Looking for mispriced assets
Real return bonds, gold miners, emerging markets credit
Some people spend their summers jumping into the water off a dock on a quiet lakefront or hiking mountain trails with a picnic lunch. We, however, find the slowness of summer makes it a perfect season for scouring markets for price series that seem stretched to the downside. Good long-term outcomes often spring from noticing a value equation that represents an outlier relationship between the price investors are paying for a security and the value they receive. Doing this in the summer of 2023, we are drawn to the following set of opportunities.
TIPS and Real Return Bonds
There was a time, not too long ago, when burgeoning post-pandemic inflation drove many investors toward TIPS (Treasury Inflation Protected Securities), Real Return Bonds, and other inflation-protected securities. However, the Federal Reserve’s sharp rate hiking program changed investors’ estimates of future inflation, and TIPS delivered a negative 13% total return between March and November 2022.
Now that the dust has settled, and disappointed investors have punted their inflation protection, we look at a five-year TIPS priced to deliver an extraordinary 2% above breakeven inflation expectations. When priced at that level in late 2008, the 5- to 10-year TIPS Total Return Index delivered over 46% over the ensuing four years. TIPS, Real Return Bonds, and closed-end funds that focus on this market all seem extremely cheap here.
Gold miners…cheap vs gold
Although there is some relationship between the price of gold and the valuation of gold mining companies, their price series can diverge significantly. From a 2011 peak, the price of gold mining companies, as measured by the NYSE Arca Gold BUGS Index, has fallen by more than 60%, while the U.S. dollar gold price has risen slightly over the same timeframe.
Plentiful, profitable, and producing gold miners are trading well below book value, and there appears to be enormous potential – both in the straight bonds and convertibles of many of these issuers. Following the gold stock selloff of 2015, the last time the miners were this discounted compared with the precious metal, mining enterprise values subsequently soared, and the NYSE Arca Gold BUGS Index nearly tripled over the next nine months.
Emerging markets credit
Emerging markets bonds offer surprisingly high yields given relatively tame inflation and fairly good credit fundamentals.
If one looks at the debt-to-GDP factor for Mexico, Brazil, Indonesia, and Turkey, it recently averaged 53% of GDP. That compares positively to the United States, for which the same ratio recently read 127% of GDP.
Inflation in Brazil recently printed at 3.2%, less than 0.2% higher than headline U.S. inflation. And yet Brazilian 10-year bonds yield more than 10%, while the U.S. 10-year yields approximately 4%.
The level of real yields for both sovereigns and corporates in select markets like Mexico and Brazil is very attractive, particularly in comparison with some developed markets. And so, selectively, we have added exposure to several issuers. We also like certain closed-end funds focused on emerging markets credit, such as such as Western Asset Emerging Market Debt Fund (NYSE: EMD), which offers a 10.3% payout and a discount to daily NAV that exceeded 15% in the latter part of July.
Geoff Castle is Portfolio Manager of the Pender Corporate Bond Fund at PenderFund Capital Management. Excerpted from the Pender Fixed Income Manager’s Commentary, July 2023. Used with permission.
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