Traditionally, investors put money into stocks for capital appreciation and invest in bonds for income with capital preservation. Financial advisers routinely recommend investing in both stocks and bonds, a strategy that proved particularly prudent over the last 30 years, when bonds outperformed stocks. However, for those of us building our portfolios now, low interest rates make bonds look only marginally more attractive than a savings account. Low interest rates have made bond offerings possible for countries formerly shut out of international markets, and investors have happily bought up the debt of countries like Bolivia and Paraguay at yields under 5%.
The capital preservation myth
Most sovereign debt carries a small default risk, but when a government defaults on its bondholders, the capital preservation perk of bonds disappears. Think Greece or Argentina: when the government defaulted, the governments gave bondholders new bonds with face values up to 70% lower than the original. Usually, default risk is priced into bond yields: medium-risk countries offer bonds with much higher yields than low-risk countries and high-risk countries are effectively locked out of bond markets by extremely high borrowing rates.
However, low interest rates have recently let countries with a high risk of default offer sovereign debt at historically low yields. For example, Bolivia sold $500 million in ten-year notes in October 2012, initially yielding 4.8%. Bolivia epitomizes a high-risk country: it set world records for inflation and coup prevalence in the 1980s and while Bolivia’s macroeconomic health has improved drastically, the current administration routinely nationalizes foreign and domestic companies. In other words, the country has a history of political and economic instability and a track record of appropriating foreign-owned assets.
Bolivia’s and neighbor Paraguay’s sovereign debt yields nearly 4.8%. For those who wish to go a notch down in risk, however, the yield falls considerably. In September, Brazil sold ten-year notes at a record low of 2.6%, or about .6% above the U.S. inflation rate. Brazil will offer ten-year notes again in the next couple weeks, with yield estimates around 3%. While Brazil shows no signs of defaulting, its economy is limping along at 1% GDP growth and a decades-long era of inflation, currency devaluations, and debt crises is only ten years behind it. Brazil is a medium-risk country, not the low-risk borrower that a 3% yield usually denotes.
Dividend stocks are a better bet
Dozens of companies operating throughout Latin America are at lower risk for bankruptcy than Bolivia is for default, and offer a higher dividend yield than Brazil’s bond yield. I argue that many of these companies offer better odds of capital preservation and income than Latin American foreign debt, and many of the region’s dividend stocks have plenty of room to appreciate as well.
Telefonica Brasil SA (ADR) (NYSE:VIV) is a Brazilian telecommunications megacap. Telefonica shares have a beta of .67, making the stock a good candidate for capital preservation. Even better, Telefonica comes with a gigantic 8% dividend, leaving Latin American sovereign debt yields in the dust and topping the dividend yields of most large U.S. telecommunications companies. Telefonica Brasil SA (ADR) (NYSE:VIV) trades at a price-to-book ratio of 1.36, leaving room for capital appreciation as well.