What's the right allocation to international bonds?

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gkaplan
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What's the right allocation to international bonds?

Post by gkaplan » Fri May 31, 2013 2:53 pm

With the introduction of Vanguard Total International Bond Index Fund and Vanguard Emerging Markets Government Bond Index Fund, along with their corresponding ETF Shares, you may have questions about the global fixed income market. Vanguard Senior Investment Analyst Chris Philips answers some common questions facing investors....
https://personal.vanguard.com/us/insigh ... ion-052013
Gordon

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Re: What's the right allocation to international bonds?

Post by OverTheHill » Fri May 31, 2013 4:12 pm

Zero.

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Re: What's the right allocation to international bonds?

Post by tc101 » Fri May 31, 2013 4:22 pm

10-15%
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Re: What's the right allocation to international bonds?

Post by gkaplan » Fri May 31, 2013 4:38 pm

Twenty-five percent of fixed income allocation, ten percent overall.
Gordon

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Re: What's the right allocation to international bonds?

Post by gnosis » Fri May 31, 2013 4:39 pm

:sharebeer Oh boy, here we go! Are we having fun yet? This debate really gets to the heart of a Boglehead principle, that bonds are for safety, so put your risk onto the stock side. Yet this is a riskier group of bonds which provides some negative correlation, which should reduce overall volatility. Hmm, starting to sound like a slice 'n dice / Fama & French discussion, only with bonds...
Last edited by gnosis on Fri May 31, 2013 4:49 pm, edited 3 times in total.

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Re: What's the right allocation to international bonds?

Post by G-Money » Fri May 31, 2013 4:40 pm

Taking a pass on it for now. But if I had a LifeStrategy or Target Retirement Fund, I wouldn't be particularly bothered by Vanguard allocating 20% of bonds to them.
Don't assume I know what I'm talking about.

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Re: What's the right allocation to international bonds?

Post by NoRoboGuy » Fri May 31, 2013 4:53 pm

Zero - instead I increased my exposure to international equities without changing the equity/bond ratio. US stocks/International stocks is 50/50. US Corporates and High Yield bonds are assumed to have a 30% equity-like component, and that is also factored into the equity/bond ratio. Overall equity/bond ratio is 50/50. The TSP G Fund factors heavily in my bond allocation, as well as I Bonds. I sleep very well without foreign bonds.
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Re: What's the right allocation to international bonds?

Post by stevewolfe » Fri May 31, 2013 5:10 pm

OverTheHill wrote:Zero.
This. Agree, it's zero.

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Re: What's the right allocation to international bonds?

Post by gnosis » Fri May 31, 2013 5:18 pm

Why zero? Why turn your nose up at such a huge global market?

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Re: What's the right allocation to international bonds?

Post by digit8 » Fri May 31, 2013 5:40 pm

Several of the early books I read on investing mentioned how 2 or 3 indexes are all you needed for investing, but warned it was dull cocktail party conversation.
Sometimes I think some of the planners at Vanguard are just looking to spice up their parties.....this strikes me as another racing-stripe option. Neat sounding, but unlikely to give much of a boost or a hindrance over the long term for any reasonably sane AA.
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Re: What's the right allocation to international bonds?

Post by connya » Fri May 31, 2013 5:51 pm

How did they come up with the 20% recommendation?

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Re: What's the right allocation to international bonds?

Post by Beagler » Fri May 31, 2013 6:11 pm

VG TR Fund shareholders are about to find out if VG's guess is right -- not that they have any choice if they want to remain invested in VG TR funds.
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Re: What's the right allocation to international bonds?

Post by Timcom99 » Fri May 31, 2013 8:33 pm

connya wrote:How did they come up with the 20% recommendation?
Just a number. Same as with Total International Stock. They at first recommended a 20% holding and now the recommended holding is between 20% and 40%.

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Re: What's the right allocation to international bonds?

Post by stevewolfe » Fri May 31, 2013 8:43 pm

gnosis wrote:Why zero? Why turn your nose up at such a huge global market?
We're talking about the Vanguard funds, which are dollar hedged. If I were to do an investment in international bonds, I'd prefer an un-hedged fund.

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Re: What's the right allocation to international bonds?

