Traditionally, investors put money into stocks for capital appreciation and invest in bonds for income with capital preservation. Financial advisers routinely recommend investing in both stocks and bonds, a strategy that proved particularly prudent over the last 30 years, when bonds outperformed stocks. However, for those of us building our portfolios now, low interest rates make bonds look only marginally more attractive than a savings account. Low interest rates have made bond offerings possible for countries formerly shut out of international markets, and investors have happily bought up the debt of countries like Bolivia and Paraguay at yields under 5%.
Most sovereign debt carries a small default risk, but when a government defaults on its bondholders, the capital preservation perk of bonds disappears. Think Greece or Argentina: when the government defaulted, the governments gave bondholders new bonds with face values up to 70% lower than the original. Usually, default risk is priced into bond yields: medium-risk countries offer bonds with much higher yields than low-risk countries and high-risk countries are effectively locked out of bond markets by extremely high borrowing rates.
However, low interest rates have recently let countries with a high risk of default offer sovereign debt at historically low yields. For example, Bolivia sold $500 million in ten-year notes in October 2012, initially yielding 4.8%. Bolivia epitomizes a high-risk country: it set world records for inflation and coup prevalence in the 1980s and while Bolivia’s macroeconomic health has improved drastically, the current administration routinely nationalizes foreign and domestic companies. In other words, the country has a history of political and economic instability and a track record of appropriating foreign-owned assets.
Paltry income
Bolivia’s and neighbor Paraguay’s sovereign debt yields nearly 4.8%. For those who wish to go a notch down in risk, however, the yield falls considerably. In September, Brazil sold ten-year notes at a record low of 2.6%, or about .6% above the U.S. inflation rate. Brazil will offer ten-year notes again in the next couple weeks, with yield estimates around 3%. While Brazil shows no signs of defaulting, its economy is limping along at 1% GDP growth and a decades-long era of inflation, currency devaluations, and debt crises is only ten years behind it. Brazil is a medium-risk country, not the low-risk borrower that a 3% yield usually denotes.
Dividend stocks are a better bet
Dozens of companies operating throughout Latin America are at lower risk for bankruptcy than Bolivia is for default, and offer a higher dividend yield than Brazil’s bond yield. I argue that many of these companies offer better odds of capital preservation and income than Latin American foreign debt, and many of the region’s dividend stocks have plenty of room to appreciate as well.
Telefonica Brasil SA (ADR) (NYSE:VIV) is a Brazilian telecommunications megacap. Telefonica shares have a beta of .67, making the stock a good candidate for capital preservation. Even better, Telefonica comes with a gigantic 8% dividend, leaving Latin American sovereign debt yields in the dust and topping the dividend yields of most large U.S. telecommunications companies. Telefonica Brasil SA (ADR) (NYSE:VIV) trades at a price-to-book ratio of 1.36, leaving room for capital appreciation as well.
Spanish-based Banco Santander, S.A. (ADR) (NYSE:SAN) operates across Latin America. Banco Santander has avoided much of the pain in Spain by making conservative loan decisions and doing business elsewhere, particularly in Latin America. Banco Santander, S.A. (ADR) (NYSE:SAN)’s share price has a beta of 1.8, making it a poor candidate for capital preservation, but its 8.9% yield puts Bolivia’s bond yield to shame.
I rate Banco Santander a long-term buy on my CAPS page. Over the last 15 years, it has spun off its Chilean, Brazilian, and Mexican operations into separate publicly-traded companies as a way to raise cash without taking on debt. The least volatile and longest-lived spin-off, Banco Santander-Chile (ADR) (NYSE:BSAC) has a beta of .9 and a smaller but respectable 3.1% dividend yield. As emerging market bank stocks with betas of .9 and 1.8, respectively, and sizable dividend yields, both companies offer little capital preservation but plenty of income and capital appreciation.
Finally, The Coca-Cola Company (NYSE:KO) is headquartered in the U.S. but operates in every Latin American country. Coca-Cola has a beta of .5 and a dividend that has increased every year for the last 50. Not only is Coca-Cola present in every Latin American country, it has a big and solid business: at $44 billion, Coca-Cola’s 2012 profits were as large as Paraguay and Bolivia’s GDPs combined. The Coca-Cola Company (NYSE:KO) shares offer capital preservation, capital appreciation and, with a yield of 2.9%, income comparable to Brazil’s sovereign debt.
With interest rates hitting historical lows around the world, governments with a high to medium risk of default are offering bonds with yields under 5%. Bolivia, Paraguay, and Brazil have all issued ten-year sovereign debt notes in the past six months and Brazil is readying for a new offering in the coming weeks. The default risks that these bonds carry – especially Bolivia’s — are not worth 3-5% yields. Investors should instead chase yield with high-quality, low volatility regional companies whose shares come with a sizable dividend.
The article Dividend Stocks Trump Foreign Bonds originally appeared on Fool.com and is written by Calla Hummel.
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