Thoughts on Pimco's Australian Bond ETF?

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Topic Author
Jagman
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Thoughts on Pimco's Australian Bond ETF?

Post by Jagman »

http://www.pimcoetfs.com/Funds/Pages/AUD.aspx

Would you consider adding this ETF to your bond allocation, if you live and work in the US?
jdilla1107
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Re: Thoughts on Pimco's Australian Bond ETF?

Post by jdilla1107 »

Incredibly small, very illiquid, and high expense ratio. No thanks.

What are you trying to achieve?
Topic Author
Jagman
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Re: Thoughts on Pimco's Australian Bond ETF?

Post by Jagman »

jdilla1107
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Re: Thoughts on Pimco's Australian Bond ETF?

Post by jdilla1107 »

Are you aware you will have currency exposure by holding AUD denominated bonds? This currency can move. Here is what it has done over the last five years:

http://finance.yahoo.com/q/ta?s=FXA&t=5 ... l&p=&a=&c=

If you make an extra 1% a year over US bonds, but lose 25% on a currency move, you may not be too happy. Just be aware that the risk is on the currency side.
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nisiprius
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Re: Thoughts on Pimco's Australian Bond ETF?

Post by nisiprius »

No.

The Prospectus notes "Currency Risk: the risk that foreign currencies will decline in value relative to the U.S. dollar and affect the Fund’s investments in foreign (non-U.S.) currencies or in securities that trade in, and receive revenues in, or in derivatives that provide exposure to, foreign (non-U.S.) currencies." It does not say anything at all about hedging, so I assume this is an unhedged fund. That means the performance of the fund will depend heavily on the currency fluctuations between the U.S. and Australian dollar. To get a rough notion of how much that amounts to, I used Morningstar to chart the tamest possible investment, Vanguard Prime Money Market, VMMXX first in U. S. dollars, then in Australian dollars. I also plotted the tiny history of AUD along with it. To a U. S. investor, investing dollars, VMMXX's low, currently zero return, is mitigated by its near-zero risk. The curve is perfectly smooth. The AUD curve, however, is quite ragged and not at all "bond-fund-like."

Image

To an Australian investor, however, VMMXX, is far from zero risk. Even ignoring 2008-2009, we see that VMMXX, measured in Australian dollars, has frequent up-and-down jinks of 10% or so over periods measured in months. Meanwhile, the orange curve, AUD, now looks relatively smooth.

The point is, since we know that VMMXX is smooth and grows steadily in U.S. dollars, what it does in Australian dollars show how big the effects of currency risk are. It turns ultrasafe, low-yielding VMMXX into a fairly volatile but still low-yielding asset.


Image

The same thing happens the other way around. The bonds in AUD are obviously higher-yielding that VMMXX, but a large amount of currency volatility rides on top of the true intrinsic bond yield of the investment.

The difference between the blue curves in the two charts is due to currency fluctuation. The difference between the orange curves in the two charts is due to currency fluctuation. In each case, the fund looks smooth and has low risk in its native currency, and looks ragged and has high risk in the foreign currency.

In other words, when you as a U.S. investor invest in Australian bonds, you are not getting a bond-like investment, you are getting a FOREX-like investment, taking up-and-down 10% fluctuations in order to get bond-like returns. I don't see who would want to do this except a speculator.

If you want to have your money somewhere outside the United Staes because you'd like to average over interest rates and fiscal policy of the whole globe, and not just the U. S., but you don't want to play currency games, you might want to wait for Vanguard's two international bond funds. One of them will hedge currency risk, the other will invest in dollar-denominated foreign bonds. I personally don't expect them to be terribly different from domestic bond funds, but if what you want is, truly, international diversification, not currency speculation, that's a way to get it.
Last edited by nisiprius on Sat Dec 22, 2012 8:31 pm, edited 5 times in total.
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Topic Author
Jagman
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Re: Thoughts on Pimco's Australian Bond ETF?

Post by Jagman »

Thanks. Very helpful!
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Mian
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Re: Thoughts on Pimco's Australian Bond ETF?

Post by Mian »

nisiprius wrote:No.

The Prospectus notes "Currency Risk: the risk that foreign currencies will decline in value relative to the U.S. dollar and affect the Fund’s investments in foreign (non-U.S.) currencies or in securities that trade in, and receive revenues in, or in derivatives that provide exposure to, foreign (non-U.S.) currencies." It does not say anything at all about hedging, so I assume this is an unhedged fund. That means the performance of the fund will depend heavily on the currency fluctuations between the U.S. and Australian dollar. To get a rough notion of how much that amounts to, I used Morningstar to chart the tamest possible investment, Vanguard Prime Money Market, VMMXX first in U. S. dollars, then in Australian dollars. I also plotted the tiny history of AUD along with it. To a U. S. investor, investing dollars, VMMXX's low, currently zero return, is mitigated by its near-zero risk. The curve is perfectly smooth. The AUD curve, however, is quite ragged and not at all "bond-fund-like."

Image

To an Australian investor, however, VMMXX, is far from zero risk. Even ignoring 2008-2009, we see that VMMXX, measured in Australian dollars, has frequent up-and-down jinks of 10% or so over periods measured in months. Meanwhile, the orange curve, AUD, now looks relatively smooth.

The point is, since we know that VMMXX is smooth and grows steadily in U.S. dollars, what it does in Australian dollars show how big the effects of currency risk are. It turns ultrasafe, low-yielding VMMXX into a fairly volatile but still low-yielding asset.


Image

The same thing happens the other way around. The bonds in AUD are obviously higher-yielding that VMMXX, but a large amount of currency volatility rides on top of the true intrinsic bond yield of the investment.

The difference between the blue curves in the two charts is due to currency fluctuation. The difference between the orange curves in the two charts is due to currency fluctuation. In each case, the fund looks smooth and has low risk in its native currency, and looks ragged and has high risk in the foreign currency.

In other words, when you as a U.S. investor invest in Australian bonds, you are not getting a bond-like investment, you are getting a FOREX-like investment, taking up-and-down 10% fluctuations in order to get bond-like returns. I don't see who would want to do this except a speculator.

If you want to have your money somewhere outside the United Staes because you'd like to average over interest rates and fiscal policy of the whole globe, and not just the U. S., but you don't want to play currency games, you might want to wait for Vanguard's two international bond funds. One of them will hedge currency risk, the other will invest in dollar-denominated foreign bonds. I personally don't expect them to be terribly different from domestic bond funds, but if what you want is, truly, international diversification, not currency speculation, that's a way to get it.
Nisi,

Great response. Answers the question precisely and eloquently. Kudos!
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