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Thursday, April 25, 2013

What to look for when investing in international bonds

Bonds yields adjust as economic conditions change
International bond ratings range from junk to investment grade
By Sandy Coops

Investing in international bonds is a smart move as it is secure and safe. Moreover, international bonds consistently yield good returns.  International bonds are otherwise known as Sovereign debt, which forms a part of major part of investment in international investment portfolios. 

Issuers

 
Today even small individual investors are turning to international bonds as they are rated high when it comes to credit ratings, are almost 100% safe, and the yields are moderately good. Especially, the bonds that are issued and guaranteed by countries with strong economies, like Canada, Switzerland, and Germany are hot favorites. Developing countries also issue bonds, and are often referred to as bonds from emerging markets. However, the credit ratings are comparatively lower, some of which do not deserve any rating at all and are as good a junk bonds. 

Yield


The law of inverse proportion applies here, and since the safety is questionable, the bond-issuing countries offer better returns.  It is interesting to note that bonds issued by the U.S. treasury are considered as Sovereign bonds, however as the focus is on international bonds; there is no need to elaborate further on domestic bonds.

Safety

The primary reason why it is advisable to invest in international bonds is that they are guaranteed by the respective governments they are issued by. Hence, they are considered to be absolutely safe. For an investor, safety and security are of prime importance, and the returns part is considered second to this. 

Most countries would not default on bonds as they need to maintain their credibility, which is essential when they need to borrow huge sums on a continuous basis.  Even with countries that are less credit worthy, the bonds are a lot safer than their other domestic investment avenues. In case the sovereign bonds of a country fare poorly, the domestic scene is bound to be disastrous.

Before deciding to invest in international bonds, one should check a few things like:

  • If the country has a healthy economy, with a debt burden that is manageable.
  • The government should have a good tax collection record, with a favorable contribution from the population.
  • The country needs to have a favorable credit rating, certified by reputed rating agencies.
  • There should not be too much volatility in the country’s currency, which is a positive sign for a buoyant economy.
  • A good track record for repayment of debt by the government backed by a good political system and able leadership.

As mentioned earlier, investing in international bonds can be rewarding as the yield is moderately good. The surprising fact with an international bond is that it has proved to perform better whenever the markets are under stress and there is a general decline in all the other instruments. 

Funds


If the investment is in an emerging markets bond fund, the rise can be phenomenal; however the risks are equally high. Especially for U.S. based investors, international bonds provide better exposure (internationally) and add to a diversified portfolio.  Investors will have the double benefit of income from interest and capital gains as well, depending on the volatility of the U.S. dollar internationally.

On the riskier side, the investor is prone to negative events such as the government (borrower) being unable to or unwilling to pay back the debt. In such a scenario, the investor stops receiving dividend (interest) payments, and may not get back even the original investment upon maturity. Several cases have been reported where people were paid just a fraction of their original investment.  

Usually what can happen under such circumstance is that the government goes in for debt restructuring and the investors agree for a reduction in the interest and principal amount. In some cases there is a mutual agreement for extending the maturity term, giving the borrower a breather. Another negative aspect that can never be predicted correctly is inflation, which results in reduction in the value of interest and principal payments. One needs to study the pros and cons thoroughly before investing in international bonds.


About the author: Sandy Coops currently works at http://www.CableTimeNC.com, a site that enables everyone to learn about how to save on broadband and internet cable.


Image attribution: Dave Dugdale; CC BY SA-2.0