What to do with International Bonds?

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Nightowl99
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What to do with International Bonds?

Post by Nightowl99 »

As Vanguard's Portfolio Watch recommends, about 20% of my bond allocation is in the International Bond fund (VTABX), which is currently showing an SEC yield of 0.30%. The current inflation rate appears to be something like 0.6% (not sure if that's correct or not). So it would seem that I'm now paying Vanguard 0.30% per year to continue holding VTABX. I've had this fund for the past several years and it is now showing about $3,345 in capital gains.

I still like the idea of holding international bonds so that my bonds are diversified, but would like to exchange VTABX for something else that doesn't have a negative real return. What other international bond funds would you suggest?

I don't really understand negative yields on bonds and money market funds or why people would want to continue buying them. Is it because they figure it would be better to lose a little money rather than to risk losing a lot in equities?
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Re: What to do with International Bonds?

Post by EnjoyIt »

To be honest, I am not a fan of international bonds. I do not see the point in taking on foreign sovereign risk on top of currency risk. It does not make sense to me and therefore I only hold domestic bonds. Some may agree with me, while others prefer more diversification.
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Re: What to do with International Bonds?

Post by Robot Monster »

Nightowl99 wrote: Fri Aug 07, 2020 12:31 pm The current inflation rate appears to be something like 0.6% (not sure if that's correct or not).
Inflation is currently expected to be 1.63% over the next ten years, so many bonds are negative on a real yield basis.

10-Year Breakeven Inflation Rate currently 1.63%
https://fred.stlouisfed.org/series/T10YIE

5-Year Breakeven Inflation Rate currently 1.53%
https://fred.stlouisfed.org/series/T5YIE
Last edited by Robot Monster on Fri Aug 07, 2020 12:57 pm, edited 1 time in total.
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Re: What to do with International Bonds?

Post by Robot Monster »

EnjoyIt wrote: Fri Aug 07, 2020 12:34 pm To be honest, I am not a fan of international bonds. I do not see the point in taking on foreign sovereign risk on top of currency risk. It does not make sense to me and therefore I only hold domestic bonds. Some may agree with me, while others prefer more diversification.
VTABX "employs currency hedging strategies to protect against uncertainty in future exchange rates, so investment returns are expected to reflect the underlying performance of international bonds."
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Re: What to do with International Bonds?

Post by vineviz »

Nightowl99 wrote: Fri Aug 07, 2020 12:31 pm As Vanguard's Portfolio Watch recommends, about 20% of my bond allocation is in the International Bond fund (VTABX), which is currently showing an SEC yield of 0.30%. The current inflation rate appears to be something like 0.6% (not sure if that's correct or not). So it would seem that I'm now paying Vanguard 0.30% per year to continue holding VTABX. I've had this fund for the past several years and it is now showing about $3,345 in capital gains.

I still like the idea of holding international bonds so that my bonds are diversified, but would like to exchange VTABX for something else that doesn't have a negative real return. What other international bond funds would you suggest?

I don't really understand negative yields on bonds and money market funds or why people would want to continue buying them. Is it because they figure it would be better to lose a little money rather than to risk losing a lot in equities?
Vanguard's published SEC yield for Vanguard Total International Bond Index Fund (VTABX) is misleading, and understates the "true" yield of the fund. It confuses a lot of people.

US investors can profitably own such international bonds because of the way that Vanguard manages the currency risk in the VTABX. In short, there are two sources of "yield" (the bonds themselves, and the currency hedging contracts) but the SEC yield only includes the former.

Its' a reasonable assumption that the total yield for VTABX is equal to or greater than Vanguard Total Bond Market Index Fund (VBTLX), and I think the current total yield of VTABX is about 1.3% to 1.4%.
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Re: What to do with International Bonds?

Post by sycamore »

Nightowl99 wrote: Fri Aug 07, 2020 12:31 pm ...
I still like the idea of holding international bonds so that my bonds are diversified, but would like to exchange VTABX for something else that doesn't have a negative real return. What other international bond funds would you suggest?

...
Nightowl99,

What kind of international bond funds do you want to hold? Just like with stocks, one basic choice centers around whether you want a passive/index-based fund, or an active/manager-driven fund.

Vanguard's Total International Bond Index Fund is obviously an index fund. If you want an index fund, it's the best and lowest cost you're gonna get. iShares has the Core International Aggregate Bond ETF (IAGG) which is just as good (they follow the same index).

