[EU] Considering investing in 10Y Spanish bonds: Change my mind

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RME
Posts: 27
Joined: Thu Jan 25, 2018 10:01 am

[EU] Considering investing in 10Y Spanish bonds: Change my mind

Post by RME » Sat May 26, 2018 4:20 pm

Hi,
Im from Spain and I follow a Boglehead approach in the stock allocation: low-cost, diversified indexes.
The issue appears in the bond part of the portfolio, the boglehead would suggest a Global Goberment Bond Fund hedged in EUR or a Europe Goberment Bond fund but as you know, the interest rates are being manipulated by the ECB (European Central Bank) and these are the current yields for some bonds:

Germany Bund 5 Year Yield: -0.23%
Germany Bund 10 Year Yield: 0.40%

By contrast, other european countries like Spain offer this yields:

Spain 5 Year Government Bond Yield: 0.48%
Spain Generic Govt 10Y Yield: 1.46%

(For reference, USA yields)
United States 10 Year: 2.75%
United States 10 Year: 2.88%

As I live in Spain I know by first hand that Spain is not going to default on its debt anytime soon so I dont understand the differential between EU bonds as they are "backed" by the ECB.

Comparison (Euro Gob Bonds vs 10Y Spanish bonds):
Image

http://www.morningstar.es/es/funds/snap ... F0GBR04SKM
http://www.morningstar.es/es/etf/snapsh ... 0P0000Y2WM

Valuethinker
Posts: 35960
Joined: Fri May 11, 2007 11:07 am

Re: [EU] Considering investing in 10Y Spanish bonds: Change my mind

Post by Valuethinker » Sat May 26, 2018 4:34 pm

If the bond market is efficient then that is the markets estimate of the default probability per annum, less likely recoveries, of Spanish bonds over German Bunds.

The European Central Bank most assuredly does not back the bonds of the member states of the Eurozone. Neither does the EU. If a default happens, the bondholders will take real pain in the restructuring. They did in Greece.

JBTX
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Re: [EU] Considering investing in 10Y Spanish bonds: Change my mind

Post by JBTX » Sat May 26, 2018 5:15 pm

Spain has somewhat higher govt debt to gdp around 100%. That is high but not as bad as others.

The risk, which is remote, is that something happens such that Spain leaves the Euro. Perhaps precipitated by Greece leaving, after which other higher debt slower economies prefer to leave (Italy and Portugal). If they were to leave it is highly likely their new currency and debt would decline vs the Euro.

Of course, this isn’t likely, but does an extra 2% of return compensation for that theoretical risk? Only you can answer that.

asset_chaos
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Location: Melbourne

Re: [EU] Considering investing in 10Y Spanish bonds: Change my mind

Post by asset_chaos » Sat May 26, 2018 6:18 pm

Bonds are the safe, stable part of your portfolio. It's easy to want a higher yield, but higher yield means higher risk perceived by the market. Also, as Spain is not a large part of the global bond market, diversification benefits should exist. If it were me, I'd go with the more diversified investment, if it could be had at reasonable cost.

Vanguard has a recent paper on hedged global bonds versus local bonds and unhedged global bonds, https://personal.vanguard.com/pdf/ISGGLBD.pdf. From memory there was a noticeable, but not overwhelming, benefit for euro investors from hedged global bonds versus euro bonds.
Regards, | | Guy

silverex
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Location: Vilnius, Lithuania

Re: [EU] Considering investing in 10Y Spanish bonds: Change my mind

Post by silverex » Sun May 27, 2018 4:22 am

Version of this Vanguard paper specifically for euro area investors is here: https://www.vanguardfrance.fr/documents ... -tlisg.pdf

Valuethinker
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Joined: Fri May 11, 2007 11:07 am

Re: [EU] Considering investing in 10Y Spanish bonds: Change my mind

Post by Valuethinker » Sun May 27, 2018 6:34 am

JBTX wrote:
Sat May 26, 2018 5:15 pm
Spain has somewhat higher govt debt to gdp around 100%. That is high but not as bad as others.

The risk, which is remote, is that something happens such that Spain leaves the Euro. Perhaps precipitated by Greece leaving, after which other higher debt slower economies prefer to leave (Italy and Portugal). If they were to leave it is highly likely their new currency and debt would decline vs the Euro.

Of course, this isn’t likely, but does an extra 2% of return compensation for that theoretical risk? Only you can answer that.
Political risk is not zero in Spain.

There have been huge corruption scandals. And the Catalonian independence movement is not likely to go away. In case someone jumps on me, I would say the same thing for both Scotland and Quebec (and Northern Ireland, now, especially after these last 3-4 weeks). Let me try to avoid a political argument (which is pointless given the impossibility of predicting accurately that sort of thing) by noting the existence of this risk, and accepting that it could be higher in the Anglo-Saxon cases I mention above (perhaps is higher, for this generation -- none of us likes to hear of our home countries breaking up).

Just to note these as additional risks to Spanish government bonds. The market clearly does not think the risk is zero-- or the spread over Bunds would be zero.

Why would we know more than the market as a whole?

RME
Posts: 27
Joined: Thu Jan 25, 2018 10:01 am

Re: [EU] Considering investing in 10Y Spanish bonds: Change my mind

Post by RME » Sun May 27, 2018 7:29 am

Valuethinker wrote:
Sun May 27, 2018 6:34 am
JBTX wrote:
Sat May 26, 2018 5:15 pm
Spain has somewhat higher govt debt to gdp around 100%. That is high but not as bad as others.

