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By M. Isi Eromosele
Global investors, particularly those in the U.S.
have expressed increasing concern about the stability of their own domestic markets. Over the
last two years, investors have worried about the de-basing of their domestic currency,
the credit quality of their “risk-free” bond market and what will happen when
their Central Banks start to tighten monetary policy.
Investors can diversify their currency and interest rate
risk by going global, and start expanding the horizons of their investment
universe. The concerns of U.S.
investors can also be applied to Europe , the UK
and Japan .
When adopting a global approach to fixed income, investors
probably should not follow bond indices. Bond indices are based on market
capitalization; so the greater the volume of issuance, the heavier the index weighting.
The bond index investor is therefore forced to buy
increasing amounts of the bonds of those countries that are issuing large volumes of
debt and is thereby locked into those countries’ declining credit story. Is there a
better way?
In measuring bond value, investors ignore the power of the
yield curve at their peril. Compared to cash rates, longer-dated bonds are historically
cheap. Absolute yield levels are low, but this a reflection of the current low
cash rates. Inflation and other assets (equities) may provide a useful measure
when global concerns begin to subside.
Commodity price inflation has been a further concern for
investors during the early part of the year. Moving into the second half of 2012, however, these
inflation expectations subsided.
The year-on-year effects are such that yearly headline
inflation statistics will likely be in decline. In the absence of a complete
collapse in the European periphery, lower inflation expectations, together with
Japan ’s return
to normal should allow economic growth forecasts to rise once more.
Eventually current concerns might subside, which would lead
to rising expectations of tighter monetary policy and in turn raise questions about
how best to diversify current safe haven assets.
From that perspective, worries about declining credit quality
and the potential for higher cash rates could eventually be applied to most
developed markets and each country would love to see its currency decline in
value.
The traditional global government bond indices are dominated
by such markets; the U.S. Dollar, European Euro and the Japanese Yen make up
just under 90% of global government bond indices.
When seeking to diversify away from these markets, one must
look for better credit quality, where higher official rates are already priced
in and a currency that has potential to rally.
Many developing markets fit this description, but their
local markets are generally, small, and subject to manipulation. There are also
a number of developed markets (Australia ,
Sweden , Norway ,
Canada , Switzerland
and Denmark ) that
could also be placed within this category.
The weightings of these markets in bond indices are small or
non-existent but their liquidity is more than sufficient for inclusion and
their share of world GDP or currency trade
puts them in the top 30 countries.
If the net is widened to include investment-grade developing
markets such as the BRICs (excluding India ),
South Korea , Mexico ,
Poland , Malaysia ,
Singapore and
the Czech Republic
Bonds and currencies are driven by monetary and fiscal
policies which, since the global credit crisis, have diverged greatly. Those
countries that are not encumbered by legacy debt issues have raised interest
rates and kept their government balance sheets clean.
The resultant tightening of monetary policy in those countries,
such as Australia
leaves them with attractive bond yields and greater fiscal credibility. Those
countries that must work through their debt problems will likely continue to
finance their rebuilding through ultra-low rates and steep yield curves.
A diversified exposure to these different themes is an
exciting way to reduce domestic risk.
M. Isi Eromosele is
the President | Chief Executive Officer | Executive Creative Director of Oseme
Group - Oseme Creative | Oseme Consulting | Oseme Finance
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2012 Oseme Group
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