Why do retirees, near-retirees, and others seeking stability typically invest only in U.S. bonds, whether U.S. Treasuries or corporate bonds? (Municipal bonds, because of their tax breaks, are a special case.) Why are bonds issued in developed foreign countries – such as Japan, Germany or Britain – considered one way or another? another as more risky or unusual?
Any financial expert who has mastered Reverse Polish (don’t ask) could tell you that the real risk comes from needlessly missing diversification opportunities – which, as they say on Wall Street, is the only free lunch in town .
If we only invest in US bonds, are we wrong?
That’s largely what Alliance Bernstein bond fund manager Nicholas Sanders says in a new note.
“The days when the U.S. fixed income market dominated the global bond supply are over,” he writes. “Today, the United States represents less than a third of the global bond universe. And the global bond market is much more diverse than the U.S. bond market. Not only does it offer more opportunities from which an active manager can choose, but its different landscapes provide significant variety and sources of diversification.
International bonds, when hedged to U.S. dollars (to protect you from currency fluctuations), have been a better investment over the past 30 years than U.S. bonds, he adds: They have produced higher returns. high with lower volatility.
The difference in returns is not large: 4.8% per year compared to 4.6% per year since 1993. Over 30 years, although it adds up, generating 308% profit compared to 285%. Volatility, for its part, was much less.
The easiest way for normal people to invest in these things is through low-cost mutual funds or index funds, such as those offered by Vanguard. As it happens, it’s been a little over 10 years since Vanguard launched its International Bond Index exchange-traded fund, BNDX, which, like many international bond funds, hedges currency risks.
Over these 10 years, the ETF has significantly beaten the US bond version, Vanguard Bond Index ETF BND.
That doesn’t seem like much: 0.6 percentage points per year. But it’s quite significant in context: 1.9% versus 1.3% per year. In an era of meager returns, the international fund once again generated half as many annual returns.
And, once again, this was done with less volatility. When you use what’s called the Sharpe ratio, which compares return to volatility, the international bond fund performs much better.
Currency hedging is a curious feature of international bond funds. Hedging involves using derivatives to protect U.S. investors from any currency fluctuations. Alternatively, if you own an international bond paying 5% interest but that country’s currency falls 5% against the dollar, you have effectively earned bupkis.
There is a long-standing and unresolved debate in finance over whether it is best to currency hedge your international equity funds. But in bond funds, this seems to be the standard MO, for various technical reasons.
Oddly enough, hedging can do more than protect you from currency fluctuations, it can also generate income. In today’s markets, Sanders writes, an international hedged bond fund will generate a higher return than the equivalent fund in the United States.
The past performance of international bonds, while perhaps surprising, is not a reason to hold them. Investors care about the future, not the past. But the logic seems pretty solid. It’s hard to argue against greater diversification, both in bonds and stocks.
Vanguard now has a global bond fund, BNDW, split about equally between its U.S. and international funds.
International bonds may seem risky, but the truth is otherwise: Investors who keep all their money in U.S. bonds are taking on more risk – or, more precisely, missing a huge opportunity to reduce their risk by diversifying. .
Oh, and not to go overboard, if you’re looking for a good reason to diversify outside of the United States, look no further than Washington, which is – once again – headed for yet another cap fiasco. debt.
The United States, a wit once said, sometimes resembles “a banana republic without bananas.”
Why do retirees, near-retirees, and others seeking stability typically invest only in U.S. bonds, whether U.S. Treasuries or corporate bonds? (Municipal bonds, because of their tax breaks, are a special case.) Why are bonds issued in developed foreign countries – such as Japan, Germany or Britain – considered one way or another? another as more risky or unusual?
Any financial expert who has mastered Reverse Polish (don’t ask) could tell you that the real risk comes from needlessly missing diversification opportunities – which, as they say on Wall Street, is the only free lunch in town .
If we only invest in US bonds, are we wrong?
That’s largely what Alliance Bernstein bond fund manager Nicholas Sanders says in a new note.
“The days when the U.S. fixed income market dominated the global bond supply are over,” he writes. “Today, the United States represents less than a third of the global bond universe. And the global bond market is much more diverse than the U.S. bond market. Not only does it offer more opportunities from which an active manager can choose, but its different landscapes provide significant variety and sources of diversification.
International bonds, when hedged to U.S. dollars (to protect you from currency fluctuations), have been a better investment over the past 30 years than U.S. bonds, he adds: They have produced higher returns. high with lower volatility.
The difference in returns is not large: 4.8% per year compared to 4.6% per year since 1993. Over 30 years, although it adds up, generating 308% profit compared to 285%. Volatility, for its part, was much less.
The easiest way for normal people to invest in these things is through low-cost mutual funds or index funds, such as those offered by Vanguard. As it happens, it’s been a little over 10 years since Vanguard launched its International Bond Index exchange-traded fund, BNDX, which, like many international bond funds, hedges currency risks.
Over these 10 years, the ETF has significantly beaten the US bond version, Vanguard Bond Index ETF BND.
That doesn’t seem like much: 0.6 percentage points per year. But it’s quite significant in context: 1.9% versus 1.3% per year. In an era of meager returns, the international fund once again generated half as many annual returns.
And, once again, this was done with less volatility. When you use what’s called the Sharpe ratio, which compares return to volatility, the international bond fund performs much better.
Currency hedging is a curious feature of international bond funds. Hedging involves using derivatives to protect U.S. investors from any currency fluctuations. Alternatively, if you own an international bond paying 5% interest but that country’s currency falls 5% against the dollar, you have effectively earned bupkis.
There is a long-standing and unresolved debate in finance over whether it is best to currency hedge your international equity funds. But in bond funds, this seems to be the standard MO, for various technical reasons.
Oddly enough, hedging can do more than protect you from currency fluctuations, it can also generate income. In today’s markets, Sanders writes, an international hedged bond fund will generate a higher return than the equivalent fund in the United States.
The past performance of international bonds, while perhaps surprising, is not a reason to hold them. Investors care about the future, not the past. But the logic seems pretty solid. It’s hard to argue against greater diversification, both in bonds and stocks.
Vanguard now has a global bond fund, BNDW, split about equally between its U.S. and international funds.
International bonds may seem risky, but the truth is otherwise: Investors who keep all their money in U.S. bonds are taking on more risk – or, more precisely, missing a huge opportunity to reduce their risk by diversifying. .
Oh, and not to go overboard, if you’re looking for a good reason to diversify outside of the United States, look no further than Washington, which is – once again – headed for yet another cap fiasco. debt.
The United States, a wit once said, sometimes resembles “a banana republic without bananas.”
