Government Owned but paying 31.25%?


More reasons why I have invested in 6% Scandinavian Airlines Systems 6.2008. bonds at a yield of approximately 8.00%.

Dear International Friend,

I just instructed Jyske Bank to invest some of my most conservative core holdings into the SAS bonds mentioned in a recent article.

That message explained why this bond might be extra attractive but there are some other reason why I have decided to risk owning these bonds which are of a lower grade than I normally choose (they are rated A – I usually hold only AAA rated in my core holdings). First my Euro income almost doubles in these bonds. For example a similar AAA Euro bond issued by Denmark that also comes due in 2008 currently only yields about 4.65%. The second reason I accepted this bond is that SAS is 46% government owned. The three largest shareholders of SAS are the Swedish government 21.4%, Danish government 14.3% and Norwegian government 14.3%. This is certainly no guarantee that the bonds will be repaid but I believe this increases the likelihood that this airline will not be allowed to go bust if it runs into serious financial difficulties.

We recently saw this happen with Swissair when the airline ran out of credit and was grounded. The Swiss government quickly gave an emergency injection of $278 million to keep the airline going. Swissair's failure was due more to its purchase of failed Sabena airlines than operating losses, but whatever the reason of failure the point that struck me was that when a national airline, even when privately owned, goes bust, even for reasons outside the country, it is seen as a national humiliation that damages the image of the country abroad. When the airline is owned by the government the chances of a bailout are even more.

Holding SAS bonds can be reckoned to depositing at a large but troubled bank because you feel it is too large to be allowed to go broke but that it pays higher rates.

The final factor that helped me decide to invest in such a long dated bond is there is some chance that interest rates will fall rather than rise. A look at the chart below which shows US dollar interest rates for the past 200 years shows that though rates are now below the weighted average they could still fall further.

Another important point was recently made by an Eclub member who wrote:

"Gary,A lot of talk goes on about interest rates being at present as low as they were forty years ago.One thing is missing. Forty years ago, at the end of the fifties and early sixties, during the era of Gen. Eisenhower and Mr. Dulles, having very low interest rates was a sign of strength. Now low interest rates are a sign of weakness. Interest rates are lowered because everything is going wrong."

All of the things that have gone wrong, especially massive unemployment and the long term trend of the market, suggests that inflation and interest rates may not take off again soon. This gives these bonds a chance to earn a capital gain (if rates fall much lower) or at least they have a chance to provide a length of time when the 8% yield will seem quite respectable.

We cannot totally relate Euro interest rates and European inflation to that in the US, but there has been a strong correlation for some years. Plus if we look at interest rates in Japan we can see that they can remain low for an extended period of time. (Japanese rates have been depressed for over a decade.)

If you are interested in investing in Euros, want a fixed return and are willing to take a little risk, then these SAS bonds are worth investigating.

If you want to take a lot of risk consider using a yen loan to create a Multi Currency Sandwich, look at the potential return if you invest $20,000 in these bonds and borrow an additional $80,000 in yen at 2% to invest in these bonds.

The return on $100,000 invested in SAS bonds yielding 8% is $8,000 a year.

The loan cost for $80,000 of yen loan is $1,600.

Your expected return (before nominal fees) is $6,400 or 31.25% on the $20,000 cash you have at risk.

The September 27th message "Multi Currency Dollar Hedge", explain that borrowing yen and investing in Euros minimizes US dollar risk. Over the past weeks this position has worked quite well for me. When the yen has risen, so too has the Euro. In the meantime I made an extra profit when the yen fell and the Euro did not. (Remember that any Multi Currency Hedges are speculative and the risk of loss must be considered.)

You can get full details, current loan rates and fees from eClub advisor Thomas Fisher at Jyske Bank fischer@jyskebank.dk or any European bank that offers collateral loans.

Until next message, Good global investing!

Gary


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