Like U.S. firms, major Latin American companies have corporate debt in the form of U.S. dollar-denominated bonds. Unlike their U.S. counterparts, however, Latin corporations tend to borrow heavily in lower-interest foreign currencies (such as dollars or, increasingly, euros) to take advantage of relatively liquid U.S. high-yield bond markets and lower U.S. interest rates.
The same Latin companies that may have American depositary receipts, or ADRs, on the
New York Stock Exchange
market will likely have dollar-denominated bonds that can offer investors better, more reliable returns than equity.
Of course, these aren't the 100%-to-200% returns that come with investing in Internet stocks or the latest IPO. Still, yields between 10% and 20% are readily available. And an investor can achieve these returns while minimizing the currency risk usually associated with overseas investing.
The Currency Is the Question
An investor is taking on direct exposure to what have been rather volatile currencies when he or she buys an ADR. Since equity represents ownership, the value declines because the assets, including earnings, of the corporation will be worth less in U.S. dollar terms if the currency of the company's home country weakens.
While the prices of corporate U.S. dollar-denominated bonds may be temporarily affected by the depreciation of the currency, the guaranteed cash flow from the bonds should be unaffected. Because both principal and coupons are denominated in dollars, they are unaffected regardless of what happens to the home-country currency. If the devaluation is severe enough to cause an economic collapse, then the company could go out of business or default on its bonds -- hence the credit risk. But guess what? If that happens, the stockholders are out of luck as well. In the case of bankruptcy, bondholders may hope to recover at least part of their investment. (If they bought the bonds at a discount, they may recover most of their investment or at least receive new bonds; stockholders are simply out of luck.)
Here's how it works. First, let's ignore stocks that are proxies for their individual markets, such as
( TBH) or
( TMX). Both those stocks tend to mirror the investor sentiment of their respective countries, Brazil and Mexico, at any given time because as former state-controlled monopolies, they represent about 20% of the capitalization of their home stock markets. In other words, if investors want to be long or short Mexico, they would buy or sell Telmex as it represents close to 20% of the Mexican stock market's capitalization and is its most active stock. In that sense, these companies can make interesting speculative plays for investors wishing to bet on short-term direction in Latin American markets.
But let's pretend we want to take a longer-term outlook (say, one year) by investing in a company that has both dollar-denominated bonds and ADRs but does not act as a proxy for the country. Further, let's examine a period that was very difficult for the emerging markets, Jan. 1, 1998, to Dec. 31, 1998.
( CMXBY), the largest cement company in Mexico and the third-largest cement company in the world, has an ADR and a series of dollar-denominated corporate bonds. In 1998, Cemex ADRs fell about 50%, in line with a 25% depreciation of the Mexican peso and a fall in the underlying stock price. The price of the company's 9.5% coupon two-year dollar-denominated bonds remained relatively stable, although there was some volatility throughout the year. At the end of the year, however, an investor in the Cemex bonds actually made 9.5% on the investment (due to the coupon), while the equity investor lost 50%. More important, because Cemex has fairly reliable U.S. dollar earnings (from sales in the U.S. Southwest), earning dollars to pay debt is more predictable than, say, translations of domestic earnings into dollar payments.
This isn't limited to Cemex. A number of Latin American companies have both ADRs and dollar-denominated corporate bonds; if investors are willing to take the credit risk by buying the stock, then the bonds merit their attention even more, particularly because the bonds carry relatively high current yields and attractive coupons. Indeed, Latin American corporate debt that trades at a discount (such as
Telefonica de Argentina
( TAR)) may actually participate in rallies of the equity, giving investors the best of both worlds.
Scott Grimberg is the emerging-market fixed-income strategist for Miller Tabak Roberts Securities. At the time of publication, he held no positions in the instruments discussed in this column, although holdings can change at any time. The opinions expressed in this article are Grimberg's and do not necessarily reflect those of Miller Tabak Roberts Securities. While he cannot provide investment advice or recommendations, he invites you to comment on his column at