A case for holding international bonds

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Elysium
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A case for holding international bonds

Post by Elysium » Tue Sep 11, 2018 9:03 am

I hold a small percentage of overall portfolio allocation (5%) to high quality international bond fund in Vanguard Total Intl Bond Index Instl shares. This is a total of 5% of overall portfolio and slightly less than 20% of bond allocation. I intend to keep this allocation steady. This fund is USD currency hedged and the expense ratio is a rock bottom 0.07%. While the interest rate is a low 0.96% SEC yield, my reasons for holding it are mainly as an insurance against US bonds collapse of any sort.

I know, I know, people say if US treasuries default or fall then there is no other place to hide, and Intl bonds aren't going to help. But, just in case, what if there is a possibility that US bonds including treasuries could fault, and high quality soveriegn foreign bonds does not. This is sort of like insurance that I expect I don't need and may even be not there, but just in case of a black swan event, it is there. Is there any reason, I should not be holding this bond fund?

I see no risk, other than giving up a few basis points over the years may be, even that is not certain, as they could likely keep up with US bonds. My other reason is that with US Treasuries giving 3%, investors still want this 1% bonds, so there has to be some merit to it, otherwise why anyone would invest in it. I know, again, people will say a US investor should have no reason to hold it.

123
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Re: A case for holding international bonds

Post by 123 » Tue Sep 11, 2018 9:12 am

You are barely getting your toes wet in international bonds. Most of the Vanguard fund-of-funds (Target Retirement, LifeStrategy) are holding international bonds as somewhere around 30 - 40 percent of their bond allocation.
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nedsaid
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Re: A case for holding international bonds

Post by nedsaid » Tue Sep 11, 2018 9:16 am

I hold International Bond Funds, but so far I have been disappointed. The strong US Dollar is the culprit as neither of my funds are currency hedged. These two funds are about 7% of my bonds and I have no plans to sell. I would say the case for International Bonds, whether US Dollar hedged or not, is a weak one. Might help, probably won't hurt much.
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Jordan4FI
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Re: A case for holding international bonds

Post by Jordan4FI » Tue Sep 11, 2018 9:24 am

I say why not... owning more is good in my thought process. I use Target Date currently and let Vanguard decide the %'s of each fund within. So I do not look to see if that specific fund is going well or not, I just see my one fund's performance when I do look. Once I am FI and quit my job, I will continue to keep my main taxable account in one of the middle LifeStrategy Funds, keeping the 4 funds of a total world market working for me. I do not need them all to be amazing performers, but to keep my return steady and between 4-8% on average to maintain my future lifestyle (in Thailand).

Tamalak
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Re: A case for holding international bonds

Post by Tamalak » Tue Sep 11, 2018 9:25 am

International stocks are going so well, I'm definitely going to buy up the world 'cap' bond fund when it comes out!

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Ketawa
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Re: A case for holding international bonds

Post by Ketawa » Tue Sep 11, 2018 10:28 am

I don't know how international bonds have done recently, or how Treasuries rates compare to other AAA government bonds, but looking at SEC yield is very misleading for hedged international bonds. It leaves out the hedge return. The SEC yield is calculated in the yield of the local currency, but after hedging back to USD, the expected return can be much higher. SEC yield is a valid predictor for expected return of US bonds, but fairly useless for hedged international bonds.

The hedge return is not random around 0%. For countries with similar credit quality, differences in bond yield reflect differences in inflation expectations. If international bonds have a lower yield, then other currencies are expected to appreciate relative to the USD, so the hedge return will be positive.

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willthrill81
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Re: A case for holding international bonds

Post by willthrill81 » Tue Sep 11, 2018 10:35 am

If I'm not being paid to take on currency risk, I see little point in doing so, hence I would avoid international bonds unless the yield's were significantly higher. Currently, they are not.

Some argue that currency risk adds a layer of diversification to one's returns because of its lack of strong correlation with other major asset classes. If that is the case, then something like managed futures and precious metals should be considered as well for the same reason.
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Elysium
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Re: A case for holding international bonds

Post by Elysium » Tue Sep 11, 2018 12:35 pm

Ketawa wrote:
Tue Sep 11, 2018 10:28 am
I don't know how international bonds have done recently, or how Treasuries rates compare to other AAA government bonds, but looking at SEC yield is very misleading for hedged international bonds. It leaves out the hedge return. The SEC yield is calculated in the yield of the local currency, but after hedging back to USD, the expected return can be much higher. SEC yield is a valid predictor for expected return of US bonds, but fairly useless for hedged international bonds.

The hedge return is not random around 0%. For countries with similar credit quality, differences in bond yield reflect differences in inflation expectations. If international bonds have a lower yield, then other currencies are expected to appreciate relative to the USD, so the hedge return will be positive.
Good point. Although, I see coupon rates on Japanese and German bonds that are top holdings in the Vanguard fund are close to 1% or less. Japanese bonds have been close to zero or negative for many years, same situation for other developed European issuers of major debt. I see the point about hedge, but I am not even looking for making money out of it this way.

