How to Earn 8.8% From Government Bonds

Tax time is rolling around. And it's one more time when I'm reminded about how much I pay -- and potentially still owe -- the government. So I thought this was a fitting time to turn the tables -- and get a government to pay me for awhile.

I could ask the U.S. government to pay me, but it wouldn't be that impressive a paycheck. The yield on the 10-Year U.S. Treasury note is only 3.7%. Luckily, I don't have to settle for that. After all, a lot of other countries issue debt. And because of the scary headlines about government debt, now may be a good time to jump in.

Government bonds are relatively safe compared with other types of debt. Companies and individuals can go bankrupt. But because governments have taxing authority, they can usually meet their debt obligations, come hell or high water. And no country wants to default, as it would shatter its credit rating and raise the cost of future borrowing.

That being said, some governments have defaulted. Russia defaulted on $73 billion of debt back in 1998 -- causing the currency to plunge more than -70% and forcing the country to pay a +7.5% premium on newly issued debt. In 2001, Argentina defaulted on $82 billion of debt, crippling its economy for years. Peru, Ecuador, Moldavia, and Uruguay are also among the handful of countries that have had issues paying back government-issued debt in the last 30 years.

Lower Default Risk
But even accounting for these well-known defaults, the sovereign debt default rate is still far below that for corporate debt. In a study conducted by Moody's, the credit-ratings agency found that the default rate on investment grade sovereign debt was just 0.667% after 10 years of issuance, compared with the corporate investment-grade default rate of 2.008%. Even speculative sovereign debt had a default rate nearly -30% lower than sub-investment grade corporate debt.

In fact, the sovereign default rate is so low, sometimes its true risk gets underestimated. Ratings agencies and debt insurers can get complacent, especially when assessing the risks of default from developed, and economically "more stable" countries. This can result in debt that isn't accurately priced for its risk. And when investors aren't being properly compensated for their risk -- that's a problem.

Greece is in hot water. The country's debt grew so large that investors began to worry about a potential government default. Other European Union members like Portugal and Spain also have monumental debt burdens.

So why is this good news for prospective sovereign debt buyers?

Safer Risk-vs.-Return Environment for Investors
It means that everyone is examining sovereign debt with a fine-toothed comb. It improves the chances that debt is being properly priced for its risk. And it means investors are being appropriately paid for their risk.

It reminds me a little of the 80's movie, The World According to Garp. The main character, played by Robin Williams, and his wife are shopping for a house. As they stand outside a prospective home, a small plane flies into the house. Williams immediately says, "We'll take the house. Honey, the chances of another plane hitting this house are astronomical. It's been pre-disastered. We're going to be safe here."

While sovereign debt isn't necessarily "pre-disastered" from default, the risk that it is overpriced or underinsured is lower today than before the scary headlines started hitting the newsstands.

For investors, the world of sovereign debt was all but closed just a few years ago. However, thanks to the proliferation of exchange-traded and closed-end funds, buying into the sovereign debt of everywhere from Thailand to Turkey is now as simple as buying a few shares on the NYSE.

And the yields are downright mouth-watering. In the March issue of my Daily Paycheck newsletter, I took the opportunity to add two new funds to my portfolio that are focused on sovereign debt. Among the picks -- a closed-end fund yielding 8.8%. This yield is high for a sovereign debt fund, but it's not unheard of.

An added bonus? Most of the funds investing in sovereign debt pay income monthly -- a nice treat for us income investors.

Good Investing!

Not sure where to park your money? High-yield debt may not be a bad place.

Over the last 10 years (1999-2009), the Merrill Lynch High Yield Master II Index -- a benchmark for sub-investment grade debt -- has returned +6.7% annually. Compare that to the S&P 500's annual return of less than +1%.

--  Research Staff

Breaking News

This Micro-Cap "War" Stock Has Hike Dividends +500% and Now Pays 10.1%

This unique little company pays a stable double-digit yield and trades at bargain levels. Still, few are paying attention.

Read On...

These Two Letters Could be the Secret to High Yields

Wait until you see how a small change in the way "pink sheet" stocks are listed opens up a fertile hunting ground for income investors. I've even flagged one intriguing pick that comes thanks to the recent change.

Read On...