Post by ftobin » Fri May 31, 2013 8:47 pm

connya wrote:How did they come up with the 20% recommendation?
In the article, it looks like their international percentage recommendations come from reflecting what other US mutual funds and ETFs have. For example, they show how in equities, 27% of mutual fund and ETF assets are in international. Similarly, 13% in international bonds.

Vanguard describes their preference for value/growth divisions as those that best reflect what the rest of the mutual fund industry does. They don't want their offerings to be outliers, simply cheaper, more efficient offerings of what the rest of the market provides. I think it's reasonable for Vanguard to take the same approach for international bonds.

For all those who are saying 0% to international bonds, how do you reconcile that with Vanguard's paper showing that a 100% allocation to international provides the lowest volatility in 60/40 portfolio?

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Re: What's the right allocation to international bonds?

Post by NoRoboGuy » Fri May 31, 2013 8:58 pm

gnosis wrote:Why zero? Why turn your nose up at such a huge global market?
I was very interested, then I started thinking about whether the diversification benefit would actually be realized given the fund is hedged to the US dollar. Then I recognized what I was really looking for was diversification away from dollar-based assets, and determined the way to do that was to increase my holdings of international equities and inflation-protected US bonds. I don't fault anyone who adds international bonds, but I would rather just hold more inflation-protected bonds and more international stocks to meet the objective of getting 'dollar diversification.'
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Re: What's the right allocation to international bonds?

Post by nedsaid » Fri May 31, 2013 10:08 pm

I own a couple of international bond funds but they are only about 2-3% of my portfolio and maybe 7-8% of my allocation to bonds.

One of the funds is down about 7% this year, mainly due to a strengthening dollar. It shows that currency risks can be substantial. Over time, currency fluctuations even themselves out. This does smart a bit though.

So if you own these, don't overdo it because of the currency risk.
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Re: What's the right allocation to international bonds?

Post by ftobin » Fri May 31, 2013 11:12 pm

nedsaid wrote:So if you own these, don't overdo it because of the currency risk.
Vanguard's international bond fund is hedged. No currency risk.

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Re: What's the right allocation to international bonds?

Post by stemikger » Sat Jun 01, 2013 12:47 am

Zero. I'll follow Mr. Bogle's advice and stick with the plain old vanilla balanced index fund.
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Re: What's the right allocation to international bonds?

Post by Valuethinker » Sat Jun 01, 2013 1:54 am

gkaplan wrote:
With the introduction of Vanguard Total International Bond Index Fund and Vanguard Emerging Markets Government Bond Index Fund, along with their corresponding ETF Shares, you may have questions about the global fixed income market. Vanguard Senior Investment Analyst Chris Philips answers some common questions facing investors....
https://personal.vanguard.com/us/insigh ... ion-052013

Given that it is currency hedged, and it's developed country bonds, I would guess 50% if you are going to do this. You are taking slightly more credit risk (Italy!) but you do get diversification.

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Re: What's the right allocation to international bonds?

Post by nisiprius » Sat Jun 01, 2013 6:24 am

Thread title: "What's the right allocation to international bonds?"

Vanguard's answer: There is no right or wrong allocation to foreign bonds.

Image

Repeat after me: "There is no right or wrong allocation to foreign bonds. There is no right or wrong allocation to foreign bonds. There is no right or wrong allocation to foreign bonds." The man said it right there. It cancels out everything else.

That article by Christopher Philips is a marvel of saying absolutely nothing at all. It amounts to saying "We recommend 20% because it's a number." The concept of "striking a balance" between global market capitalization and home bias is... fascinating. It's either a really dumb idea or a sensible, down-to-earth practical idea, not sure which. Although he talks about "balancing" costs as well, nowhere does he even hint at a calculation or methodology you could use to "balance" these factors and come up with the number 20.

I think the idea of 20% is about as scientific as "5% for fun money," except that this fund is (hopefully) so boring you have to have four times as much to get the same amount of fun. It's a big enough number that if it does do well, you'll see some effect in your portfolio

I mean, what can you say? They're just bonds. Intermediate-term, investment-grade, bonds. Given that the currency is hedged, there's just no reason to expect them to be very different from domestic bonds. I mean, seriously, international trade has existed for a long time. If Siemens promises to pay 1.75% on an 8-year bond they issued March, 2013--I just Googled and found that, it's a real bond--I'd believe them. I also have to believe that there's enough international trade that thing like credit quality being equal, there's just no way there could be any huge persistent difference in interest rates across countries--why would anyone buy domestic bonds if they could get much higher rates overseas?

