Aside from favouring investment grade bonds from what we at Stratton Street deem ‘Wealthy Nations’ (NFA ranking above 3 stars), one of our most important criteria for inclusion in the investable universe is risk-adjusted relative value. A great example could be a bond issued by Singapore’s holding company, Temasek 5.375% 2039. Using our proprietary Net Foreign Asset Model, we calculate that Singapore is wealthy, with NFA exceeding 200% of GDP, thus achieving the highest, 7 star ranking. State-owned Temasek in-turn is rated AAA by both Moody's and S&P. In terms of risk adjusted relative value, we calculate that the USD bond maturing in 2039 offers an expected return and yield around 9.2%; thus cheap.
Compare this with sub-investment rated Nigeria, with a NFA 4 star rating. One would expect this B2/B+ bond to offer more in terms of attractiveness. However, if we look at Nigerian Government 7.696% 2038s, the expected return is calculated at -20.25%. Some may look at the ‘attractive’ 7.7% yield in isolation, however, when we add this back, the comparable yield and return would not justify a position in our portfolios; at an expensive -12.55%. Currently trading at a spread around 480bps over Treasuries, this bond could actually suffer a capital loss of 19 points to reach an estimated ‘fair value’ spread of ~700bps.
The saying goes: ‘buy cheap, buy twice’, in this case we’d be happy owning twice the amount of Temasek.