Are international bonds necessary?

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BogleBuddy12
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Are international bonds necessary?

Post by BogleBuddy12 »

Many experts say that you only need US bonds. Corporate, Government, Municipal, etc. The purpose of bonds is safety. International diversification is not needed.

However in a recent webcast from Vanguard, they said that 30% of your bonds should be international.

Is there any reason to own international bonds, like BNDX or VWOB?
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Re: Are international bonds necessary?

Post by beardsworth »

It's nearly always a good idea to use that search box at the top of the Bogleheads page to see what other threads already exist about a topic, which in this case has been discussed extensively. For example, a simple search for the phrase "international bonds" yielded these, among others.

viewtopic.php?t=158206

viewtopic.php?t=139939

viewtopic.php?t=142019

viewtopic.php?t=136201

viewtopic.php?t=159268
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Re: Are international bonds necessary?

Post by nisiprius »

"When experts disagree, often it is because it doesn't matter much."--Taylor Larimore

1) High-grade bonds are high-grade bonds. Most bonds are promises to pay specific numbers of dollars on specific days. If the bond is investment-grade, that means for ordinary purposes we assume the promise will be kept. If particular kinds of bonds contain an "if" in their promise, such as "if the bond is not called," then the "if" introduces uncertainty that must be accounted for. But, by and large, if two bonds both are investment-grade and both promise to pay the same number of dollars on the same days, they should be pretty much interchangeable.

2) (Ignore emerging markets bonds for the moment, because although they promise to pay in dollars, they are not investment-grade and the promise might not be kept).ADDED: And see lack_ey's corrections, below.

3) Many foreign bonds are investment-grade, but they promise to pay Euros or other currencies, not dollars.

4) Currency fluctuations are huge. If you invest in a Euro-denominated foreign bond, in addition to small changes due to market fluctuation in the European bond market, you will also see big changes due to changes in the dollar value of the Euro.

5) Low interest rates in the U.S. have made many investors decide to reach for yield by investing in "bonds" that are much riskier than the kinds of bonds found in Vanguard Total Bond. Thus there is enthusiasm for junk bonds, euphemistically called "high yield;" emerging markets bonds; long-term bonds (found in Total Bond but only in a small proportion); a zoo of stuff I never even heard of before, like bank loan bonds.

I will use the phrase "bond-like" to mean "similar to Total Bond or some other tame, low-risk, 'core' bond fund that might be part of a Bogleheadish portfolio.

6) In Ye Olde Days a typical "international bond fund" might have been something like Templeton Global Bond, TPINX. That is, an unhedged bond fund that invests in foreign denomination bonds and has to exchange currencies to pay you in dollars. Such a fund is really as much an investment in "foreign exchange" (FOREX) as it is in bonds. Clever investors can theoretically make money in FOREX by guessing market movements, and unhedged bond funds usually do some of that. FOREX is traditionally a speculative, very risky kind of investment. The 15-year standard deviation, one measure of risk, is 7.85 for TPINX versus 3.54 for Total Bond. There's a case to be made for it because return is also much higher, but it is not at all "bond-like." It's some totally other investment category.

7) Bond fund managers can hedge currencies by buying future contracts that promise to deliver X Euros in Y years for a payment of Z dollars today. It is possible to constructed a hedged bond fund which all but eliminates the effect of currency movements. Such a fund is "bond-like" and is a candidate for inclusion in bond component of a traditional Bogleheadish portfolio, in which bonds just sit there, hold a fairly stable value, and crank out interest.

8) Hedging adds costs.

9) It also removes the possibility of profiting from FOREX operations by the fund managers. It also removes the "currency insurance" factor of holding foreign currencies if the dollar were to weaken, plunge, collapse, etc. People who say they want "currency diversification" don't want a hedged bond fund, because to them a bond fund is more like "a non-dollar currency investment that earns interest" rather than "a bond investment."