I wouldn't own less than 0%, i.e. I wouldn't short the ETF if this fund becomes available as an ETF, which the web page seems to suggest. (I don't short anything. I can't. I don't have a brokerage account that would let me, and I can't open one because it would mean signing my name to a pack of fibs and little white lies on the special brokerage agreement...)

I wouldn't own more than 100%, i.e. I wouldn't buy this fund using leverage.

One thing is for sure. I certainly wouldn't buy this fund until at least enough time has past for Vanguard's website to be showing something other than dashes in its table of "characteristics!"

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Re: What's the right allocation to international bonds?

Post by Random Musings » Sat Jun 01, 2013 7:06 am

Years ago, the idea of most investors to invest in foreign equities was, well, a foreign concept. Today, foreign equities are accepted as an important diversifier in a well constructed portfolio. Most people on this board are between 20% and world market weight.

In the future, I betcha the same will be said about foreign bonds. I think the real question will be whether those funds should be unhedged in a well constructed portfolio.

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Re: What's the right allocation to international bonds?

Post by Scooter57 » Sat Jun 01, 2013 7:24 am

If these bonds are paying pretty much what US bonds are paying, where does the diversification come in? Is there any evidence that investment quality foreign bond interest rates don't rise and fall in tandem with US bonds?

This seems to me to be akin to "diversifying" your CD investment by investing in banks in different states--ones you have no personal knowledge of. Minus the FDIC insurance, of course.

With bonds, my understanding is that the interest rate directly reflects risk, so the only way you'd get a better rate would be to take on more risk.

I listened to the Vanguard online presentation about these bonds a few months ago, but nothing I heard gave me a compelling reason to invest in them. The risks seem higher and the unknowns greater. Plus, I have to wonder whether Vanguard has on staff the kind of experts it takes to evaluate foreign bonds. I'd be more inclined to go with specialists, i.e. PIMCO, were I investing in that domain. (Which I am, as I have just under 2% of my assets invested in their unconstrained Income fund, PIMIX.)

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Re: What's the right allocation to international bonds?

Post by tc101 » Sat Jun 01, 2013 9:12 am

Scooter57 wrote: Is there any evidence that investment quality foreign bond interest rates don't rise and fall in tandem with US bonds?
Several people have asked that question. Does anyone know the answer?
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Re: What's the right allocation to international bonds?

Post by gkaplan » Sat Jun 01, 2013 12:33 pm

Valuethinker wrote:
gkaplan wrote:
With the introduction of Vanguard Total International Bond Index Fund and Vanguard Emerging Markets Government Bond Index Fund, along with their corresponding ETF Shares, you may have questions about the global fixed income market. Vanguard Senior Investment Analyst Chris Philips answers some common questions facing investors....
https://personal.vanguard.com/us/insigh ... ion-052013

Given that it is currency hedged, and it's developed country bonds, I would guess 50% if you are going to do this. You are taking slightly more credit risk (Italy!) but you do get diversification.
That's pretty much the way I feel. I still haven't convinced myself to invest in the fund. My uncertainty is less of a fear factor and more of a desire not to complicate my life.
Gordon

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Re: What's the right allocation to international bonds?

Post by burma7734 » Sat Jun 01, 2013 12:50 pm

tc101 wrote:
Scooter57 wrote: Is there any evidence that investment quality foreign bond interest rates don't rise and fall in tandem with US bonds?
Several people have asked that question. Does anyone know the answer?
Here is a source that shows the correlation between International Bonds and US Bonds at 0.3, 0.0, 0.3 for 1, 3, and 10 year timeframes. So, there is a slight positive correlation, but it is a weak one suggesting addition of International bonds provides diversification benefits.

Some seem to be saying "I don't need international bonds because I have internationals stocks." That makes no sense to me. You wouldn't say that of US holdings. Stocks and bond serve different functions in a portfolio, regardless of the base country. The same source shows International bonds and International stocks around 0.3 - 0.4 correlation.

Please notice that International Stocks and US Stocks have had a 0.9 correlation over the past decade.

I have 35% of my stocks in international holdings and currently 12% of my bonds. I have been holding some Roth IRA money to put into the new VTABX, which would bring me to 25% of bonds as international.

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Re: What's the right allocation to international bonds?