My whole point which I laid out is this is insurance. Insurance against some unseen blackswan event for US bonds / treasuries. I know the usual argument that if US bonds fault then there will be major problems and Intl bonds will not save you. However, there could be a possibility it may not be that catastrophical, or something that gets worked out eventually, but short term losses could result in US Bonds. Meanwhile, having a small insurance in the form of 5% Intl Bond allocation is for safety.

JBTX
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Re: A case for holding international bonds

Post by JBTX » Tue Sep 11, 2018 12:43 pm

Elysium wrote:
Tue Sep 11, 2018 12:35 pm
Ketawa wrote:
Tue Sep 11, 2018 10:28 am
I don't know how international bonds have done recently, or how Treasuries rates compare to other AAA government bonds, but looking at SEC yield is very misleading for hedged international bonds. It leaves out the hedge return. The SEC yield is calculated in the yield of the local currency, but after hedging back to USD, the expected return can be much higher. SEC yield is a valid predictor for expected return of US bonds, but fairly useless for hedged international bonds.

The hedge return is not random around 0%. For countries with similar credit quality, differences in bond yield reflect differences in inflation expectations. If international bonds have a lower yield, then other currencies are expected to appreciate relative to the USD, so the hedge return will be positive.
Good point. Although, I see coupon rates on Japanese and German bonds that are top holdings in the Vanguard fund are close to 1% or less. Japanese bonds have been close to zero or negative for many years, same situation for other developed European issuers of major debt. I see the point about hedge, but I am not even looking for making money out of it this way.

My whole point which I laid out is this is insurance. Insurance against some unseen blackswan event for US bonds / treasuries. I know the usual argument that if US bonds fault then there will be major problems and Intl bonds will not save you. However, there could be a possibility it may not be that catastrophical, or something that gets worked out eventually, but short term losses could result in US Bonds. Meanwhile, having a small insurance in the form of 5% Intl Bond allocation is for safety.
To me, this is the primary benefit both for international stock and bond investing, and also for going unhedged, at least for international stock.

jclear
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Re: A case for holding international bonds

Post by jclear » Wed Sep 12, 2018 5:09 am

Ketawa wrote:
Tue Sep 11, 2018 10:28 am
The hedge return is not random around 0%. For countries with similar credit quality, differences in bond yield reflect differences in inflation expectations. If international bonds have a lower yield, then other currencies are expected to appreciate relative to the USD, so the hedge return will be positive.
You mean "so the hedge return will be negative."
JBTX wrote:
Tue Sep 11, 2018 12:43 pm
To me, this is the primary benefit both for international stock and bond investing, and also for going unhedged, at least for international stock.
I'd prefer it if Vanguard's international bond funds were unhedged. They don't produce foreign taxes paid credit, and I could stick them in tax-advantaged accounts and get the currency exposure.

typical.investor
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Re: A case for holding international bonds

Post by typical.investor » Wed Sep 12, 2018 5:36 am

jclear wrote:
Wed Sep 12, 2018 5:09 am
Ketawa wrote:
Tue Sep 11, 2018 10:28 am
The hedge return is not random around 0%. For countries with similar credit quality, differences in bond yield reflect differences in inflation expectations. If international bonds have a lower yield, then other currencies are expected to appreciate relative to the USD, so the hedge return will be positive.
You mean "so the hedge return will be negative."
JBTX wrote:
Tue Sep 11, 2018 12:43 pm
To me, this is the primary benefit both for international stock and bond investing, and also for going unhedged, at least for international stock.
I'd prefer it if Vanguard's international bond funds were unhedged. They don't produce foreign taxes paid credit, and I could stick them in tax-advantaged accounts and get the currency exposure.
No, the hedge return will be positive.

In fact, it should be so positive that the return from your hedged Japanese and German bonds should in theory return what US bonds do. I think the yield curve determines exactly whether or not they end up the same especially for longer durations, but lower short term yields in foreign bonds means a positive hedge return.

The advantage would be credit diversification and possible a different timing with rates hikes.

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nisiprius
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Re: A case for holding international bonds

Post by nisiprius » Wed Sep 12, 2018 5:59 am

Elysium, have you read Vanguard's paper, Global fixed income: Considerations for U.S. investors? It's quite interesting and full of data. It is also the paper that convinced me not to bother with it. I'm a pretty casual, sloppy, "satisficing" investor, who doubts that the exact choice of bond type can possibly matter much in a portfolio that has a "normal" stock allocation.

