Foreign Bonds

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Foreign Bonds

Postby squawk » Mon Mar 29, 2010 12:11 am

I don't currently own any. Does anyone have any strong pros or cons for the category?

I have thought about taking a small position in Emerging Markets bonds via EMB.

Performance of TEGBX and FNMIX over the past 15+ years has been excellent (>12%).

I think they should be highly uncorrelated with the SP500.
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Postby IndependentlyPoor » Mon Mar 29, 2010 12:45 am

My quickie calculations show the correlation of the fractional daily NAV change for TEGBX and VTSMX is -0.004 for 3463 trading days since 6/24/1996.

Correlation for FNMIX and VTSMX is 0.372 for 3464 trading days since 6/21/1996.

For comparison, correlation for VBMFX and VTSMX is -0.163 for 3464 trading days since 6/21/1996.

The data is from the Mathematica server. I can't get data for earlier dates.
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Postby stratton » Mon Mar 29, 2010 12:53 am

IndependentlyPoor wrote:Correlation for FNMIX and VTSMX is 0.372 for 3464 trading days since 6/21/1996.

Check the correlation between FNMIX and VEIEX. EM bonds and stocks should have a really high correlation. I wouldn't be surprised if its in the 0.8% range.

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Postby IndependentlyPoor » Mon Mar 29, 2010 1:17 am

Okay. Its late, I can't sleep, and I am bored, so....

The correlation between VEIEX and FNMIX was 0.452 for 3660 trading days since 9/13/1995.

For comparison, the correlation between VEIEX and VTSMX has been 0.689 for the period since 6/21/1996.

However, correlations like this are nowhere near stable. Rolling 30 or 60 day correlations, for example, are all over the map.
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Re: Foreign Bonds

Postby yobria » Mon Mar 29, 2010 2:01 am

squawk wrote:Performance of TEGBX and FNMIX over the past 15+ years has been excellent (>12%).


That would be the 15 year when the EM risk premium went from very high (due to the early 90s crisis) to very low. This can't happen twice, but things could easily go the other way.

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Postby BigD53 » Mon Mar 29, 2010 3:32 am

Cute dog. What kind is he/she?
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Postby DaveS » Mon Mar 29, 2010 3:54 am

The idea of holding bonds is to have an asset that conserves your capital when other things go bad. Foreign bonds don't fit that purpose because they add currency risk, and interest rate risks in the host country. How would you like it if you had diversified into Greek Sovereign bonds last year? Would you have seen that crises coming? Foreign bond funds generally have higher expense ratios. Costs matter a lot more when your holding something which only has a 3-6% interest rate to begin with. So the common Boglehead advice is to take your currency risk only by holding foreign equities.

That being said, I occasionally buy some small amount of something to keep an eye on. So about a year ago I got small amount of of the ETF WIP which has world inflation protected bonds in it's portfolio. It is up a bit, but if you get a graph of it since it's inception you will observe it's performance is quite erratic.

I found the correlations posted above quite interesting. But they only go back a short time during a period when markets were really volatile and as a result might be misleading. That is not intended as a criticism of the person who posted them.

I say if your concerned about things like the dollar, get more international and especially int. small caps. If the dollar went down it would hurt foreign exporters which are mostly large caps. Smaller companies tend to sell things in their host countries. Diversify but do not overdo it. Check out VSS. Dave
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VSS

Postby squawk » Mon Mar 29, 2010 6:55 am

My only problem with VSS is the lack of long term historical returns.

Is there a good proxy for it? Would the DFA International Small Cap Value (DISVX) be close or does the value tilt make it significantly different?

The foreign bonds would be in place of 0-5% of foreign equity. I am strong believer that bonds should be US Govt or Muni backed.
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Postby Random Musings » Mon Mar 29, 2010 10:00 am

TEGBX and FNMIX have expense ratio's a touch above 1.3%. Seems like a high price for diversification - wouldn't it be more effective just to take a little more equity risk at much lower cost?

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Expense Ratio

Postby squawk » Mon Mar 29, 2010 11:24 am

The EMB etf has expense ratio of 0.60%....not great but much less than most foreign bond mutual funds.

BEGBX and OIBCX are also in the category
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Postby dkdoy » Mon Mar 29, 2010 7:54 pm

Good quote from Rick Ferri on foreign bond funds
"Foreign bonds provide currency diversification rather than security diversification, and they do it at a high cost. You can invest in US bonds via the Vanguard Total Bond Market and pay about 0.14% in fees. Or, you can divert some of that money into global bond fund that charges 0.50% in fees or more. Consequently, whatever benefit may be gained from currency diversification is wiped out by the higher fee.