The risk, which is remote, is that something happens such that Spain leaves the Euro. Perhaps precipitated by Greece leaving, after which other higher debt slower economies prefer to leave (Italy and Portugal). If they were to leave it is highly likely their new currency and debt would decline vs the Euro.

Of course, this isn’t likely, but does an extra 2% of return compensation for that theoretical risk? Only you can answer that.
Political risk is not zero in Spain.

There have been huge corruption scandals. And the Catalonian independence movement is not likely to go away. In case someone jumps on me, I would say the same thing for both Scotland and Quebec (and Northern Ireland, now, especially after these last 3-4 weeks). Let me try to avoid a political argument (which is pointless given the impossibility of predicting accurately that sort of thing) by noting the existence of this risk, and accepting that it could be higher in the Anglo-Saxon cases I mention above (perhaps is higher, for this generation -- none of us likes to hear of our home countries breaking up).

Just to note these as additional risks to Spanish government bonds. The market clearly does not think the risk is zero-- or the spread over Bunds would be zero.

Why would we know more than the market as a whole?
This is the same market that thinks that the risk on Spanish 5Y debt is lower than American.

Spain 5 Year Government Bond Yield: 0.48%
United States 5 Year: 2.75%

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Lauretta
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Re: [EU] Considering investing in 10Y Spanish bonds: Change my mind

Post by Lauretta » Sun May 27, 2018 7:35 am

RME wrote:
Sun May 27, 2018 7:29 am
Valuethinker wrote:
Sun May 27, 2018 6:34 am
JBTX wrote:
Sat May 26, 2018 5:15 pm
Spain has somewhat higher govt debt to gdp around 100%. That is high but not as bad as others.

The risk, which is remote, is that something happens such that Spain leaves the Euro. Perhaps precipitated by Greece leaving, after which other higher debt slower economies prefer to leave (Italy and Portugal). If they were to leave it is highly likely their new currency and debt would decline vs the Euro.

Of course, this isn’t likely, but does an extra 2% of return compensation for that theoretical risk? Only you can answer that.
Political risk is not zero in Spain.

There have been huge corruption scandals. And the Catalonian independence movement is not likely to go away. In case someone jumps on me, I would say the same thing for both Scotland and Quebec (and Northern Ireland, now, especially after these last 3-4 weeks). Let me try to avoid a political argument (which is pointless given the impossibility of predicting accurately that sort of thing) by noting the existence of this risk, and accepting that it could be higher in the Anglo-Saxon cases I mention above (perhaps is higher, for this generation -- none of us likes to hear of our home countries breaking up).

Just to note these as additional risks to Spanish government bonds. The market clearly does not think the risk is zero-- or the spread over Bunds would be zero.

Why would we know more than the market as a whole?
This is the same market that thinks that the risk on Spanish 5Y debt is lower than American.

Spain 5 Year Government Bond Yield: 0.48%
United States 5 Year: 2.75%
I think you would have to compare the yields when hedged to the same currency (otherwise even EU high yield bonds earn less than treasuries when you measure the yield of each in local currencies!). Once you take into the account the cost (or in the case of a US investor buying EU bonds hedged to the USD, the benefit) of currency hedging, the yields tend to reflect the risk.
When everyone is thinking the same, no one is thinking at all

Valuethinker
Posts: 35960
Joined: Fri May 11, 2007 11:07 am

Re: [EU] Considering investing in 10Y Spanish bonds: Change my mind

Post by Valuethinker » Sun May 27, 2018 3:28 pm

RME wrote:
Sun May 27, 2018 7:29 am
Valuethinker wrote:
Sun May 27, 2018 6:34 am
JBTX wrote:
Sat May 26, 2018 5:15 pm
Spain has somewhat higher govt debt to gdp around 100%. That is high but not as bad as others.

The risk, which is remote, is that something happens such that Spain leaves the Euro. Perhaps precipitated by Greece leaving, after which other higher debt slower economies prefer to leave (Italy and Portugal). If they were to leave it is highly likely their new currency and debt would decline vs the Euro.

Of course, this isn’t likely, but does an extra 2% of return compensation for that theoretical risk? Only you can answer that.
Political risk is not zero in Spain.

There have been huge corruption scandals. And the Catalonian independence movement is not likely to go away. In case someone jumps on me, I would say the same thing for both Scotland and Quebec (and Northern Ireland, now, especially after these last 3-4 weeks). Let me try to avoid a political argument (which is pointless given the impossibility of predicting accurately that sort of thing) by noting the existence of this risk, and accepting that it could be higher in the Anglo-Saxon cases I mention above (perhaps is higher, for this generation -- none of us likes to hear of our home countries breaking up).

Just to note these as additional risks to Spanish government bonds. The market clearly does not think the risk is zero-- or the spread over Bunds would be zero.

Why would we know more than the market as a whole?
This is the same market that thinks that the risk on Spanish 5Y debt is lower than American.

Spain 5 Year Government Bond Yield: 0.48%
United States 5 Year: 2.75%
You cannot do a read across on credit risk for bonds of different currencies

They are on different interest rate cycles and have different shapes of yield curve.

In addition the market is pricing different expectations re currency.

The strength of the US economy and the Fed stance towards tightening has pushed up US interest rates relative to Euro ones.

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