10) If the interest rates etc. were the same, there's no glaringly obvious reason why you'd want a low-risk bond that happens to be in Euros rather than a similar that happens to be in dollars, once the currency risk is removed However, different countries have different economies and financial policies, and, particularly when interest rates in the United States are "repressed," one might hope for higher rates overseas. Of course, sometimes overseas rates are lower as well a higher. But one can make a very very very feeble case that hedged foreign bonds provide interest rate diversification, and that the very small value of that diversification very slightly outweighs the costs, if you can get them low enough.

Vanguard makes that very, very, very feeble case in Global fixed income: Considerations for U.S. investors

11) You didn't used to hear much about unhedged foreign bond funds because they're not "bond-like."

12) You didn't used to hear much about hedged foreign bond funds because there weren't too many of them. One was PIMCO Global Bond (USD-Hedged), PAIIX, had an 0.90% expense ratio. Inception in 1995. Compared to Total Bond, 15-year standard deviation ("risk") and return are both higher than Total Bond and the Sharpe ratio (reward for risk) is essentially identical.

13) Before launching the fund, Vanguard had been making noises about the difficult to getting hedging costs down far enough make the fund worthwhile, then they said they thought they'd managed to do it. Morningstar says Vanguard Total International Bond, VTIBX, has an expense ratio of 0.23%, compared to the "category average" of 1.03% and the "fee level comparison group median" of 0.86%. ADDED: but the hedging costs are not in the ER, so strike that comment, as irrelevant, thanks BigJohn and troysapp.

14) If we talk about "low-cost dollar-hedged international bond funds" Vanguard has something fairly new (6/1/2013) and more or less unique.

15) Vanguard talks about the virtues of low-cost dollar-hedged international bond funds a lot. Most fund companies don't offer them--certainly not low-cost funds--and don't discuss that investment category.

16) It's really hard for me to believe that including Vanguard Total International Bond Fund in lieu of a portion of Total Bond could possibly make much difference either way, so personally I shrug it off and opt for "simplicity" and "sticking with what I have."

17) I think someone with a strong conviction in internationalism-for-the-sake-of-internationalism--when in doubt, internationalize--might find this fund appealing.
Last edited by nisiprius on Sat Aug 22, 2015 7:07 am, edited 7 times in total.
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Re: Are international bonds necessary?

Post by lack_ey »

nisiprius wrote:2) (Ignore emerging markets bonds for the moment, because although they promise to pay in dollars, they are not investment-grade and the promise might not be kept).
There exist plenty of emerging market bonds denominated in local currency and also commonly used international ones other than the USD such as the Euro and Yen. Some US investors deliberately buy emerging markets local currency bonds (funds). Also, a large number of emerging market bonds are investment grade. Vanguard's emerging markets (USD denominated) bond index fund based on a Barclays index has 10% Aa, 10% A, and 49% Baa: significantly more investment grade than sub-investment grade.
nisiprius wrote:10) If the interest rates etc. were the same, there's no glaringly obvious reason why you'd want a low-risk bond that happens to be in Euros rather than a similar that happens to be in dollars, once the currency risk is removed However, different countries have different economies and financial policies, and, particularly when interest rates in the United States are "repressed," one might hope for higher rates overseas. Of course, sometimes overseas rates are lower as well a higher. But one can make a very very very feeble case that hedged foreign bonds provide interest rate diversification, and that the very small value of that diversification very slightly outweighs the costs, if you can get them low enough.

Vanguard makes that very, very, very feeble case in Global fixed income: Considerations for U.S. investors
Depends on the (expected) hedge return, which can cut both ways. I guess I can't claim this as glaringly obvious because I don't really understand the why and the magnitude as well as I'd like, but suffice to say that nominal yields aren't quite directly comparable when there is the currency difference, even after hedging.
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Re: Are international bonds necessary?

Post by herpfinance »

Thank you nisiprius for such an excellent post :sharebeer
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Re: Are international bonds necessary?

