuals to access because orders need to be at least $100,000 (so says Schwab).

And where, in my opinion, is this headed? Easier access to sovereign debt from a lot of countries, either with funds or brokerage firms making it just as easy to buy foreign bills as it is for U.S. bills.

For example, I could see people allocating 5% each to ten different countries, and 50% to U.S. debt. By sticking with sovereigns, investors would avoid having to manage all sorts of different risk issues, such as quality and changes in spreads between different qualities and segments.

One obvious concern would be how to analyze and understand countries well enough to feel comfortable buying their debt. Well I believe in learning, and then following any country you invest in. Developed countries are not a realistic risk to default. Neither are emerging markets, very often.

We all know Russia famously defaulted in 1998, Ecuador seriously threatened to default earlier this year, and Venezuela seems to threaten default every couple of weeks (intentional hyperbole). For anyone who doesn't like those odds for emerging debt, then a blend of individual issues for developed countries and a fund or two for emerging debt seems like a good mix.

By allocating just 5% to a country, the risk is mitigated somewhat.

What about currency risk? One thing to remember is that the dollar has been a one way trade against everything of late. That is unlikely to last forever, even if the dollar does generally weaken. One way to address currency risk is to take in countries with different economic characteristics. Offset a deficit country with a surplus country, or maybe a carry funding country and a carry trade destination, or maybe a commodity based country with a service based country, and, lastly, an in-its-own-world country and a very cyclical country.

The bigger macro here is portfolio evolution, a favorite topic of mine. The way I view this is that the goal is not to go for the most yield possible; in that case 50% Turkey, 50% Iceland, and be done with it. I think some extra yield is available but going with all high yielders would be a lopsided bet.

I actually think managing a bunch of different t-bills is easier than managing a portfolio consisting different types of investment grade corporates, converts, high yield and so on. Anyone investing in individual countries from the top down has already done the legwork. The decision to buy a short term debt instrument is not a reach at all, compared to the decision to buy a stock or country fund.

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