January 9, 2008

Bond performance

I have discussed bonds as potential idea in a previous post, read it here. The conclusion was Emerging market Debt is a good bet but municipal bonds and high yield bonds are laced with losses despite their very attractive yields to treasury.

The credit problems have put indiscriminate pressure on all types of debt. However Emerging Market debt risks have not changed as a result of the liquidity crunch. Long gone are the days of the Russian, Mexican and Asian tigers defaults. Emerging markets economies are performing well even at the risk of US rescission their economies will slow significantly but they have graduated to more investment grade debt. Indeed the funds that I have talked about have performed relatively well compared to the market retauns have ranged from 4-10% from my earlier post. And I still think they have more to run.

Several issues from Indonesian, Mexican and other sovereign governments bent up issuers are waiting to hit the market. The demand for these bonds is expected to be strong. Off course the risks associated with this idea is the severity and the duration of US weakness. If the rescission is severe and long all world economies will falter and debt will reprice.

Municipal bonds continue to be recommended by media and analysts because their yield s have spiked to levels higher that treasuries and investment grade corporate on after tax basis. However, there are several notable risks facing munis which include, see also this article:
  • The pension payment crisis unfolding in many states and communities.
  • Increasing budget shortfalls for basic infrastructure projects.
  • Reduced tax collection due to foreclosures.
  • Rejection of tax increases by voters in communities facing economic stress.
  • Probable insolvency of bond insurance firms (ACA Capital, MBIA, Ambac Financial)
  • Falling revenue from community projects.
  • Impending court rulings about state tax interest deductibility.
  • Community investment fund losses (see Will State SIV Funds bankrupt local communities?).
  • An increasing number of bond downgrades from rating agencies.
Some reports on CNBC speculated that the municipal bonds backed by the unsuccessful Vegas monorail could default on interest payments. If you have to invest in munis then the only way I would do it is to buy what Buffett insures. He already started with a New York issue.

Sources: bloomberg, bondsonline.com, Reuters

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