This week we look at A- rated investment grade Morgan Stanley bonds debt denominated in Brazilian Real and its 8.5% yields to achieve the difficult task of providing higher fixed income returns with a short to medium term maturity in a strong growth economy.
Corporate Bond linked to the Brazilian Real
Morgan Stanley (MS) has issued debt, denominated in the Brazilian real, which currently has a yield of over 8.5% for 59 months. The high yield of this five year Brazil bond, when considered with its solid “A-” rating and favorable positioning within the US financial system, offers an extremely favorable reward to relatively low risk position. As the European debt crisis continues to muddle along, the vacillating concerns over the euro and the effect they have on many global currencies appears to be growing old. Quantitative easing remains a major concern for many investors, who seek protection against further devaluation of the dollar and the continued erosion of its buying power. In our ongoing effort to address the concerns of our clients in protecting their existing wealth from the destruction caused by this persistent currency devaluation, we believe this short to medium term Morgan Stanley Brazil bond represents this week’s best opportunity to add the higher yields of one the world’s best emerging economies to our Foreign and World Fixed Income holdings at a reasonable exchange rate.
Wealth Preservation Concerns
Wealth preservation continues to be one of the biggest concerns among our clients. In other words, the focus for many people is not necessarily towards making more money, but to preserve the wealth they have already accumulated by taking what we call “intelligent risks” to achieve reasonable returns that can simply outpace moderately rising inflation. With US Ten Year treasury yields hovering slightly above 1.5%, and with energy commodities (up over 6% year over year) threatening to push the CPI average back over 3%, a certain degree of wealth destruction is virtually assured within these otherwise commonly considered “safe” US government notes.
Regardless of the euro’s two year lows against the dollar, the flight to safety evoked by the ever evolving European debt crisis appears to be having noticeably less effect on the exchange rates between other global currencies. Consequently, the dollar appears to be pondering a returning to its longer term decline relative to many other major global currencies.
Here at Durig Capital, we are continuing in the effort to protect our client’s assets against the persistent destruction associated with an ever increasing supply of US dollars by scouring the globe in search of sound investments in a basket of the strongest global currencies, and it is why we have chosen Morgan Stanley’s very high yield, medium term Brazil bond as This Week’s Best Bond.
Brazilian Economy
By far the largest and most populous country in South America, Brazil continues to pursue industrial and agricultural growth and development of its interior. Exploiting vast natural resources and a large labor pool, it has large and well-developed agricultural, mining, manufacturing, and service sectors. It is the world’s largest producer of coffee, sugar and orange juice and the second-largest exporter of iron-ore and soybeans. Brazil’s offshore oil fields have turned it into a net crude exporter, helping it expand its presence in world markets, and its economy outweighs that of all other South American countries. Currently, Brazil is the world’s 11th largest oil producer.
Brazil’s economy slowed sharply last year, but remained among the world’s best at near 3%. Despite concern about the impact of slower Chinese growth, Brazil recently moved up to be the world’s sixth-largest economy and while it was expected to continue growing about 3 1/2 percent in 2012, this has been lowered to just over 2% according to the latest central bank survey. This fundamentally solid economic growth underscores the importance of emerging markets, if it should even still be regarded as emerging, as the developed world continues to struggle with a sluggish rebound from the global economic slowdown and the European debt crisis.
Despite continued price pressures in Latin America’s largest economy, the Brazilian Central Bank suddenly shifted course late last year to cut interest rates because of concerns about global economic growth. Given that the inflation rate in Brazil slowed to below 6% and is projected to pace closer to 5 ¼% for 2012, the rate cut appears warranted. The government’s official inflation target remains around 4.5%. Last month, the inflation rate fell to just below 5%, the lowest level in nearly two years. After recently announcing that the long-term reference rate for loans from the BNDES state development bank will be cut to a record low 5.5 percent from 6 percent, Finance Minister Guido Mantega states that Brazil’s government plans to “maintain a devalued real” using various mechanisms to anchor the currency at a lower exchange rate that will help maintain competitiveness. Central bank President Alexandre Tombini has reduced the target lending rate by 4 percentage points to a record low 8.5 percent since last August to shield the economy from the European debt crisis. Traders expect the benchmark to fall to at least 7.75 percent this year, according to interest-rate futures. To counter the weakening of its currency, Brazil’s central bank has been stepping up intervention in the market, holding auctions to put more dollars in the market. The bank recently held three swap auctions, selling the equivalent of $9 billion in contracts.