Post by tc101 » Sat Jun 01, 2013 1:41 pm

I have 35% of my stocks in international holdings and currently 12% of my bonds. I have been holding some Roth IRA money to put into the new VTABX, which would bring me to 25% of bonds as international.
Will you rebalance that 25% in international bonds as they go up and down? If so, how often or after how much variation?
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Re: What's the right allocation to international bonds?

Post by burma7734 » Sat Jun 01, 2013 2:11 pm

tc101 wrote:
I have 35% of my stocks in international holdings and currently 12% of my bonds. I have been holding some Roth IRA money to put into the new VTABX, which would bring me to 25% of bonds as international.
Will you rebalance that 25% in international bonds as they go up and down? If so, how often or after how much variation?
Yes, I would rebalance this position just like all the rest. I built myself a nifty little spreadsheet I use to track and rebalance. My rebalance threshold is 3% of my total portfolio (e.g. $3k for $100k portfolio). I calculate the target $ holding of each of four classes (domestic + international for each stocks and bonds). If one of the classes is out by more than the threshold, the cell flashes red and tells me to rebalance.

Since International Bonds would be smallest of the four classes (25% * 36% = 9% of my total portfolio), mathematically this one gets a wider berth than the rest and would take a bigger relative fluctuation to trigger a rebalance.

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Re: What's the right allocation to international bonds?

Post by tc101 » Thu Jun 06, 2013 3:05 pm

Does the Vanguard Total International Bond Index Fund include emerging market country bonds? Why aren't the holding listed on the web site?
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Re: What's the right allocation to international bonds?

Post by Boglenaut » Thu Jun 06, 2013 3:17 pm

tc101 wrote:Why aren't the holding listed on the web site?
It's too new.

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Re: What's the right allocation to international bonds?

Post by bpp » Thu Jun 06, 2013 5:20 pm

My personal answer is: 50%, unhedged.
Same as stocks.

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Re: What's the right allocation to international bonds?

Post by nedsaid » Thu Jun 06, 2013 9:19 pm

One reason I invested in International Bonds was for the currency exposure. The fund at my favorite mutual fund company is unhedged. It seems to be that a hedged fund would defeat part of the purpose of owning it, that is to diversify away from the US Dollar.

So yes, I know one can invest in funds that are either hedged or not hedged against currency risk. I didn't know the Vanguard Fund was hedged.

So I have stayed invested in my fund, but with a 7% drop I am more aware of the currency risk.

As far as a right allocation to international bonds, that is a matter of preference. I saw it as another asset class to invest in.
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Re: What's the right allocation to international bonds?

Post by dharrythomas » Thu Jun 06, 2013 9:33 pm

I would think that anywhere between 0% and the market weighting of the international to US investment grade bonds would be within reason. :confused Since we own both Target Retirement funds and LifeStrategy Moderate Growth, we'll own some. Since the fund is hedged, my guess is the extra expenses of teh hedge are equal to or greater than the benefit of adding the additional bonds to the portfolio. Since the fund is hedged, it should not make much difference (still have my currency risk concentrated in equities).

Could Vanguard have added the funds to Target Retirement and LifeStrategy in order to provide an asset base to make it easier to launch the fund? :annoyed

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Re: What's the right allocation to international bonds?

Post by Valuethinker » Fri Jun 07, 2013 5:08 am

gkaplan wrote:
Valuethinker wrote:
gkaplan wrote:
With the introduction of Vanguard Total International Bond Index Fund and Vanguard Emerging Markets Government Bond Index Fund, along with their corresponding ETF Shares, you may have questions about the global fixed income market. Vanguard Senior Investment Analyst Chris Philips answers some common questions facing investors....
https://personal.vanguard.com/us/insigh ... ion-052013

Given that it is currency hedged, and it's developed country bonds, I would guess 50% if you are going to do this. You are taking slightly more credit risk (Italy!) but you do get diversification.
That's pretty much the way I feel. I still haven't convinced myself to invest in the fund. My uncertainty is less of a fear factor and more of a desire not to complicate my life.
If the fund was not currency hedged then you have taken on big currency volatility, which will make the return of the bonds almost irrelevant-- and we tend to hold here that currency volatility is a risk that is not compensated for by higher return.

