longinvest wrote:Thebigc wrote:
Moringstar has cited minimal tracking errors with BNDX and only a minor .05% hedge drag on the fund.
I tried to explain that this can be quite misleading. BNDX follows a "hedged index", which means that the index tracks the performance of a hypothetical portfolio that buys both (1) foreign bonds and (2) 1-month forward currency contracts. As a result, any anticipated gain/loss due to the use of derivatives is included in the index, hiding potentially significant tracking errors relative to a
proper index.
In my opinion, a proper index would look at the value of foreign bonds today, in local currencies. In one month, the index would do the same (including the value of reinvested coupons, of course). The difference would determine the monthly growth of the index.
I am sure that most investors think that BNDX is using what I call a proper index, but it is not!
Maybe that's what one wants; maybe one doesn't want to experience Japan's local bond returns in US dollars, but the gains and losses due to derivative instruments are far from transparent.
Do you know whether it easy is or not to front-run currency contracts? Unlike bonds which can be held for decades, these contracts have to be renewed monthly. There is a lot of opaqueness in BNDX on top of difficult to quantify derivative risks.
I don't doubt that BNDX behaves as expected from a broad bond index fund. I am sure that Vanguard made in depth studies before proposing this fund to investors. All I am expressing is my personal inability to fully appreciate the risks embedded in hedged foreign bond funds.
In other words, currency hedging adds a whole layer of complexity to a fund. I do not understand this layer well enough to feel at ease investing in it.
Ok I see what is going on, so you are concerned about the derivative and the currency hedging that takes place within. Yes it iis layer of complexity, but in this specific case I don't think it is the risk that you think it is. A dirivative can be very risky, but it can also be very simple and safe, it depends on what it is written in it, it's just a contract based on a specific asset, in this scase bonds. Now in the contract Vanguard wishes to hedge us currency, simply because that is what we us and this is a international trade agreement.
So in order for both parties to add stability to the contract so neither gets screwed Vanguard uses a currency hedge. This actually benifits both sides. Vanguard is just seeking a balances exchange rate, and the .05% drag would seem to suggest they are rather good at it and are very close to hiting the mark on average. Vanguard is agreeing to buy these bonds one month ahead at a given exchange rate, price, intrest rate etc. There is a level of speculation involved but I doubt they are doing heavy currency speculation in order to gain a profit. One month contracts also work against this, they are constantly buying and selling every month from different markets with different currency risks and fluctuations. They talked about it in one of the links I posted. They have graphs and all that stuff addressing it. This is very common and happens every day hundreds of thousands of times a day. Someone from China wants to buy grain from the US, well you need a derivative and a hedge so that the exchange will be eqitable.
They are not trying to use derivatives for debt financing and options to gain leverage and all that. There is not really a reason for them to do anything crazy. The reason they can't give you an exact yield is because because it's a floating rate do to the monthly contract price and fluctuating currency. Every month in this case it is probably going to be different. You yourself would need to look at thousands of contracts every month. You would probably see that there is a range to the currency hedge, stable is between such and such, high is between such and such. Chances are that it's a stable hedge within a nominal range. Chances are you don't really make much or lose much.
The hedge is not what is making the bonds expensive and the intrest rates low, neither is the derivative. Also you need to remember Vanguard does not have to buy or agree to something unfavorable. Such and such does not want to give us a decent deal so we will by more France, Britian and Sweden who are offering sweet deals. We have been doing forex trades for a very long time and the US is really good at getting a proper exchange rate on standard trades. People can make it really complex and gamble doing it, but that is really not what is going on here as far as I can tell, I can't even think of a reason why they would do it.
In my opinion it's what they say it is, they use a hedge in there contract to purchase bonds at a fair price reguardless of what happens in either country. It takes a lot of volatility out, and the entire idea is based on a fair exitiable exchange of an asset. After that the hedge might create minor boon or a minor bust. Or .05% drag in this case. If in that one month window the bonds gain value your set price guarantees you a boon, if it loses some value a bust. If the dollar is a little stronger or weaker in that period compared to the given currency you gain or lose a little. Vanguard is not really hiding anything but on a month to month basis it is just to much information for most people to go through.
