Mexico, South Africa government bonds exciting, Japan less so, says Brandywine’s Hess

Brian Hess, portfolio manager of the Legg Mason Brandywine Global Fixed Income fund, sees opportunity in government bonds issued by Mexico and South Africa, but is less convinced of the case for holding Japanese government debt.

In many countries across the developed world, a divergence has opened up between government tax revenues and expenditure as working populations age and deflation takes hold.

Japan is a prime example, funding the gap between revenues and expenditure by issuing debt. This now stands in excess of 200% of GDP, which is why we avoid its bonds.

One of the markets that we are really excited about is Mexico, where 20-year bonds have a 6% yield, inflation is 3.5 to 4% and the peso is undervalued. We also like South African bonds, where we own 10-year and 30-year paper on yields of 7.5% and 8.5% respectively. South Africa will likely be joining the Citigroup World Government Bond Index in October, which should provide a boost to its bond market. Plus the rand has fallen to levels where we feel very comfortable owning it.

Australia is a high-quality market that is one of our deflation hedges, while the UK has been our other preferred safe haven – although holdings are in two-year bonds, which means from a duration standpoint we are significantly underweight.

We are looking to take on additional risk but only once we feel fundamentals are set to improve. In the interim, we are sticking to our approach of identifying high real yields and undervalued currencies in countries where the fundamentals are already strong or we can see a catalyst for improvement.

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