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Rising overseas borrowing

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From my experience within the fixed income space, specifically the riskier bonds segment, we have been observing an increase in the number of companies borrowing from other jurisdictions. Over the past years we have seen a substantial increase of US companies borrowing in Europe. Undoubtedly, the low interest rate environment is one of the main reasons, but not the sole factor.

Looking at the ICE Bank of America Merrill Lynch European Currency Non-Financial High Yield Constrained Index, an index that is composed of risky bonds, 16.3 per cent are American companies, while a further 8.9 per cent of this high yield index are non-European issuers.

Companies look at several aspects when considering borrowing from other jurisdictions. In our view the lower financing cost is one of the primary factors. Admittedly, when interest rates over the past years in the US started to rise while in Europe these remained intact, the spread over European counterparts increased notably. In fact, the current yield spread between the US 10-year and the European 10-year government bonds currently stands at around 2.48 per cent. Thus, when considering, for instance, pricing a 10-year bond in the US, the starting point is 2.5 per cent, whereas in Europe the starting point would be -0.003 per cent in the case of the current 10-year German Bund.

There is clearly a remarkable discrepancy and therefore the lower borrowing costs entice companies to borrow capital in lower-yielding jurisdictions. Europe is a clear example. In fact, over the recent years, we have seen companies such as Apple, Netflix, Hertz and Avis, among others, issuing bonds in euro as opposed to their historical dollar issues.

Another very interesting aspect is the alignment of debt to revenues. At times companies want to reduce risk by adopting the alignment concept. A very practical example is Global Ports, a Turkish port operator, which coincidently has an important shareholding of 55.6 per cent in Malta’s Valletta Cruise Port. In 2014, the operator issued a dollar-denominated bond, which was aligned to its revenue dollar stream.

Indeed, apart from the fact that it was cheaper for the company to borrow in dollar rather than in Turkish lira, this acted also as a natural hedge. Simply put, given that half of its revenues were in the US currency, the company could hold the dollar cash received and use the same proceeds to service its dollar-denominated debt, thus mitigating the possibility of facing currency risks. This is a very important aspect which we, as portfolio managers, look into detail as general market movements might generate opportunities.

Another aspect are mergers and acquisitions. A company might be targeting a transaction involving an overseas company and would want to raise funds in local currency to finance the deal. Given its potential strong reputation and performance among domestic investors, this would ease capital funding.

Undoubtedly, there are other aspects, but certainly, the above-mentioned factors are very important considerations which companies adopt in their financing rationale.

From an investor’s point of view, one of the prime advantages is the mispricing element. As investors are aware, the macro aspect has a huge impact on pricing. At times, price movements tend to move irrationally and this is when investors should take the plunge and invest at lower valuations. For instance, in line with the above aforementioned concept, emerging markets dollar-denominated issues were trading at very opportunistic levels in January this year. Companies that local investors are familiar with, such as Petrobras, were at the forefront of this trend.

Another advantage for investors is the diversification aspect. For those investors who would like to broaden their investment portfolio, this is surely a huge advantage. In addition, they would not be exposed to currency risk for the said diversification. For instance, Apple in 2014 issued for the very first time a euro-denominated bond which gave the opportunity to euro-based investors to invest in the firm and thus take the operational risk of the company, without the necessity of currency conversions. This diversified their investment spectrum.

Furthermore, apart from the diversification aspect, an unknown issuer to investors in other jurisdictions might need to ramp up the coupon to entice investors. This is seen as added advantage for investors to lock in a higher return.

In today’s globalised markets, having a well-diversified portfolio is imperative. In this regard, lending to solid companies outside one’s comfort zone is surely a helping hand in achieving diversification.

Research companies like ours and others across the globe encounter very interesting business models, which potential might not be tapped given the geographical positioning of such companies. By consulting with investment professionals, investors should take the plunge and search for investment options which are beyond the usual geographical parameters and which offer the possibility of investing in our base currency.

The Calamatta Cuschieri Traders Blog is available daily on CC WebTrader. Other market coverage including coverage of the International Bond Markets is also available.

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