The part that really gets me is--remember, this is in a paper advocating international bonds--Figure 7 on page 10, which purports to show that "Adding hedged international bonds historically has decreased the volatility of balanced portfolios." Well, yes, but they are talking about a reduction from 9.4% to 9.3%! In 2014 I challenged forum readers to tell me which of these curves had higher standard deviation. One of them has a standard deviation of 9.6%, one of 9.5% (the numbers Vanguard was showing in an older version of that paper). The point is that even if you take the paper completely at face value, and even if you are certain that the difference in standard deviation will persist, it seems extremely unlikely that you would notice the volatility reduction.

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I think your comment that "I see no risk, other than giving up a few basis points over the years may be, even that is not certain..." is correct. I see no reason either to include or exclude currency-hedged international bonds, I just don't think they're going to make any noticeable difference at all.

In short, I agree with an article in Morningstar, Diversification for the sake of diversification, by Samuel Lee and Thomas Bocellari. (No-cost registration required to read full article). They say
I don’t know why Vanguard bothered to launch Vanguard Total International Bond ETF (BNDX), a currency-hedged developed-markets bond fund. When you hedge foreign sovereign bonds, you end up with something that looks a lot like U.S. Treasuries.
I have a kind of conspiracy-theory idea that the reason why Vanguard is offering the fund, pushing it, and including it in their LifeStrategy and Target Retirement funds is that it does something good for Vanguard to include them, either because it is just generally helping them internationalize their actual investing operations, or possibly because they have become so gigantic that there are small difficulties for them in buying enough US bonds for their all-in-one funds. I don't mean serious difficulties, I just mean incremental problems--Vanguard has complained that because of lack of liquidity in corporate bonds it is difficult to track the Bloomberg Barclay's aggregate index.
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Elysium
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Re: A case for holding international bonds

Post by Elysium » Wed Sep 12, 2018 6:39 am

Hi Nisiprius,

Yes, I am aware of the research from vanguard, and folowed it when this was all discussed at length here. I am not so much concerned at all about small differences any asset will contribute to reduce portfolio volatility. My only concern that I stated in OP, is default from US bonds with a recovery period that takes longer than my liquidity needs. Perhaps I am overthinking this, and this isn't a likely scenraio to worry about? and if I must really make a hedge against it, I should actually be having foreign currency denominated bonds in a foreign account, which is too much effort for me, so I wouldn't bother with that. This bond fund was available to me at rock bottom institutional share class cost, and I said why not, instead of asking why. In end, probably no additional value, except may be psychological protection against non-existent risk.

Edit: I know political topics aren't allowed here, so trying not to make one, however, concerns about stability of leadership is a factor. Perhaps, that too is unfound.

Valuethinker
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Re: A case for holding international bonds

Post by Valuethinker » Wed Sep 12, 2018 7:03 am

Elysium wrote:
Wed Sep 12, 2018 6:39 am
Hi Nisiprius,

Yes, I am aware of the research from vanguard, and folowed it when this was all discussed at length here. I am not so much concerned at all about small differences any asset will contribute to reduce portfolio volatility. My only concern that I stated in OP, is default from US bonds with a recovery period that takes longer than my liquidity needs. Perhaps I am overthinking this, and this isn't a likely scenraio to worry about? and if I must really make a hedge against it, I should actually be having foreign currency denominated bonds in a foreign account, which is too much effort for me, so I wouldn't bother with that. This bond fund was available to me at rock bottom institutional share class cost, and I said why not, instead of asking why. In end, probably no additional value, except may be psychological protection against non-existent risk.

Edit: I know political topics aren't allowed here, so trying not to make one, however, concerns about stability of leadership is a factor. Perhaps, that too is unfound.
Unfortunately you can find equivalent political factors in every country. Such as Brexit.

Just saying that the US has unique risk in this, perhaps, but other countries have their own unique risks.

jclear
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Re: A case for holding international bonds

Post by jclear » Wed Sep 12, 2018 7:42 pm

typical.investor wrote:
Wed Sep 12, 2018 5:36 am
No, the hedge return will be positive.

In fact, it should be so positive that the return from your hedged Japanese and German bonds should in theory return what US bonds do. I think the yield curve determines exactly whether or not they end up the same especially for longer durations, but lower short term yields in foreign bonds means a positive hedge return.
I think we're trying to say the same thing, but I'm talking about all bond durations and not necessarily about the countries with high credit quality. If German bunds and USA Treasurys are equal credit quality, you can get 2% positive futures return over a year to compensate for expected FX changes. But you have a problem trying to cover a 3% difference for a 10-year; if you use 10-year interest rate swaps you might as well just buy Treasurys in the first place. If you look at the issues from countries with lower credit quality - and if they're not Yankee bonds - then the hedging has a different result. I view the portion of an international portfolio dedicated to Germany and Japan as just neutral wasted space in a fund; the LatAm bonds and such are where the point of the fund is. How does that saying go? "Exchange rates come and go, but hedging costs are forever."

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