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Harry Koza

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A little bonding time

Harry Koza

TORONTO (GlobeinvestorGOLD) - You can't pick up the business section of the paper or turn on the TV these days without running into some expert recommending that you go global with your personal portfolio. Diversification, the theory goes, is essential. You shouldn't be over-concentrated in the resource-heavy domestic market, because it's had a great run for a number of years, and is thus due to be over any day now.

Of course, these are often the same people who were warning me not to be so heavily invested in the energy sector for the past five years because oil was going back to twenty bucks, and who advised moving into the U.S. stock markets in a big way back when the Loonie was 1.45 to the U.S. buck. Ignoring their advice has worked very, very well so far.

But, as I will be the first to admit, there is nothing wrong with diversification, and indeed, it is a worthy objective. Proper diversification lowers the overall risk of a portfolio and lowers the volatility of returns. That, as Martha would say, is a good thing. The problem with all this international investing, however, is that, because of the Loonie's appreciation, a lot of global investment returns, translated into Canadian dollars, have been lousy.

So how best to diversify your fixed income holdings? There is no shortage of bonds in other countries: US Treasuries, JGB's (Japanese Government Bonds), German Bunds, UK Gilts - in fact, virtually every government around the world issues bonds in various currencies. While it is possible to buy some of these for your own account, it is even more difficult, expensive and time-consuming than buying retail amounts of domestic bonds here at home, so it is not a viable alternative for most investors.

The best way to get global bond exposure for your portfolio is to buy a foreign-bond ETF. I like bond ETF's a lot. They are easy to trade, offer complete price transparency, and generally have much lower MER's than bond mutual funds. If you are looking to create a specific income stream, however, they may not be ideal. As well, unlike actual bonds, they never mature. Still, if you want exposure to international bond markets they are hard to beat. Here's a bunch of them that cover most of the world.

I already own the Barclays' i-Units based on Canadian bond markets. Barclays also has a handful of US bond i-Units, variously tracking the Goldman Corporate index (LQD-A); the Lehman 1-3 year Treasury Index (SHY-A); the Lehman 20+ year Treasury index (TLT-A); the Lehman 7-10 yr Treasury Index (IEF-A); the Lehman Aggregate Index (AGG-A), and the Lehman TIPS index (TIP-N). These all offer good exposure to various parts of the U.S. bond market, with the usual low MER's (all 0.15 per cent except for AGG, which is 0.2 per cent). Current yields range from 3.70 per cent (SHY) to 4.56 per cent (LQD).

Outside of the U.S. market, there are several options. There are all kinds of closed-end, exchange traded funds in various emerging markets. Some are high-yield; some specialize in government bonds, some in Brady bonds, some in local currencies, and some in U.S. Dollars.

Many of these closed-end funds trade at a discount to net asset value. There are all kinds of trading strategies involving buying them when discounts are high and selling them when the discounts shrink, but I am just looking at them as income producing instruments for now. So here's a sampling of some of the available bond ETF's that offer exposure to various global areas and sectors.

I already own the Aberdeen Asia-Pacific Prime Income Fund (FAP-T), which is currently yielding about 8.18 per cent. I must admit, it is down about 10% since I first bought it, mainly because of foreign exchange losses - it invests in Aussie, South Korean, Philippines and U.S. bonds, mostly under 10 years, and those currencies have all depreciated against the Loonie. Still, it cranks out a decent yield, currently 8.18 per cent, and has an MER of around 1.2 per cent. Its 1-, 3-, 5-, and 10-year total returns are, respectively 3.98 per cent , 14.17 per cent , 14.03 per cent , and 7.81 per cent . At current prices, it looks more attractive than when I bought it.

Salomon's Emerging Markets Income Fund (EMD-N) invests in mostly emerging markets debt (95.39 per cent), with an average credit quality of BB+. Its biggest holdings, geographically, are Brazil, Russia, Philippines, Turkey, Colombia and Venezuela. Total MER 2.46 per cent. Total returns: 1 year 14.76 per cent, 3 year 20.95 per cent. Current yield 7.84 per cent.

Templeton offers the Global Income Fund (GIM-N), with a current yield of 5.61 per cent. It has a relatively low MER of 0.76 per cent, an average credit quality of A+, and its main holdings are South Korea, Sweden, Poland, Canada, Thailand, Indonesia and Australia. Its 1-, 3-, 5-, 10-year total returns are 2.89/12.04/12.46/9.17 per cent.

Bond giant, Pimco, offers the Strategic Global Government Fund (RCS-N). Its mandate is to offer a higher yield than intermediate U.S. Treasuries, while still being 85 per cent invested in the U.S.. It holds 45 per cent of its portfolio in FHLMC paper and 32 per cent in mortgages. It has a 1.32 per cent MER. Total returns for 1/3/5/10 years are 1.97/5.44/7.68/8.49 per cent. It has traded at a premium to NAV since its inception. Current yield is 7.46 per cent.

UBS offers the Global High Income ETF (GHI-N). It has a portfolio that is about 25 per cent U.S. dollar denominated emerging markets debt, 35 per cent non-dollar, and about 50 per cent in Brady bonds, Yankees and Eurobonds. Its biggest holdings are in Brazil, Argentina, Russia, Mexico, Philippines and Turkey, with 73 per cent of its portfolio BBB or lower, and about 62 per cent 10-years or longer. It has a MER of 1.43 per cent, a current yield of 8.80 per cent. Total returns for 1/3/5/10 years are 13.89/17.11/14.12/13.7.

If it's Euro-zone exposure you want, CEF Advisors offers the Global Income Fund (GIF-A). It has a current yield of 6.9 per cent, a 1.41 per cent MER, and offers exposure to the Netherlands, Germany, the UK, USA, and France. It has 9.4 per cent of its portfolio in US government paper. Total returns for 1/3/5 years is -3.14/4.23/3.82 per cent.

DWS Scudder offers the Global High Income Fund (LBF-N), with a current yield of 6.4 per cent. It holds bonds issued in Brazil, Russia, Venezuela, Philippines and Argentina, with around 77 per cent US Dollar denominated and 18 per cent foreign currency denominated. It has a MER of 2.65 per cent. Total returns 1/3/5/10 years are 18.55/22.69/18.45/9.44.

Morgan Stanley's Global Opportunity Bond Fund (MGB-N), offers a current yield of 10.9 per cent and a MER of 2.52 per cent. It hold U.S., Russian, Mexican and Brazilian bonds with an average credit rating of B. Forty-four per cent of its portfolio is rated BBB or lower, and 65 per cent of it is high-yield. Total returns 1/3/5/10 years are 7.85/15.79/5.48/6.92.

You can find all kinds of similar bond ETF instruments at www.etfconnect.com. Click on their fund finder. It has a handy feature that lets you pick a bunch of funds and then compare them to each other. You can sort them by current yield, by discount to NAV, or other criteria. All these ETF's can be purchased easily through your broker or on-line trading account.

I'm not recommending any of the above ETF's in particular. I just picked out a handful of them that offer exposure to various parts of the global market. The main problem that I have had with these things in the past was the rising Loonie: there's not much point in owning something that yields, say 10 per cent, when it is denominated in a currency (like U.S. dollar) that has been dropping against the Canadian dollar at a rate higher than the yield of the investment. But the Canadian dollar seems to have found its level lately. I doubt if it is going to go to par with the U.S. dollar any time soon, and it seems even more doubtful that it will fall back to the 1.50 area that it had not all that long ago. That suggests that some of these foreign bond ETFs may now be worth a look.

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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