One Way Not to Chase Yield

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In a climate of record low interest rates, investors are hungry for yield. The domestic bond market’s bull years have pushed yields on some domestic bonds below inflation, and investors have increasingly looked to riskier asset classes such as foreign sovereign debt. The appetite for bond yield regardless of risk has enabled tiny and poor Paraguay to enter the bond market for the first time, with 10 year bonds at 4.6%.

Don’t bet on it

Paraguay is a landlocked South American country of six million people, and not to be confused with its smaller but more stable neighbor, Uruguay. Paraguay is only slightly wealthier than neighboring Bolivia, the poorest country in South America, who successfully offered ten year bonds at 4.6% last year. While Paraguay does not have Bolivia’s stunning history of nationalizations, it features a solid record of one party rule by strongmen whose semi-legal business dealings make or break in-country business and Paraguay’s international reputation. For example, Paraguay’s president was impeached in June and the current frontrunner ahead of the April elections owns cigarette factories and banks implicated in smuggling operations to Brazil and the U.S as well as drug-related money laundering.

Paraguay has experienced bouts of high inflation and violent fluctuations in growth, conditions that precipitated foreign debt defaults in its neighbors. While Paraguay is expecting 9% growth in 2013, its GDP tends to follow the fortunes of the soy crop, which is becoming a bigger portion of the country’s economy. If soy prices drop in the next ten years – a likely prospect for a cyclical commodity -- Paraguay will face the difficult economic conditions that lead governments to default on bond payments.

Better risks

Plenty of stocks feature yields of 4.6% or higher. Many with operations in or around Paraguay offer a yield comparable to Paraguay’s sovereign debt. While the cheaper stocks come with risk and uncertainty, I wager that they are less likely to go bust in the next four years than Paraguay’s government is to default on its bond payments. Here are three stocks with exposure to South America that I have recently bought and that I bet will perform better than Paraguayan sovereign debt over the next ten years.

Banco Santander’s (NYSE: SAN) yield of 10% knocks Paraguay’s bond out of the park. However, Santander’s yield comes with the caveat of being in Santander stock, but that is only a problem if you do not automatically reinvest your dividends. As a foreign bank headquartered in Spain, Banco Santander has had a turbulent five years and its P/E stands at 9. Bulls point out that the bank has decent profits despite adverse conditions, it is better capitalized than most Spanish banks, and its operations are mostly in Latin America and financially calmer parts of Europe, not in Spain. In the past several years, Santander spun off its Brazilian, Chilean, and Mexican operations as separate publicly-traded companies, raising cash and its profile without taking on debt.

Petrobras (NYSE: PBR) operates in Paraguay and most other South American countries. Petrobras shares had a bad 2013 – down 20% -- with problems from falling prices and output estimates to rising labor costs. Problems will likely continue in 2013, but Brazil is set for a better year and Petrobras may finally be able to raise domestic fuel prices. Risk and uncertainty are priced into Petrobras’s shares, but with a 5.1% dividend yield and a P/E of 13, it looks like a much better risk than a poor and landlocked country’s foreign debt.  

For an all but guaranteed dividend and exposure to every Latin American market, look no further than Coca-Cola (NYSE: KO). With a dividend yield of 2.7%, you would be going down only two percentage points from Paraguay’s sovereign debt for a huge reduction in risk. Coca-Cola has not only preserved its dividend through hard times, it’s raised it every year for the last 50. However, security comes with a price and Coca-Cola is the most expensive stock of the bunch, with a P/E of 19.

The international market is full of deep risks and opportunities. Looking abroad can lead you to excellent yields and huge upsides, but international investments can also be harder to research and keep track of. None of these companies are risk-free, but I wager that they will provide better and safer returns over the next ten years than Paraguay’s foreign debt.

CallaMarie owns shares of Banco Santander Central Hispano SA (ADR), Coca-Cola, and Petroleo Brasileiro S.A. (ADR). The Motley Fool recommends Coca-Cola and Petroleo Brasileiro S.A. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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