Post by BigJohn »

lack_ey wrote:13) Before launching the fund, Vanguard had been making noises about the difficult to getting hedging costs down far enough make the fund worthwhile, then they said they thought they'd managed to do it. Morningstar says Vanguard Total International Bond, VTIBX, has an expense ratio of 0.23%, compared to the "category average" of 1.03% and the "fee level comparison group median" of 0.86%.
Nisi, maybe I'm reading too much into this comment but are you sure that the hedging cost are reflected in the ER. I thought it was akin to transactions fees, there but with no documentation to know how much of your return it is eating up. At least with transaction fees you can look at portfolio turnover and get some relative feel for which funds will be higher than others. However, the hedging costs are completely hidden as far as I know.
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Re: Are international bonds necessary?

Post by Beardog »

Are they necessary? No.

May they be a reasonable part of a well diversified portfolio? Perhaps.
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Re: Are international bonds necessary?

Post by nisiprius »

BigJohn wrote:
lack_ey wrote:13) Before launching the fund, Vanguard had been making noises about the difficult to getting hedging costs down far enough make the fund worthwhile, then they said they thought they'd managed to do it. Morningstar says Vanguard Total International Bond, VTIBX, has an expense ratio of 0.23%, compared to the "category average" of 1.03% and the "fee level comparison group median" of 0.86%.
Nisi, maybe I'm reading too much into this comment but are you sure that the hedging cost are reflected in the ER. I thought it was akin to transactions fees, there but with no documentation to know how much of your return it is eating up. At least with transaction fees you can look at portfolio turnover and get some relative feel for which funds will be higher than others. However, the hedging costs are completely hidden as far as I know.
:oops: I'm not sure either. I think I remember Vanguard suggesting that they had gotten the hedging costs down into the 0.2%-0.3% range which would mean they could not be in the ER.
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Re: Are international bonds necessary?

Post by SeeMoe »

80% of the bond market is non-USA products I saw recently on CNBC . So it makes sense to own some foreign bonds . Q. Do you count foreign bonds in with foreign stocks to arrive at the long term asset mix of 60% USA, 40% international portfolio ? Guess so, since USA bonds are counted in that mix, eh ?
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Re: Are international bonds necessary?

Post by columbia »

What's the scenario, where owning them could make a sustained difference in total returns?
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Re: Are international bonds necessary?

Post by BogleBuddy12 »

nisiprius wrote:
BigJohn wrote:
lack_ey wrote:13) Before launching the fund, Vanguard had been making noises about the difficult to getting hedging costs down far enough make the fund worthwhile, then they said they thought they'd managed to do it. Morningstar says Vanguard Total International Bond, VTIBX, has an expense ratio of 0.23%, compared to the "category average" of 1.03% and the "fee level comparison group median" of 0.86%.
Nisi, maybe I'm reading too much into this comment but are you sure that the hedging cost are reflected in the ER. I thought it was akin to transactions fees, there but with no documentation to know how much of your return it is eating up. At least with transaction fees you can look at portfolio turnover and get some relative feel for which funds will be higher than others. However, the hedging costs are completely hidden as far as I know.
:oops: I'm not sure either. I think I remember Vanguard suggesting that they had gotten the hedging costs down into the 0.2%-0.3% range which would mean they could not be in the ER.
Rick Ferri says the hedging costs are not included in the expense ratio. I think he said they probably add another 10 basis points or so.
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Re: Are international bonds necessary?

Post by randomguy »

columbia wrote:What's the scenario, where owning them could make a sustained difference in total returns?

When international bonds drastically outperform US ones:) After all the 1 year Total international return is 3.5 versus the US 1.7. Thats like 100% more return.:) Long term I would expect them to give about the same returns (if one is returning a lot more than another investors will flock to it). But in the short term (call it 15 years), you are subject to the same sequence of return issues that affect stocks.

