What is your foreign-bond asset allocation?

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Postby bpp » Thu Jan 06, 2011 6:44 pm

Hi Kramer,

kramer wrote:Since I live abroad and spend mostly in non-dollar currencies, I do count my "foreign currency" exposure, or at least non-dollar exposure, as a separate diversification category (commodities futures, precious metals equity, foreign stocks, foreign bonds).


I do think foreign bonds are economically distinct from either domestic bonds or foreign stocks, and I subscribe to the "diversification is good" philosophy (perhaps also expressible as "foreign bonds are for safety" :wink: ), and backtesting and simplified theoretical spreadsheeting don't show them to be a disastrously stupid addition to a portfolio, so I include them. I understand the argument for commodities futures, but don't like their tax-unfriendliness.
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Postby Eric R » Thu Jan 06, 2011 8:15 pm

I think the main value of foreign currency diversification is a protection against domestic (USD) inflation. If USD devalues compared to foreign currencies, then there will be inflationary pressures on products that are built abroad as well as comodities used to make domestic products. During these times (which could include stretches of many years), foreign currency-denominated investments (stocks or bonds) will help mitigate this effect (although it may not help against global inflation).

Eventhough the US government may not default on its debt, it could substantially devalue the dollar which in effect reduces the real returns.
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Postby kramer » Fri Jan 07, 2011 1:14 am

valuethinker wrote:And presumably 100% globally diversified as to equities?

Depending on where you want to retire, Phillipines is both historically linked to the USD, but also has big exposure to the Chinese phenomenon.
Yes, I own about 45% foreign stocks. I tilt to value and small, mostly in my USA portion. I owned a higher percentage of foreign equity before but I can recover almost none of the foreign tax paid on those funds, since I pay little USA federal taxes by living off capital gains and dividends (which prevents one from deducting the foreign tax). So my effective cost for ownership of foreign funds is about 0.15% higher than the listed expense ratio. This effect, ironically, makes owning low-taxed foreign bond funds cheaper, relatively speaking, for me (and other retirees) than most other people in higher tax brackets.

There seems to be less fluctuation on some of the SE Asian currencies relative to the dollar, and that is an advantage for a retired American compared to other expats. I think this effect is attenuating over time, however.

bpp wrote:Hi Kramer,

kramer wrote:Since I live abroad and spend mostly in non-dollar currencies, I do count my "foreign currency" exposure, or at least non-dollar exposure, as a separate diversification category (commodities futures, precious metals equity, foreign stocks, foreign bonds).


I do think foreign bonds are economically distinct from either domestic bonds or foreign stocks, and I subscribe to the "diversification is good" philosophy (perhaps also expressible as "foreign bonds are for safety" :wink: ), and backtesting and simplified theoretical spreadsheeting don't show them to be a disastrously stupid addition to a portfolio, so I include them. I understand the argument for commodities futures, but don't like their tax-unfriendliness.
I basically agree with you on foreign bonds. Thankfully, I am able to put all my commodities futures (PCRIX) in my IRA. But due to the issues with that asset class, I am unwilling to go above 5%.

I checked the spread on IGOV yesterday. IGOV is the ishares foreign government bond ETF with a duration of around 7 years and an ER of 0.35%. It has been around for 2 years now. The spread was a whopping 0.3% over several minutes and transactions. So one could probably figure an additional 0.15% cost on the way in and out. Ouch.

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foreign bond allocation

Postby droodman » Wed Jan 12, 2011 9:29 pm

As threatened, I performed some simulations with a spreadsheet. I used BEGBX (American Century international bond fund) and VBMFX, with price and dividend data from Yahoo going back to April 92. From the monthly returns for each, I subtract the risk-free rate of return, represented by one-month treasuries, which I think is the proper thing to do. I posted the spreadsheet at
http://j.mp/eyFFLp

The results are interesting, I suppose.

Whether rebalancing monthly or yearly (in the latter case each April 1), moving the bond portfolio from 100% to 99% domestic increases standard deviation. Even though domestic and foreign are only correlated 0.48, the latter are so much more volatile that this overrides the diversification benefit of even a tiny bit of foreign bond.

It happens that over the April 1992-December 2010 period domestic beat foreign by a cumulative 75.26% vs. 68.43% (both figures relative to the risk-free return rate). So as one shifts to foreign, one's return goes down. I put less weight on that, as a predictor of future patterns, than the results just mentioned regarding s.d.

