John Dizard: Bonds, risk and a backlash from Brazil
By John Dizard
Published: May 23 2003 5:00 | Last Updated: May 23 2003 5:00
By far the most abusive e-mail I have received since starting this column came in April of this year in response to my suggestion that investors bail out of Brazilian debt and, in particular, the "C" dollar bond. My favourite was one from someone calling himself "Indignate [sic] people from Brazil!", who wanted to know: "How can you put news against C Bonds?? Something wrong with people of Brazil? . . . By the way, who is England?? King of the world?? Wanna figth [sic] with another country killing the starving people!!".
Mr Market also initially chose to disagree with me. From the end of March, when I wrote the piece, to May 13, the benchmark C bond's spread against the US Treasury curve (a measure of its riskiness) dropped from about 1,000 basis points to 739 basis points. "Indignate people!" was winning the argument.
Since then, however, there have been a few second thoughts among some in the mob chasing yield in emerging markets. By the middle of this week, the C bond's spread was back up to 850 basis points over the Treasury curve. I still think there will be more of a correction to come.
"What worries me," says one trader, "is that people who wouldn't buy Brazil at 1,800 over are eager to buy it at 800 over."
None of this is due to any failings on the part of Lula da Silva's government. The president has done a heroic job of maintaining a responsible policy course while retaining a broad popular base.
But I am trying to look out for the interests of investors. Even if Lula gets through Congress the government pension savings needed to meet his goals, the changes will be under attack in the country's Supreme Court. That is true even if Lula gets his changes through as a constitutional amendment, thanks to the superprotected status of what are known there as "acquired rights". Any serious setbacks on pension reforms are likely to mean a sell-off in Brazil's external debt.
I also had an interesting response to last week's column on the Premier Low Risk Fund, confirming my thoughts that its name might not be a literal description. At the suggestion of a reader, I contacted Ned Cazalet of Cazalet Consulting in London. Mr Cazalet is a well-regarded expert on the UK life insurance industry. He has been an adviser to the UK Financial Services Authority and the UK Treasury.
As Mr Cazalet said of the PLRF's unbroken record of monthly increases in value: "You have to ask yourself why it is not going down and are these numbers real." After all, he points out, the "with-profits" insurance policies in which the fund invests have been hit by the equity market declines in the past three years. "One had its with-profits maturity value slashed overnight by 19 per cent last year. That was the extreme but the others cut them by 10-15 per cent." PLRF and its fellow investors in "Traded Endowment Policies" depend on these maturity values for their profits.
Mr Cazalet, who was on the FSA's "with-profits" standing panel, also said he "had to raise an eyebrow" over the common directorships held by the fund, a market-maker selling policies to the fund, and the company that sets the net asset value of the fund. "You would want to make absolutely sure that the valuation was actually carried out by someone with absolutely no connection to the market maker or the manager of the fund.
"The more the numbers look too good to be true the more it is incumbent on them to put all their cards on the table face up."
There is another interesting aspect to the Premier Low Risk Fund. Any immediate liquidity requirements the fund has can be met by either new investors' cash or through the use of a secured line of credit from the Royal Bank of Scotland. The bank can be repaid by selling the underlying assets if insufficient cash is generated from new investors or realised profits.
This is where it can get absolutely fascinating, as the Air America pilots used to say. If more fund shares are sold back than there is cash on hand to cover them, the bank is first in line to get its money back. If the underlying assets have been overstated and cannot be liquidated at a price close to their book value, then investors who try to take their cash out could be hit with a double blow, since the bank will be made whole before they see a penny. That is the magic of leverage.
Bad things have already happened to some investors in TEP funds. Neville James, another TEP fund, was forced to suspend dealing. Last November a "restructuring" turned investors' Net Asset Value into a Net Realisable Value for any who wished to redeem shares. Redemption is now available only once a month, and at a large discount to what investors thought was their NAV.
johndizard@hotmail.com |