And I suppose you could also worry about the US market collapsing (see Weimar germany) if you want to be paranoid.
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Re: Are international bonds necessary?

Post by nisiprius »

SeeMoe wrote:...80% of the bond market is non-USA products I saw recently on CNBC..
If they said 80%, then it sounds to me like they are twisting some definitions to prove a point.

Vanguard says in their 2014 paper says "more than half." They do not give an actual percentage number but they present this chart that shows that "non-U.S. bonds are now the world's largest asset class." As nearly as I can determine by eyeball, according to their chart, bonds (U.S. and international) were ~56% of the global investable market, U.S. bonds were ~22% of the global investable market, and thus, at year-end 2013,

U.S. bonds represented about 40% of the global bond market.

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Re: Are international bonds necessary?

Post by troysapp »

ajacobs6 wrote:
nisiprius wrote:
BigJohn wrote:
lack_ey wrote:13) Before launching the fund, Vanguard had been making noises about the difficult to getting hedging costs down far enough make the fund worthwhile, then they said they thought they'd managed to do it. Morningstar says Vanguard Total International Bond, VTIBX, has an expense ratio of 0.23%, compared to the "category average" of 1.03% and the "fee level comparison group median" of 0.86%.
Nisi, maybe I'm reading too much into this comment but are you sure that the hedging cost are reflected in the ER. I thought it was akin to transactions fees, there but with no documentation to know how much of your return it is eating up. At least with transaction fees you can look at portfolio turnover and get some relative feel for which funds will be higher than others. However, the hedging costs are completely hidden as far as I know.
:oops: I'm not sure either. I think I remember Vanguard suggesting that they had gotten the hedging costs down into the 0.2%-0.3% range which would mean they could not be in the ER.
Rick Ferri says the hedging costs are not included in the expense ratio. I think he said they probably add another 10 basis points or so.
Hedging costs are most definitely not included in the expense ratio. Vanguard published the paper linked below in July 2014 which estimated hedging costs at less than 0.20%.

Cheers

https://institutional.vanguard.com/iam/ ... _FINAL.pdf
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Re: Are international bonds necessary?

Post by abuss368 »

Excellent post!
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Re: Are international bonds necessary?

Post by Dandy »

I think of fixed income for safety, income and asset preservation purposed. I do believe in having some diversity to just having the Total bond fund. I would add TIPS, CDs and other FDIC or Federal Government guaranteed products. As a retiree I'm not sure adding International bonds are needed. I'll stay out. If I were younger I'd keep an eye on them.
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Re: Are international bonds necessary?

Post by abuss368 »

I was curious how the Total International Bond Index Fund would perform over the last month with the market pullback. Appears to be fine and paying dividends.
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Re: Are international bonds necessary?

Post by Gort »

SeeMoe wrote:80% of the bond market is non-USA products I saw recently on CNBC . So it makes sense to own some foreign bonds
Why?
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Re: Are international bonds necessary?

Post by Tamales »

Gort wrote:
SeeMoe wrote:80% of the bond market is non-USA products I saw recently on CNBC . So it makes sense to own some foreign bonds
Why?
Yes, I'l like to know the logic behind that statement as well. Even if it's not 80% and is only ~55%, why does it matter in the case of investment grade bonds?
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Re: Are international bonds necessary?

Post by Call_Me_Op »

ajacobs6 wrote:Many experts say that you only need US bonds. Corporate, Government, Municipal, etc. The purpose of bonds is safety. International diversification is not needed.
"Need" is a strong word. I don't think most folks "need" bonds at all. Most certainly do not need all of the types mentioned.
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Re: Are international bonds necessary?

Post by dc81584 »

I have some (through VFIFX), but I wouldn't say they are necessary.
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Re: Are international bonds necessary?