The spreadsheet includes a scatter plot of BEGBX - r against VBMFX - r, where r is the risk-free rate of return. BEGBX emerges as far more volatile, yet broadly correlated with VBMFX.

So, no super-strong argument for foreign bonds here.

On the other hand, I did the same thing for stocks, and the empirical argument for foreign stocks didn't seem that much stronger. It's also in the spreadsheet.

Here, I used VTSMX and VGTSX, starting in July 1996. The statistical relationship between domestic and foreign is quite different. The correlation is 0.86 instead of 0.52, meaning much less potential for diversification benefit. S.d. is minimized at 82% domestic, 18% foreign. But the reduction in s.d. compared to 100% domestic is tiny: 4.89% instead of 4.91%.

Even more so than with bonds, domestic beats foreign over the period with data--64.31% vs. 36.66% cumulative, net of the risk-free return.

So what surprises me about this is that I didn't find a particularly strong case for foreign stocks *or* foreign bonds. Maybe my data periods are still too short?
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Re: foreign bond allocation

Postby bpp » Thu Jan 13, 2011 7:34 am

droodman wrote:So what surprises me about this is that I didn't find a particularly strong case for foreign stocks *or* foreign bonds. Maybe my data periods are still too short?


If you had run the same exercise for a Japan-based investor for the past 20 years, you would have found a very strong case for foreign stocks, and a very weak, though slightly positive, case for foreign bonds. So it can be a time- and location-specific thing.

But, as I said a few posts up, the MPT case (which you're trying to get at empirically here) is not the primary justification. At least not for me at this point; I too spent a while looking into it, expecting to see a clearer answer one way or another than in retrospect I conclude I really found. For me, simply not putting one's eggs all in one basket is the primary justification. I use MPT rather to check that there is no strong argument against diversification into these asset classes.
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Postby grep » Fri Jul 01, 2011 11:19 am

from Laudus Funds' Revisiting the Case for International Fixed-Income, found on Schwab's web site:

Investors don’t have to allocate large portions of their total portfolios to international bonds in order to maximize risk-adjusted performance. An analysis based on 25 years of U.S. and international bond returns showed that allocating 15% of a fixed-income portfolio to international bonds produced optimal risk-adjusted performance as measured by the Sharpe ratio. For investors who allocate 60% of their portfolio to equities and 40% to fixed-income, a 15% allocation of the fixed-income portion to international bonds would represent 6% of the total portfolio.
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Re: foreign bond allocation

Postby nisiprius » Fri Jul 01, 2011 11:27 am

droodman wrote:So what surprises me about this is that I didn't find a particularly strong case for foreign stocks *or* foreign bonds. Maybe my data periods are still too short?
"Strong" is in the eye of the beholder, but I think this is pretty consistent with what Vanguard says in Global fixed income: considerations for U.S. investors, specifically their pretty chart, Figure 8, a two-dimensional short of the standard deviation of a 60/40 portfolio as the percentage of international is varied within stocks and within bonds.

But I don't know why a small effect for foreign stocks should surprise you, as this is almost as intense a topic for debate as foreign bonds.

If you want to make the case for foreign allocation, you point to where the optimum is. If you want to make the case against it, you point to the size of the effect, which is small. If you want to make the case either way, you point to the fact that there are only a few decades of data, and all the numbers fluctuate wildly from decade to decade. If you're agin' it, that proves the effect is unreliable. If you're fur it, the weakness of the past effect doesn't prove weakness of future results.
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foreign bond allocation

Postby droodman » Fri Jul 01, 2011 11:51 am

Thanks, nisiprius. I hadn't seen that report before. I guess it came out just as I was playing with the numbers in my own simple way. Here's what I don't get (though I'm not saying anything new). The report says:

For the average investor seeking to minimize volatility in a diversified portfolio, we find that allocating from 20% to 40% of the fixed income portion to international bonds can provide a reasonable balance between diversification and cost, assuming that the currency risk inherent to this asset class is hedged.


Of course if the average investor wants to do this through a low-cost Vanguard international bond fund, she's out of luck, since no such fund exists.