In conclusion, theoretically foreign bonds may make sense; operationally they lose all their luster. "
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Postby marana » Tue Mar 30, 2010 2:35 pm

dkdoy wrote:Good quote from Rick Ferri on foreign bond funds
"Foreign bonds provide currency diversification rather than security diversification, and they do it at a high cost. You can invest in US bonds via the Vanguard Total Bond Market and pay about 0.14% in fees. Or, you can divert some of that money into global bond fund that charges 0.50% in fees or more. Consequently, whatever benefit may be gained from currency diversification is wiped out by the higher fee.

In conclusion, theoretically foreign bonds may make sense; operationally they lose all their luster. "


The lowest ER so far for intl. bond funds is 0.35% (IGOV & ISHG), and intl. bond funds with lower ERs could reasonably be expected.

I have not seen data comparing the correlation between hedged intl. bond funds and the U.S. equity market versus unhedged funds and the U.S. equity market.
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Postby Paladin » Tue Mar 30, 2010 3:09 pm

DaveS wrote:How would you like it if you had diversified into Greek Sovereign bonds last year? Dave


That would not be diversification would it? No more so that "diversifying" into CA bonds!
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Currency

Postby squawk » Tue Mar 30, 2010 3:37 pm

From my limited understanding of foreign market bonds, many are dollar dominated due to past currency crashes.

The diversification factor is basically a risk premium on EM Governments vs. Developed Governments.

EM's crashed heavily in the 80's and 90's resulting in a higher risk premium since then.

The question is: will it remain?

I think it will because investors will always be more hesitant to lend to the government of Russia versus US Governments.

I am still neutral on them -- looking for more input
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Postby Ping Pong » Tue Mar 30, 2010 4:26 pm

DaveS wrote:How would you like it if you had diversified into Greek Sovereign bonds last year?


I look at that the other way. How would you like it if you were Greek, and you only held domestic (i.e. Greek) bonds? Having foreign bonds would have helped you tremendously.
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Postby Karamatsu » Tue Mar 30, 2010 7:47 pm

Does anyone have any strong pros or cons for the category?


For someone other than an expatriate, or with business interests in a foreign country, I think the question just comes down to how foreign bonds behave in a portfolio, so you could try something like MVO and look at the efficient frontier as you add different quantities of foreign bond index or fund into the mix. Of course that's just past data, but at least it would give you a sense of whether such funds have much merit. But basically what you're doing is taking an asset class with very little risk and adding an overlay of FX risk. It might be more cost-effective to keep your bonds domestic and place a side bet in the currency futures market. I don't do this currently, but I often wonder about it.
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Re: Currency

Postby stratton » Tue Mar 30, 2010 9:35 pm

squawk wrote:From my limited understanding of foreign market bonds, many are dollar dominated due to past currency crashes.

The diversification factor is basically a risk premium on EM Governments vs. Developed Governments.

EM's crashed heavily in the 80's and 90's resulting in a higher risk premium since then.

The question is: will it remain?

I think it will because investors will always be more hesitant to lend to the government of Russia versus US Governments.

I am still neutral on them -- looking for more input

You're confusing several issues here:

There are EM bonds issued in USD which are also refered to as "Brady bonds." This is usually what you'll find in an EM bond fund. They have *had* equity like returns, but will act like EM stock and take a nose dive when they things go bad. There is credit risk here if the issuing countries currency drops and they don't have enough foreign reserves to buy dollars to pay the bond coupons. If it becomes too expensive they can default.

There are also EM bonds issued in local currency, but only a few funds have them. PIMCO has one. There is supposedly an ETF coming in this area containing corporate bonds. EM corporate bonds may have higher credit rating than the EM country they are located in. These will be volatile. In this case currency risk is on the bond holder and not the issuer.

There are EM "developing local currency" funds which are unhedged containing essentially MMF term bonds. The currency fluctuations make these pretty volatile. The credit ratings on these are higher because the term length is short. In this case currency risk is on the bond holder and not the issuer.


There are the usual unhedged foreign bond funds such as BWX and BWZ.

There are hedged foreign bond funds too. The strength of the hedge will show up as volatility. PIMCO's hedged foreign/global bond funds aren't strongly hedged so they have more volatility than US bond funds. DFA and Payden have strongly hedged bond funds that aren't any more volatile than US bond funds.

Index funds in this area are generally market weighted by the amount of foreign bond funds floated. PIMCO has a fund that is GDP weighted with the idea of reducing exposure to big borrowers such as the US and Japan.

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