Investment opportunities in the islands
Last week I had the pleasure of joining the dynamic Toni Waterman on her weekly show The Breakdown, recorded locally at the Bermuda Broadcasting Company. The programme airs regularly on Thursday evenings and the topic for the last week's edition was investing in the island markets, including Bermuda, the Cayman Islands and Jamaica.
A fun fact discussed was how well a select few of these markets have performed over the past several years. For example, the Jamaican stock market was the world's best performing stock market in 2018 rising about 29 per cent in US dollar terms and is up a total of 320 per cent over the past five years. Whether or not the rally can be sustained is yet to be seen, but the sharp upswing demonstrates the potential for smaller markets to make progress under the right set of circumstances.
Closer to home, the Bermuda Stock Exchange fell about 11 per cent last year, but has more than doubled over the past five years if one includes dividends. The BSX's annualised five-year return of about 17 per cent easily trumped the S&P 500 stock index, but mainly because of two stocks: Butterfield Bank and Ascendant Group which lived up to its name over the period.
Going back to a few more years, however, paints a different story for the BSX. Measured from the beginning of the Great Recession in 2007, the BSX now trades at less than half its former value. Considering Bermuda's gross domestic product remains lower than it was 11 years ago, the price action makes sense.
What's interesting about the islands is that they share many of the same problems and opportunities; and yet, looking across the Caribbean islands and Bermuda we see vast differences in the way business and politics are handled and very diverse economic performance between them.
In many cases, one economy is thriving while one island away, another is falling apart. The failed state of communist Cuba is less than 300 miles away from booming Cayman. In fact, the Cayman Islands government bonds are ranked among the highest in the world at “AA3” by Moody's rating service.
Further to the East, the Dominican Republic “has enjoyed strong economic growth in recent years and a significant reduction in poverty” according to a recent World Bank report. Economists are broadly optimistic about DR's future.
On the other hand, Barbados and Puerto Rico have gone backwards. Puerto Rico declared bankruptcy last May and bonds issued by the government of Barbados are in default with the lowest rating of “D” by the Standard and Poor's rating agency. Irresponsible fiscal policies pushed both countries into economic crisis. Island nations have the potential to learn from each other by paying attention to the mistakes and successes of other islands.
According to the respected Caribbean economist, Marla Dukharan, a primary ingredient for island economy success is a country's ability to adopt policies which embrace and support growth in the private sector. Robust economies such as Cayman have implemented policies which permit equitable ownership of property and have adopted progressive immigration policies.
Looked at through a global lens, Bermuda's sluggish economy is likely the result of its anti-foreigner policies, high cost of living and more recently rising taxes. Policies such as these tend to deflect capital to other jurisdictions. Declining employment translates into lack of growth and opportunity.
Bermuda has few natural resources, with the possible exception of good weather and nice beaches. Raising taxes in a tax haven country is probably a risky plan. Immigration would solve many problems for Bermuda as it did in Cayman. Small island economies must be careful not to overplay their hands.
As fiduciaries for client's funds we need to see growth and fiscal responsibility in the entities backing our investments. However, we do understand that growth comes with its own challenges at ground level. Embracing progress often means making difficult decisions and rising to the occasion, a vision which is not always achievable.
Due to their smaller size, low level of liquidity and foreign ownership constraints, island markets are broadly classified as “frontier markets”, using the methodology of a leading index provider.
Frontier markets are effectively a subset of emerging markets and have the potential to do well under the right set of circumstances, but investors need to understand the risks. Diversification and liquidity are two key factors when considering this asset class.
In the fixed-income sector, debt issued by island governments and the preferred stocks and bonds of local corporations are options. As a caveat, a large portion of Caribbean island government bonds are rated below investment grade, making it critical for investors to understand and monitor these credits. However, many of these government bond issues have a reasonable level of liquidity for institutional investors.
A promising vehicle for income investors is the preferred stock of Bermuda-based companies. Most of these securities are rated investment grade and pay between five and seven per cent dividend yields.
Generally classified as “hybrid securities”, preferred stocks are not well followed by Wall Street analysts as they usually fall somewhere between debt and equity in a company's capital structure. Lack of coverage by the analyst community often creates attractive opportunities when prices swing to extremes.
LOM has two BSX-listed fixed income mutual funds which participate in emerging market debt, and we have another income-orientated fund which owns a fair amount of Bermuda-based preferred stock.
Our Fixed Income Fund, the only locally managed Morningstar 5-star rated bond fund, tends to hold up in difficult times. For example, last year our flagship bond fund did not lose value compared to a drop of about 5 per cent in the average offshore fixed income fund, using Bloomberg data.
In 2017, the LOM Fixed Income Fund was up about 4 per cent, achieving almost twice the return on our benchmark index.
Bryan Dooley, CFA is the senior portfolio manager and general manager of LOM Asset Management Ltd in Bermuda. Please contact LOM at 292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority