This week, we looked to A/A+ rated bonds from the Export-Import Bank of Korea, denominated in Mexican pesos, maturing in November of 2017, to achieve a 7% return for our clients that are seeking more income from their investments than the paltry yields found in similar US debt instruments. Considering the head of Mexico’s central bank, Governor recently stated that the peso’s current exchange rate doesn’t accurately reflect the strength of the Mexican economy and that the currency has room to appreciate, we have selected it for this high yielding, investment grade bond as This Week’s Best Bond.
Wealth Preservation and US Dollar Concerns
With both domestic and emerging market bond yields continuing to drift lower amid the current global economic uncertainty, wealth preservation remains a top priority for many people. Declining equity and property prices, ultra-low interest rates, minimal pay raises, elevated inflation, ineffective politicians, potentially increased taxes, and the Fed’s easy money policies continue to precipitate a widespread erosion of wealth that will likely continue until the aforementioned conditions begin to change.
Here at Durig Capital, we are continuing with our efforts to stay ahead of this destruction of wealth by searching the globe for the highest fixed income opportunities exceeding our stringent criteria of lower risk relative to its potential for positively accruing returns.
The economy of Mexico is 13th largest in the world in nominal terms and 11th by purchasing power parity, according to the World Bank, and the United Nations reports that Mexico’s standard of living – including health, education and per capita income – is now higher than Russia, China and India. As an export oriented economy in the trillion dollar class, it remains integrally correlated to the US economy because of its prominent role at 80% of exports trading partner. However, Mexico’s last reported debt to GDP ratio grew by only 1.9 percent compared to the end of 2011, and now stands at the equivalent of 33.6 percent of GDP, compared to the US ratio well over three times that, having now passed 100%. Mexico’s Finance Department says the country’s economy grew by 4 percent in the second quarter of the year as compared to the same period of 2011, and unemployment is about 4.97% compared to 8.6% for the US.
The Bank of Mexico kept its main policy rate unchanged at 4.5% in July–its stance for the past three years–but signaled the outlook for the country’s economy appears to be weakening as global growth slows. Many analysts expect the bank to keep rates on hold at least until early next year. The annual rate of inflation in Mexico accelerated to 4.45% in early July from 4.34% at the end of June, but annual inflation is expected to slow to below 4% by the year-end, as recent increases in some food prices should prove temporary.
Given these healthy domestic economic fundamentals and the improved US growth prospects, the low direct exposure of the peso to European stress, the recent upward bias in crude oil prices, and the peso’s under-valuation versus its longer term fair-value metrics, we think the Mexicn peso is poised to potentially outperform the US dollar relative to other world currencies.
The Export-Import Bank of Korea (KEXIM), one of Korea’s three policy banks, is an official export credit agency providing comprehensive export credit and guarantee programs to support Korean enterprises in conducting overseas business. Since its establishment in 1976 as a special financial institution, the bank has actively supported Korea’s export-led economy and facilitated economic cooperation with foreign countries and is wholly owned by the Korean government, which held a direct stake of 73.9% as of December 31, 2009. Korea Eximbank’s primary services include export loans, trade finance, and guarantee programs structured to meet the needs of clients in a direct effort to both complement and strengthen the clients’ competitiveness in global markets. The bank also provides overseas investment credit, natural resources development credit, import credit, and information services related to business opportunities abroad.
Furthermore, the bank is responsible for the operation of two government funds: the Economic Development Cooperation Fund (EDCF), a Korean Official Development Assistance program, and the Inter-Korean Cooperation Fund (IKCF), an economic cooperation program with North Korea. The bank strives to become “The Global Financial Partner Connecting Korea to the World” as reflected in its vision by continuously fostering innovation and development throughout its operations.
In 2011, Korea Eximbank continued to provide comprehensive support for Korean companies by increasing customer-oriented financing programs to better support domestic players maintain competitiveness in the global market. These efforts significantly increased the business performance of the Bank and contributed to the steady and stable growth of the Korean economy, especially during the global economic slowdown sparked by European countries. The bank reported total unconsolidated assets of KRW55 trillion (US$48.3 billion) as of Q1 2012, and has a book value of equity equivalent to KRW45.78 trillion (US$44 billion.) It’s long term credit ratings are A1 at Moody’s, A for S&P, and A+ for Fitch.
In 2012, the Korean economy is projected to grow by approximately 3.8%. While Korea’s GDP is forecast to record a relatively lower growth rate of 3.2% in the first half due to economic slowdowns and lingering uncertainties in developed countries, it is anticipated to pick up in the second half to record 4.2% as uncertainties are gradually resolved.
The default risk is KEXIM’s ability to perform. Given both their current government ownership, high quality credit rating, and current strong economic forecast, it is our opinion that the default risk is significantly less than the currency risk of the Mexican peso.
The currency risk could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to Mexico’s economy.
Per capita income in Mexico is roughly one-third that of the US, and income distribution remains highly unequal. The current Mexican administration continues to face many economic challenges, including improving the public education system, upgrading infrastructure, modernizing labor laws, and fostering private investment in the energy sector. Because of the dominance of exports to the US, its economy will remain correlated to that of the US.
Accessibility and Liquidity
During 2011, Korea Eximbank tapped various non-US dollar markets to source the equivalent of USD6.82 billion. In total, KEXIM maintains over KRW39.2 trillion (US$37.68 billion) in long term debentures, primarily U.S. dollars, Euros, and other currencies. Aside from owning various emerging market funds and ETFs that blend together various winners and losers into a mixed yield cocktail, we believe holding individual maturity certain bonds offers more favorable interest income certainty and predictability. Many times broker/dealers require an institutional sized single bond purchase. However, with a broker and adviser’s assistance, it is possible for a number of retail clients to be combined together in order to make a larger institutional sized purchase. Previously, we have been able to facilitate purchases as low as US $10,000.
In spite of the dollar’s remarkably strong performance this year, largely the effect of broad global concerns stemming from the European debt crisis, the era of dollar devaluation and “easy money” from the Fed appears to be far from being over. Regardless of how opaque the economic “stimulus” reasoning is, or how it is presented to the average American citizen as being vital and necessary for our economy, the global economy dependence on the dollar and the dollar’s dominant position as the reserve currency of the world continues to be challenged. However, we believe that diversification into higher yielding corporate debt instruments denominated in foreign currencies poised to strengthen relative to the dollar offer a savvy hedge against what some might view as an inevitable devaluation of the US dollar.
As a result, it is our opinion that this short term, higher yielding investment grade Mexican peso bond, issued by a sound and well respected financial institution, provides an intelligent alternative to the US dollar’s further devaluation and loss of buying power, which is why we have added it to our Foreign and World Fixed Income holdings.
Ranking: SR UNSECURED
Disclosure: Durig Capital clients may currently own these bonds.
To know more about this Korea Eximbank bond call our fixed income specialist at 971-327-8847
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