How to Boost Your Overseas Yields While Minimizing Risk

Ryan Fuhrmann's picture

Monday, May 16, 2011 - 11:00am

by Ryan Fuhrmann

In Omaha during Berkshire Hathaway's (NYSE: BRK-B) annual shareholder meeting, Tom Gaynor, chief investment officer of Markel Corp. (NYSE: MKL), detailed an asset class he follows -- SID -- which stands for "stocks in drag." This was meant to highlight that certain "safer" securities may not actually be that safe and instead will demonstrate price volatility similar to stocks.

International bonds were one asset class he referred to in his talk. Most investors buy bonds for their price stability, steady coupon payments and the fact that there is a very high likelihood of getting your investment back once a bond reaches its maturity date. For the most part, these characteristics closely fit domestic bonds issued by the U.S. government, corporations and municipalities.

These same securities exist in other countries. In general, international bonds are an appealing asset class because they help investors diversify their portfolios and can offer higher yields than in the United States. The main drawback for U.S. investors is that buying international bonds subjects them to currency fluctuations, since the U.S. dollar must be exchanged for a foreign currency to purchase the underlying bond. This is because foreign entities issue their bonds in their local currency. Currencies can exhibit quite a bit of volatility and this means the price of the underlying bond can also be quite volatile.

In addition to the currency volatility, the near-term outlook for international bonds is negative, given the U.S. dollar has been weak. The weakness is due to low interest rates and a weak economy. From the currency perspective, when the dollar declines, a foreign investment decreases in value. But there is a way to mitigate some of these problems through foreign bonds issued in U.S. dollars, which are fittingly referred to as "Yankee Bonds," and can carry very appealing dividend yields.

The portfolio manager for the DoubleLine Emerging Market Fixed Income Fund (Nasdaq: DBLEX) is currently investing in emerging market bonds issued in dollars in order to avoid the impact of a weak dollar, currency fluctuations and to gain exposure to individual investments that are trading at appealing valuations. The fund currently has an appealing dividend yield of about 5.3% and holds a Yankee bond from Brazilian oil giant Petrobras (NYSE: PBR). Investors in U.S. corporate bonds have to invest in 30-year bonds just to get a 4% coupon, meaning they can pick up substantial income gains from Yankee bonds.

Selecting individual investments in Yankee bonds requires extensive legwork, but it can be worth it. In the Petrobras example, I believe investors would be well served by considering the company's common stock, but other more conservative (or income-minded) folks may be more comfortable with holding the underlying bond that currently yields 5.88% and matures in five years and returns the initial investment, as opposed to the stock, which has been volatile. The five-year rate for U.S. corporate bonds is comparatively stingy at a recent 1.87%.

Reuters also recently detailed that Yankee bonds from foreign financial institutions have been popular and that $96 billion have been issued so far this year from banks in Canada, Australia and Europe. Last year, CIBC Bank in Canada and Commerzbank in Germany both issued bonds in U.S. dollars.            

Action to Take --> I don't have any specific Yankee bonds to recommend and believe most investors are better of leaving the individual security selection to fixed income experts, such as through the DoubleLine fund I mentioned earlier that pays a high overall dividend to investors.  StreetAuthority's High Yield International newsletter, written by StreetAuthority co-founder Paul Tracy, is also always on the lookout for compelling international opportunities, including the appealing Yankee Bond class.

Overall, given that U.S. interest rates are low, the current weak-dollar investing environment and the fact that currency fluctuations are inherently volatile and unpredictable, the Yankee bond asset class is worthy of adding to many investor portfolios.

P.S. -- If you're looking for quality stocks with high yields, you should take a look at this one. It pays a 19.2% dividend yield. It borrows cheap, gets paid handsomely and then pockets the spread. You'll get the full story on this cash machine and others like it in this video.

Ryan Fuhrmann does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.