Stay Away from Emerging Market Debt

By Calla Hummel - October 22, 2012 | Tickers: KO, ABV, PBR | 0 Comments

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Bolivia and Paraguay are enigmatic countries full of deeply introspective and articulate people. Both countries will begin selling debt on the international bond market within a year, at around the startlingly low rate of 4.7%. Both countries have detailed plans for taking advantage of historically low rates and putting the proceeds towards much-needed infrastructure projects. However, unless you get deep enjoyment from taking huge risks for small yields, stay away from these bonds.

Be an Intelligent Investor

In Intelligent Investor, Benjamin Graham cautions against foreign bonds over and over again. In summarizing his view of an intelligent and enterprising investor, he states that such an investor will “…let someone else buy foreign-government bond issues, even though the yield may be attractive (Graham, 1973, p. 134).” Foreign bonds are risky, governments default for a range of unforeseeable reasons, and the asset class has a bad performance history (ibid, p. 138). Finally, at 4.7%, Paraguay’s and Bolivia’s bond yields will be under the modest 6% annual portfolio growth target that Graham advises, hardly making them a tempting buy.

Pick Your Risk

I use Paraguay and Bolivia as case studies in my research because they are dynamic, tumultuous countries with interesting political phenomena, including nation-wide protests, coups, nationalizations, populism, drug and contraband lobbies, and experimental social policies. For a superficial first take, Bolivia has a long history of nationalizations and has nationalized at least five operations this year, while Paraguay’s populist president was ousted in June, and the leading presidential candidate has been investigated by the D.E.A. for drug trafficking. In other words, everything that makes my dissertation research exciting also makes those bonds particularly risky; these countries feature almost every political risk you could think of.

What to Buy?

Latin America has pockets of excitement of both the flaming barricade and the exhilarating yield varieties. Plenty of profitable and well-managed companies operate in Bolivia, Paraguay, and the rest of Latin America, and some even have dividend yields approaching 4.7%. For example, Petrobras (NYSE: PBR) operates in both countries and has had a bad year – down 8% year-to-date -- with issues ranging from falling oil prices to rising capital and labor costs. Risk is priced into Petrobras’s shares, but with a 4.3% dividend yield and a P/E of 13, it looks like a much better deal than risky foreign debt.  

For a possible growth stock, look at Companhia de Bebidas das Americas (NYSE: ABV), which makes 7 of every 10 beers sold in Brazil, and owns Paraguay and Bolivia’s most popular breweries as well. Even with a run up in recent years, shares have a 2.3% yield, and the biggest risk is that the company will not grow into its valuation.

If you want exposure to Latin America and very low risk, buying Coca-Cola (NYSE: KO) is a much better idea than buying bonds. The company operates in every Latin American country and will continue to, despite rumors earlier this year that the Bolivian government would kick the company out. Even Graham recognizes Coca-Cola as one of the safest stocks available, and with a dividend yield of 2.7%, you would be going down only two percentage points for a huge reduction in risk.

In sum, Bolivia and Paraguay offer many chances for reliable yields, but you would be well advised to chase them through dividend stocks instead of government bonds.

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