It can get really complex, because a dirivative is a contract and as we all know contracts can be very complex. In this case these are probably pretty standard trade contracts with fair exchange rates. No matter what you do with international bonds you will have an exchange rates or rates really, this just minamalizes that to create lower volatility.
The reason the rates are low and the bonds are expensive, has little to do with those contracts, or the hedge fee. People are always in search of safe haven assets, weather it's in the US or over seas. The reason the rates are low and the bonds are expensive is because us investors have been flooding that market driving the prices up which is lowering the yield, when China just had it's flash crash, a lot of investors rushed to bonds over seas and here and again bond prices up and rates go down, and finally Greece sent many international investors rushing towards bonds and again the same thing happened. Both over seas and here intrest rates are at historic lows in many countries, people have been flooding out of 20 and 30 year treasuries because they are higher risk do to duration and have been flooding into corporate high yeild bonds to try and capture yield which is why many say there is a high yield bubble. Stocks are expensive right now, and people want safe assets but bonds are also expensive judging by the yields. Note that the BNDX intrest rate took a dive around the Greek debt crises because people were seeking refuge.
I guess in the case of BNDX you need to be comfortable with the idea that Vanguard is paying fair value in the current market and not doing heavy speculation, that it is more likely a simple stabalizing mechanism for a international exchange which is done all the time by lots lots of people every day. It's not a great time for any bonds so bonds don't look that great. There is a lot of weight on the bond market right now. The derivative and the hedge are not a big concern for me, unhedged bond funds have taken a beating with the rising dollar. Like I said for me I can except those factors as a pretty common practice in Forex, and that an over weight bond market low intrest rates international, rising intrest rates US, people scrambaling for yeild in risky bond assets, extended duration in search of yield, higher credit risks in search of yield etc... All concern me more. In the stock market I am ready for a correction, I am ready for a slow down, that is all logical to me. Bonds are different story right now, they are riskier and more expensive than they normally are. I am not saying they are as risky as stocks right now, just that for bonds they are riskier than normal. I see long term positives for the bond market, but I can't give you a good reason to buy anything you are not comfortable with and I am not trying to, I just don't see it the exact same way, I see some risk, a little more complexity with hedging, but nothing with Vanguard that really makes me uncomfortable.
I think Vanguard has explained it well enough and gone out of their way to explain hedging and international bonds. I am not going to tell you any bonds are a good buy right now domestic or international, because I don't think they are and there is more safety in CD's and savings, and given current yields I see them as very exceptable options. Most of the money I want to spend on bonds in the future are in CD's and savings, and that money will stay there until I feel comfortable with the bond market. Just took a little money out of riskier assets yesterday, because I wanted to and it made me feel more comfortable. I can put that where I want in the future when I feel comfortable with certain things. I am not against bonds I am just not for them right now with these yields and prices, and people constantly in search of higher yields through increased risk. Does not matter which fund you point too, I only have about 7-8 percent in bonds.
Conclusion, I think you are a little to worried about the hedge and the derivative contract, and that other factors in the bond market are more concerning. Not end of the world concerning but just not a great time for the bond market in the near term. I also can't give a good reason for Vanguard to be pushing international at this time, maybe they know something I don't which would not be a surprise but nothing looks great enough to warrant 40 percent of my equity portfolio, 30 percent international bonds is like 2-3% of my portfolio right now, I can deal with that for a long time. But that is my portfolio. I am pretty much ok with this fund, and everything Vanguard has written about it, I don't see anything that risky or fishy other than it seems a poor time to own bonds at current yields and prices in the short term and possibly intermediate term market. Things will probably improve but who knows when and how much? Not this guy. I get it this is a different type of fund for you, you don't fully get it, I don't either most people probably don't and we always fear what we don't understand. But with all the reading and discussion, it does not really seem risky when compared to other Bond funds in the same class. Bonds in general really.
I am spent, I feel I learned a lot today which is always good, good discussion, good reading, thank you. Maybe you might want to have beer or 12. I am going to have one... after another, until I am no longer thinking about international bond fund and hedging. If you want safety you can always buy silver bullion, sure you probably lose money in the short term, but at least the werewolves won't be a problem. I carry a silver coin with me every where, and I have never been attacked by a werewolf... so totally works. I also may be way ahead of you on the beer.