Perhaps this new study is a harbinger of a Vanguard international bond fund to come?
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Re: foreign bond allocation

Postby nisiprius » Fri Jul 01, 2011 1:54 pm

droodman wrote:Thanks, nisiprius. I hadn't seen that report before. I guess it came out just as I was playing with the numbers in my own simple way. Here's what I don't get (though I'm not saying anything new). The report says:

For the average investor seeking to minimize volatility in a diversified portfolio, we find that allocating from 20% to 40% of the fixed income portion to international bonds can provide a reasonable balance between diversification and cost, assuming that the currency risk inherent to this asset class is hedged.


Of course if the average investor wants to do this through a low-cost Vanguard international bond fund, she's out of luck, since no such fund exists.

Perhaps this new study is a harbinger of a Vanguard international bond fund to come?
I've wondered that, too. A currency-hedged bond fund, I presume.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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Postby louis c » Fri Jul 01, 2011 6:04 pm

One might argue adding foreign bonds diversifies the bond portfolio against sovereign default risk. While the assumption until late was that the USA would never default on its debts - I still have strong doubt such an event will happen - adding foreign bonds to reduce sovereign default risk is a bonafide consideration when deciding whether to include this asset class in the bond portfolio.

More fundamentally, it meets two basic criteria for investability - low correlation with other assets, and provides a real return. The third, a big negative of expenses, should be tackled by Vanguard. They have to know it is a legitimate asset class.
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Re:

Postby kwan2 » Thu May 09, 2013 10:47 pm

LH wrote:0

I have not read a reason to own foriegn bonds as of yet.

But I am open to it if someone has a reason to share : )


mike piper tweeted this one :
http://money.cnn.com/2013/05/01/investi ... index.html
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Re: Re:

Postby LH » Fri May 10, 2013 12:11 pm

kwan2 wrote:
LH wrote:0

I have not read a reason to own foriegn bonds as of yet.

But I am open to it if someone has a reason to share : )


mike piper tweeted this one :
http://money.cnn.com/2013/05/01/investi ... index.html


Thanks, yeah, I still just do not get the whole bond bubble thing for an accumulator. If BND drops, I will just buy more BND low. Rinse Repeat.

BND will then be rolling over bonds, and buying the new bonds with higher interest rates (if when that happens, see japan). BND even now, could significantly outperform stocks if stocks tank long term.

I see no reason still to change the course.

Now if bonds where higher in my portfolio, I may well want more diversification, but now I get pretty good correlation with stock side, which is 81 percent of my portfolio currently. I only have 8 BND, 8 TIPS currently. I am thinking about upping my bonds, it may be time, the market it up, and I am older : )

Now for a decumulator, different deal.
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Re: What is your foreign-bond asset allocation?

Postby allocator » Fri May 10, 2013 3:24 pm

Zero %
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Re: What is your foreign-bond asset allocation?

Postby nedsaid » Fri May 10, 2013 11:15 pm

The foreign bonds are between 2 and 3 percent of my retirement portfolio. Probably about 7-8 percent of my fixed income investments.
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Re: What is your foreign-bond asset allocation?

Postby vanguardrocks » Sat May 11, 2013 9:13 am

0%, don't see a need at this time.
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Re: What is your foreign-bond asset allocation?

Postby Sunny Sarkar » Sat May 11, 2013 9:43 am

0%.

Reason: "I think it unnecessarily complicates things" - Jack Bogle at Las Vegas 2006 reunion
Reason2: the quote below...
"Cost matters". "Stay the course". "Press on, regardless". ― John C. Bogle
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Re: What is your foreign-bond asset allocation?

Postby Blues » Sat May 11, 2013 9:53 am

Zip-a-Dee-Doo-Dah at the moment but I'd be willing to revisit the matter if and when a compelling reason to own them is presented.
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Re: What is your foreign-bond asset allocation?

Postby TinkerPDX » Mon Jun 23, 2014 6:56 pm

Vanguard's white paper on the topic: https://advisors.vanguard.com/iwe/pdf/I ... omain=true

They conclude that a USD-hedged international bond allocation reduces volatility, and that, given international bonds make up a huge share of the universe of investable assets, investors should at least seriously consider holding some exposure.
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Re: What is your foreign-bond asset allocation?

Postby jstash » Mon Jun 23, 2014 7:50 pm

Within my bond allocation, 50% are international, which is 5% of my total portfolio.
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Re: What is your foreign-bond asset allocation?

Postby IlliniDave » Mon Jun 23, 2014 7:52 pm

About 0%
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