Post by abuss368 »

Dandy wrote:I think of fixed income for safety, income and asset preservation purposed. I do believe in having some diversity to just having the Total bond fund. I would add TIPS, CDs and other FDIC or Federal Government guaranteed products. As a retiree I'm not sure adding International bonds are needed. I'll stay out. If I were younger I'd keep an eye on them.
Hi Dandy,

I agree and I too have been curious if international bonds are needed at any stage, let alone retirement. Vanguard allocates an increasing percentage in the Target Retirement Fund to international bonds.

Best.
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Re: Are international bonds necessary?

Post by watchnerd »

Morningstar has said that Vanguard's currency-hedged international bond fund is pointless.
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Re: Are international bonds necessary?

Post by pascalwager »

I don't know if it's a diversifying asset or not, but I don't like it's structure, just like I don't like TBM's structure. For one thing, the duration is too long to suit me.
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Re: Are international bonds necessary?

Post by small_index »

The correlations shown in the following article suggest un-hedged international bonds could be better for diversification than international stock.

http://www.forbes.com/sites/greggfisher ... portfolio/
... we looked backed over the period from January 1, 1992 to March 31, 2012 and calculated a 0.80 correlation between the MSCI World ex-US Index and the S&P 500 Index. By contrast, during the same time frame the correlation between the Citigroup World Government Bond Index ex-US 1-3 Years index and five-year US Treasury notes was 0.35, and the relation with the S&P 500 was just 0.1.
Yet Vanguard's paper on the topic suggests that un-hedged international bonds add volatility to an overall portfolio of 60% stocks/40% bonds:
http://www.vanguard.com/pdf/icrifi.pdf
(page 7 shows un-hedged graph, page 10 international bonds with hedging to US currency)
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Re: Are international bonds necessary?

Post by slowmoney »

So, the expense ratio is more like 0.50…Mmmm. Total US Bond has an expense ratio of 0.07.

I have been thinking about this for some time, so I thought I would just post about it and move on to other things.

In Vanguard’s paper, “Global fixed income: Considerations for U.S. investors” on page 4:
A departure from market-cap-weighted exposure to international bonds assumes that the market is incorrect in it valuation and that there is better way to invest.
Correct.

So when Vanguard “hedges” it currency exposure, it is really “pegging” the currency to a very specific time period. That specific market-cap-weighted exposure.

Well, the next day, the global capital markets which includes the international currency market, reset the global market-cap-weighted value of all assets. It is different than the historical “pegging” date.

Any deviation from a market-cap-weighted approach is called ACTIVE management. You really, really want to make active timing bets in the international currency market?

For simplicity, let’s say the dollar doubles in strength the week after you purchased International Bond. The market-cap-weighting of international bonds has just been cut in half from a US investor perspective! What happened to Vanguard’s hedged international bond fund, nothing. If the dollar weakens by half, the international bonds double! Vanguard hedged, nothing.

What is more sacred than a personal AA?

An investor in an unhedged international bond fund would see the allocation to international bonds rise and fall depending upon the daily change in the market-cap-weighted strategy. That investor could rebalance his AA for his risk exposure. As the dollars rises, he buys more. As the dollar declines, he sells.

In Vanguard’s international bond fund, there is no to little movement. Your AA is constantly incorrect and deviating from a market-cap-weighting. If the dollar declines, you are way, way overweight international bonds and DON’T EVEN KNOW IT!

How do you feel about your AA lying directly to your face?

They should call them Pegged International Bonds. For the record, currency pegs never work out in the long run. Maybe in the short run, the benefits could outweigh the cost but not in the long run. Are not most Bogleheads long term investors? Short term investors are in cash or CDs, no?

Currency pegs only serve to send distorted and incorrect price signals to people. As people chase these purposefully incorrect price signals, incorrect decisions are made and imbalances grow. Eventually the imbalances grow so large that they collapse and crush people and entire economies.

Does anyone really understand Vanguard’s currency hedging? They say it is short term. So, if the international bond is for 3 years, you actually are not completely hedging out currency exposure, only partially but yet you are paying 0.50 for hedging? Paying for something that you are not getting? Great.

