Loyal readers of the Daily Pfennig need little persuasion when considering allocations to foreign currencies within a well diversified portfolio. The risks to wealth preservation within a debasing currency environment have been thoroughly vetted, even more urgently now in the light of the recent “Fiscal Cliff” negotiations, which produced higher taxes for many with few solutions for reduced spending. It is likely that the excessive spending and egregious debt scenario Chuck has been describing for the past decade will continue unabated. This will lend further credence to the benefits for diversification away from the US dollar.
While the benefits of currency diversification have been well described, investment outside of the US dollar is not limited to direct allocations to currencies alone. Individuals wishing to use foreign currency denominated investments1 as part of their overall investment strategy can now utilize international bonds2 within portfolio allocations. Short to intermediate durations can provide enhanced yield opportunities while limiting sacrifices to safety and liquidity. These investments can take the form of investing in sovereign, supranational, or foreign corporate bond issues, offering investors both the benefit of currency diversification as well as the opportunity to potentially capture higher yields from these bonds.
My name is Don Ries, and I am responsible for the fixed income trading at EverTrade Direct Brokerage, Inc.3, a specialty that I have been perfecting for most of the last four decades. My history with the professionals at EverBank dates back to working with Frank Trotter and Chuck at Mark Twain Bank since 1989, when I was tasked with building out the municipal bond trading desk. The ultimate goal is to offer individuals greater access to attractive global investment opportunities, providing investing options for both domestic and international bonds.
Simplifying The Investment Process
Although most investors are comfortable with the domestic bond market, individuals new to investing in foreign bonds may experience trepidation with either the strategy or structure of the trade. The fact is that transacting in these securities is very straightforward.
To those individuals first considering investments in foreign denominated bonds, an initial suggestion is to identify those currencies where exposure is desired. In this environment, most investors prefer either commodity sensitive currencies such as the Australian Dollar, Canadian Dollar, Norwegian Krone, or Brazilian Real (for more aggressive investors), or currencies exposed to economies with strengthening growth fundamentals in the Asia region such as the Singapore Dollar. Many experts agree that rather than chasing yield, selection of currency exposure is THE critical decision in identifying astute international investments.
Once a currency has been selected, investors can compare the yields of different investment structures in order to choose the most appropriate vehicle. Investors have a number of different solutions to consider including direct investment in the sovereign bonds of a country, corporate bonds of companies residing within the country, or supranational bonds. Supranational issues are bonds denominated in the respective currency yet issued and backed by an institution or consortium residing outside of the country. Institutions such as The World Bank, The European Investment Bank, or Inter-American Development Bank, Kommunalbanken, or Export Development Canada often issue these bonds with the goal of creating credit for developing nations by offering strong ratings to back these bonds.
Comparing yields on these various bonds will generally come down to a trade off between credit quality, duration and volatility. Longer term credits will have higher yields, with the trade off being increased volatility and interest rate sensitivity at longer durations. Preferable foreign bond markets will typically be those countries with strong internal fundamentals and high credit qualities. Investors may find limited yield opportunities in countries such as Switzerland or Germany, where demand has driven bond pricing to levels producing negative yields, implying allocation would be best suited directly into such currencies.
Security selection is but one aspect of the investment process. Risk management is an integral overlay to any allocation decisions, focusing primarily on credit, interest rate, and liquidity risks. Many individuals invest only with the highest rated sovereign or supranational bond issuers, thereby minimizing credit and default risks of their investments. Focusing on shorter duration securities, ranging between 1- and 3-year bonds, reduces interest rate risks as longer term maturities will tend to be more price-sensitive to changes in interest rates. Finally, using only the most liquid global securities with multiple market makers can provide price efficiency and liquidity should investors wish to exit the currency.
As securities, foreign bonds must be purchased in a brokerage account. The current minimum size trade requirement is $25,000, though in some cases this could increase to $50,000 depending on order flow in a given currency. EverBank and EverTrade Direct Brokerage will offer no advice or recommendations on individual securities. EverTrade Direct Brokerage can also accommodate inquiries in more traditional domestic bond markets, including taxable and federally tax-free municipal bonds, treasury and agency issues, and corporate bonds.
Frank, Chuck and I have shared a strong working relationship in the past. There can be good value in diversifying some portion of wealth away from US dollar denominated investments. Having acute attention on the management of risk within the selection of investments, particularly with respect to foreign denominated securities, can also be a good philosophy. In a real sense, a fixed income trading desk presents a complementary investment strategy to support investors looking for more flexibility in meeting their diversification objectives.
We look forward to helping you achieve your investment goals.
Fixed Income Specialist
EverTrade Direct Brokerage, Inc.
1. Investments in foreign securities carry additional risks, including exposure to currency fluctuations, less liquidity, less developed or efficient trading markets, lack of comprehensive company information, political and economic instability and differing auditing and legal standards.
2. Failure of an issuer to make timely interest or principal payments, or a decline in credit quality of a bond can cause a bond’s price to fall. Investments can fluctuate in price, value and/or income and may return less than the original investment.
3. EverTrade Direct Brokerage, Inc. investment products:
|Are Not FDIC Insured||Are Not Bank or Government Guaranteed||May Lose Value|
EverTrade Direct Brokerage, Inc. is registered as a broker/dealer with the Securities and Exchange Commission and is a member of the FINRA/SIPC.
Due to the nature and volatility of the foreign exchange market, the values of currencies are subject to wide fluctuations against the U.S. dollar and investments in foreign currency denominated instruments will entail significant risk exposure to adverse movements of the foreign currency relative to the U.S. dollar. It should be understood that the value of an investment denominated in a foreign currency will vary over time and may not be worth as much as the original purchase cost. If any amount of foreign currency is exchanged for U.S. dollars, a corresponding foreign exchange gain or loss may be recognized. FDIC deposit insurance does NOT insure against any loss in the value of your account due to foreign currency fluctuations. Another risk associated with owning an investment denominated in a foreign currency involves the possibility of a government’s imposition of exchange controls or prohibitions. Foreign exchange controls could include severe limitations on the amount of foreign currency that could be removed from the foreign country and limitations or prohibitions on foreign exchange transactions. These exchange controls could prevent EverBank World Markets or EverTrade Direct Brokerage, Inc. from obtaining the foreign currency necessary to deliver to you. In such an event, EverBank World Markets and/or EverTrade Direct Brokerage, Inc. will attempt to obtain foreign currency on your behalf, but makes no representation or warranties as to its ultimate ability. These exchange controls also could require EverBank World Markets or EverTrade Direct Brokerage, Inc., to convert your foreign currency to U.S. dollars without advance notice to you, even if such conversion is contrary to your instructions. The foreign currency exchange rate that we are able to obtain is determined by the dealers through which we trade foreign currencies, and those rates are influenced by supply and demand and other factors outside of our control. The exchange rates available to customers of EverBank World Markets or EverTrade Direct Brokerage, Inc. are not publicly available through any third party publications or sources. Exchange rates stated in third party publications generally are indicative only of possible rates for very large, institutional transactions and are not accurate indicators of exchange rates that are available to our customers.