If currency hedged (a la VG fund) then the diversification benefit is because different economies are on different interest rate cycles. But whilst Australia was on a different cycle from the USA (tight monetary policy but now being loosened due to domestic downturn) not much else is. Japan is stuck on something else (last 6 months an experiment in radical monetary policy may change that, but not to the benefit of JGB bondholders). Europe is in the US-squared in terms of slowdown and low interest rates for an extended period. UK is in austerity blues etc.

So basically you are not, to my mind, diversifying much. Or at least not for much gain. The real interest rate cycles just are not that different right now.

I'd rather tweak up my international stock diversification. You get full on the benefits/ risks of what is going on in the Eurozone (when the panic averts, the stocks look dead cheap, they shoot up, then panic reasserts), Japan (currency down 30%, market up 60%; now we are not sure Bank of Japan will stick to its guns in permanently doubling the monetary base, so it drops back, etc.), commodities (Australia and Canada), etc.

In other words, international stock markets can diverge from the US more than developed country international bond markets can. Counterargument (not checked): recent correlation has been about 0.9 ie very limited gains from developed country international diversification.

The US bond markets seem to give a USD investor what one wants out of bonds, especially if we add in the inflation linked components (TIPS and ibonds).

If there's no big gain to it in expected return nor diversification, why complicate your life?

The real diversification out there would be finding a transactions-cost efficient fund that really tracks international small value equity. Larry Swedroe has made this point. Unfortunately that basically seems to mean DFA-- if you can find a way to get into their funds. (I think they do an EM value or an EM small product as well? Again, there, it's *really* important to minimize transactions costs given the high dealing spreads on EM stocks and limited liquidity AND based on a newspaper article I read they do an in depth numbers clean. Some EM companies are probably outright fraudulent on their numbers, and the markets are not so efficient that that is always caught in the share price. The wise investor (recognizing the illiquidity) doesn't buy blind).

The mantra, that has led DFA away from being a 'pure' indexer, with these esoteric asset classes has to be: minimize transactions costs and be tax efficient.

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Re: What's the right allocation to international bonds?

Post by burma7734 » Fri Jun 07, 2013 4:54 pm

In other words, international stock markets can diverge from the US more than developed country international bond markets can. Counterargument (not checked): recent correlation has been about 0.9 ie very limited gains from developed country international diversification.
I don't see the data to support this. Please elucidate.

From the asset correlations I see, US Bond:International bonds 0.0-0.3 depending the time period, with US Stocks:International stocks is 0.9 over recent time periods.

Maybe you are saying that correlations over the past 10 years are abnormal, but would be greatful for any data to support this.

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Re: What's the right allocation to international bonds?

Post by epilnk » Fri Jun 07, 2013 5:45 pm

I'm going with zero. I don't have anything against this asset class. But if I were going to raise the risk of my bond allocation I would need to compensate by lowering my equity/bond ratio. I don't particularly want to buy more bonds right now. So I'll continue to leave the bulk of my risk on the equity side.

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Re: What's the right allocation to international bonds?

Post by arbogast777 » Fri Jun 07, 2013 5:58 pm

My personal philosophy continues to be that I have no way of knowing what asset class will outperform in the future so my portfolio is constructed based on the following...

1) large and small 50/50
2) value and growth 50/50
3) domestic and international 50/50

and now as of this week...

4) domestic bonds and international bonds 50/50

FYI for stocks and bonds I, of course, adjust based on my age. Add a dash of real estate and we'll sit back and see where it takes me :sharebeer

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Re: What's the right allocation to international bonds?

Post by Default User BR » Fri Jun 07, 2013 6:09 pm

I don't use international bonds. I'm not sure there's a compelling reason to do so. In my 401(k), the global bond fund is not international only, so there are US bonds in it. It's actively managed (PIMCO) and its ER is relatively high at 0.32% compared to the aggregate bond fund at 0.06%. I'm not eager to give up any of my Roth space to hold them either.


Brian

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Re: What's the right allocation to international bonds?

Post by Clearly_Irrational » Fri Jun 07, 2013 7:03 pm

Not enough data to answer the question yet. I'm intrigued by the idea of an international bond index fund but currently it has no place in my portfolio design. Once it's been around for a few years I'll probably take a look.

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Re: What's the right allocation to international bonds?

Post by arthurdawg » Fri Jun 07, 2013 10:19 pm

I might consider adding them in the next few years... no hurry though. I'm doubtful that they would really add that much to my portfolio.
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