About Morgan Stanley
After the Glass-Steagall Act of 1933 which separated commercial banking from securities underwriting, Morgan Stanley opened for business after separating from J.P. Morgan. When the global financial crisis of 2008 brought down rivals Bears Sterns and Lehman Brothers, Morgan Stanley secured a $9 Billion capital investment from Mitsubishi UFJ (MUFG.) The firm also helped the U.S. Treasury navigate the crisis at mortgage providers Fannie Mae and Freddie Mac. In 2009, James Gorman helped create the largest wealth management platform in the world when he led the merger and integration of Morgan Stanley’s retail brokerage operations and Citibank’s Smith Barney brokerage unit. The wealth management platform is a very good annuitized income, lower risk business. The Morgan Stanley Smith Barney joint venture is now a global leader with more than 18,000 financial advisors and $ 1.5 trillion in client assets.
Morgan Stanley delivered strong full year results, reporting fourth quarter net revenues at $5.7 Billion and full year net revenues for 2011 at $32.4 Billion. The Global Wealth Management Group delivered net revenues of $13.4 billion, with global fee-based asset flows of $42.5 billion and net new assets of $35.8 billion, the highest for both since the inception of the Morgan Stanley Smith Barney joint venture (MSSB). The year’s pre-tax margin improved to 10% from 9% a year ago. Asset Management reported net revenues of $1.9 billion, with assets under management or supervision of $287 billion and positive net flows of $25.8 billion. In strategic actions that further strengthen Morgan Stanley’s capital and liquidity, their Series B Preferred Stock held by MUFG was converted into common stock, and several outstanding strategic and legacy issues were resolved, including a settlement with MBIA.
Issuer
Currency
5 Year Bond Yield
Ratings
US Treasury
US Dollar
0.72%
AA+,AAA,AAA
Morgan Stanley
US Dollar
4.75%
A-, A2, A
Morgan Stanley
Brazilian Real
8.5%
A-, A2, A
his Morgan Stanley Brazil bond indicates a yield pickup of about 8% when compared to similar maturity US Treasuries, and a yield that is nearly twice that of similar Morgan Stanley bonds denominated in US dollars. Even if the Congressional Budget office is wrong and we have strong appreciation in the dollar, as long as the currency appreciation averages less than 3.75% annually relative to the Real, this bond would still outperform its US dollar counterpart. However, if the CBO is correct, and should the US currency decline instead of gain that same amount annually, that much appreciation of the Real would likely result in a better than 12% annual return.
Please compare this Brazilian Real Linked Morgan Stanley Bond to Bank of America (BAC) Brazilian real bonds and Australian dollar bonds of shorter maturities.
Risks
The default risk is Morgan Stanley’s ability to perform. Given last year’s great results, their improved balance sheet, and the positive outlook for Morgan Stanley, it is our opinion that the default risk for this short term bond is minimal relative to the currency risk of the Brazilian real.
The currency risk of the Brazilian real could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to the Brazilian economy.
Accessibility and Liquidity
Morgan Stanley currently has over $415 billion of outstanding debt, mainly denominated in U.S. dollars. Aside from owning various emerging market funds and ETFs that blend together various winners and losers into a mixed yield cocktail, the question arises as to how a retail investor might own or acquire individual, maturity definite Morgan Stanley Brazilian real linked notes. Many times broker/dealers require an institutional sized single bond purchase. However, with a broker and advisor’s assistance, it is possible for a number of retail clients to be combined together in order to make a larger institutional sized purchase. Previously, we have been able to facilitate purchases as low as US $10,000.
Conclusion
We hope NOT to see any further destruction of wealth resulting from a constant decline in the US dollar relative other global currencies as forecast by the Congressional Budget Office, and we acknowledge that a strengthening of the US dollar would directly reduce the total returns of this Brazilian real denominated bond. On the other hand, should the US dollar continue on the long term path of devaluation that it has been on, this alone could add quite significantly to the already highly positive accruing returns of this bond, not to mention the possible stellar returns that would result should the US dollar ever loose its domineering status as the world’s reserve currency and collapse against a basket of other stronger currencies.
Considering Brazil’s prominent position as the leading emerging market economy, stable political system, and solid growth prospects in spite of broader global slowdowns, we view the gaining of over twice the yield as an incredibly compelling reason for choosing Morgan Stanley’s Brazilian real bond over their similar US dollar bond. The combination of a remarkably high yield, a protection against the further loss of wealth that would result should the US dollar continue to weaken against the real, and a diversification away from heavily overweighted US dollar based assets into one of the world’s top emerging markets is why we have chosen to add this 59 month Morgan Stanly bond linked to the Brazilian Real to our Foreign and World Fixed Income holdings.
Coupon: 10.09
Maturity: 5/03/2017
Rating: A-
Price: 105.0
Yield to Maturity: 8.757%
Disclosure: Some Durig Capital clients currently own these bonds.
Disclosure:
Durig Capital clients may currently own these bonds.
Contact our fixed Income analyst for questions at 971-327-8847.
Durig.com | Bond-Yields.com
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