Lastly, international bonds have been around for like centuries. Yet it took until 2015 for people to be smart and technical enough to figure this out? Please. As stated by many Boglehead authors, there are plenty of fundamental reasons not to have international bonds in your AA.
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Re: Are international bonds necessary?

Post by Dandy »

I get the idea of why being more global with fixed income could make sense. I don't see the same need for fixed income as there may be for equities. For me fixed income is for stability and some income. I can get pretty much all of that with U.S. based fixed income bonds, CDs etc. International bonds seem a bit more of an expensive bet on a bit more risky fixed income alternative. I'm sure it adds some diversification but in retirement I'll pass and see what happens.

There does seem to be a trend toward globalizing portfolios - I'm a late adopter --clung to my rotary phone too long. :oops:
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Re: Are international bonds necessary?

Post by abuss368 »

Here is on aspect of this asset class that I am thinking through. It appears anymore that companies are now offering bonds in overseas markets and foreign companies are offering bonds in U.S. markets. Apple and Berkshire Hathaway come to mind as two U.S. companies offering bonds in Europe. When checking the Vanguard Total International Bond Fund, I noted there were U.S. companies listed. Likewise, Total Bond Index includes foreign companies offering bonds in the U.S.

Was this always the case many years ago? Has this change as the markets have evolved into a more global approach? Were the international and U.S. bond funds of years ago more specific to home countries and no offerings in foreign markets?
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Re: Are international bonds necessary?

Post by Northern Flicker »

Vanguard estimates the hedging cost at about 20 bp. There also is a forex cost of just converting dollars into the currency used for a bond purchase, corresponding to half the currency bid-ask spread, which I think VG estimated at 17 bp, so you are looking at about 37 bp on top of the ER to hold the intl bond fund. I'd be more inclined to consider TIPs as a diversifier for a US-based nominal bond portfolio, but Vanguard is standing on their research about this with confidence.

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Re: Are international bonds necessary?

Post by abuss368 »

jalbert wrote:Vanguard estimates the hedging cost at about 20 bp. There also is a forex cost of just converting dollars into the currency used for a bond purchase, corresponding to half the currency bid-ask spread, which I think VG estimated at 17 bp, so you are looking at about 37 bp on top of the ER to hold the intl bond fund. I'd be more inclined to consider TIPs as a diversifier for a US-based nominal bond portfolio, but Vanguard is standing on their research about this with confidence.

-jalbert
Hi jalbert,

Vanguard has recently recommended to increase the allocation to Total International Bond Index from 20% to 30% of fixed income.

Best.
Last edited by abuss368 on Thu Sep 24, 2015 4:46 pm, edited 1 time in total.
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Re: Are international bonds necessary?

Post by Northern Flicker »

Yes, that's why these threads exist. My issue with intl bonds is if you look at (yield - duration) as a measure of interest rate risk, it is pretty high (lower value equals higher risk) while yield is low.

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Re: Are international bonds necessary?

Post by abuss368 »

jalbert wrote:Yes, that's why these threads exist. My issue with intl bonds is if you look at (yield - duration) as a measure of interest rate risk, it is pretty high (lower value equals higher risk) while yield is low.

-jalbert
Hi jalbert,

Do you invest in the Vanguard Total International Bond Index Fund?

Best.
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Re: Are international bonds necessary?

Post by Northern Flicker »

abuss368 wrote:
Hi jalbert,

Do you invest in the Vanguard Total International Bond Index Fund?

Best.
I'd suggest using PM's for personal messages, but in any case, the answer is no, Vanguard research notwithstanding.

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Re: Are international bonds necessary?

Post by vitaflo »

Personally I like them. I like owning more of the market especially one that large. Of course you need to add the risks into your risk profile, but I certainly see nothing wrong with diversifying when you can.
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