If you want an actively managed fund, that's a different story. I don't have any suggestions for that.
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Re: What to do with International Bonds?

Post by Steve Reading »

Nightowl99 wrote: Fri Aug 07, 2020 12:31 pm As Vanguard's Portfolio Watch recommends, about 20% of my bond allocation is in the International Bond fund (VTABX), which is currently showing an SEC yield of 0.30%. The current inflation rate appears to be something like 0.6% (not sure if that's correct or not). So it would seem that I'm now paying Vanguard 0.30% per year to continue holding VTABX.
Well for one thing, that yield does not take into account the additional return from the currency hedge (and judging by some responses, it appears some don't even know it's currency hedged).

But even if the fund really did have a yield of 0.3% in dollars, the above statement is still wrong. You're not "paying Vanguard 0.3% to hold VTABX". You're paying Vanguard 0.11% (that's the ER) for a product where instead of your dollars losing 0.6% real value every year, now they will only lose about 0.3% real value per year instead.
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Re: What to do with International Bonds?

Post by jrbdmb »

vineviz wrote: Fri Aug 07, 2020 12:55 pm
Vanguard's published SEC yield for Vanguard Total International Bond Index Fund (VTABX) is misleading, and understates the "true" yield of the fund. It confuses a lot of people.

US investors can profitably own such international bonds because of the way that Vanguard manages the currency risk in the VTABX. In short, there are two sources of "yield" (the bonds themselves, and the currency hedging contracts) but the SEC yield only includes the former.

Its' a reasonable assumption that the total yield for VTABX is equal to or greater than Vanguard Total Bond Market Index Fund (VBTLX), and I think the current total yield of VTABX is about 1.3% to 1.4%.
Why? There is no guarantee that the currency hedging contracts will add to the yield of VTABX. (Or perhaps I misunderstand how these contracts work.)
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Re: What to do with International Bonds?

Post by Nightowl99 »

Okay, so assuming that the fund will lose money for the unknown future, why not exchange some of it for something else? For example, I was considering the Emerging Markets Bond Fund (unhedged?) or the BWX etf (SPDR Bloomberg Barclays International Treasury Bond). Maybe it's better to stay put if there's some benefit from the hedging. I haven't really read enough about hedging to understand how that works.
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Re: What to do with International Bonds?

Post by 000 »

I would prefer an unhedged emerging market bond fund because it is actually a diversifier (with more risk). A USD hedged investment grade foreign bond fund will probably not perform very differently than US investment grade bonds.
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Re: What to do with International Bonds?

Post by Robot Monster »

Nightowl99 wrote: Fri Aug 07, 2020 2:08 pm I was considering the Emerging Markets Bond Fund (unhedged?)
Vanguard Emerging Markets Bond Fund Investor Shares (VEMBX) "does subject U.S.-based investors to currency risk as it has the ability to invest in local currency denominated bonds on an unhedged basis but the majority of bonds are expected to be invested in in U.S. dollar-denominated bonds or hedged back to the U.S. dollar." It has a 30 day SEC yield of 3.89%.
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Re: What to do with International Bonds?

Post by vineviz »

jrbdmb wrote: Fri Aug 07, 2020 2:02 pm Why? There is no guarantee that the currency hedging contracts will add to the yield of VTABX. (Or perhaps I misunderstand how these contracts work.)

What you can be sure of is that the any changes in hedge yield will be offset by changes in the yield of the bonds as reported in USD. So the relative contribution of each component can evolve, the net effect of currency moves will be zero if the hedge is competently implemented.
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Re: What to do with International Bonds?

Post by vineviz »

Nightowl99 wrote: Fri Aug 07, 2020 2:08 pm Okay, so assuming that the fund will lose money for the unknown future, why not exchange some of it for something else?
Because that’s not a reasonable assumption: the expected return is higher than for the US Total Bond Market Fund. That’s really what I was trying to explain.
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Re: What to do with International Bonds?

Post by Nightowl99 »

Thanks. Obviously this subject is above my paygrade....
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Re: What to do with International Bonds?

Post by EnjoyIt »

Steve Reading wrote: Fri Aug 07, 2020 1:38 pm
Nightowl99 wrote: Fri Aug 07, 2020 12:31 pm As Vanguard's Portfolio Watch recommends, about 20% of my bond allocation is in the International Bond fund (VTABX), which is currently showing an SEC yield of 0.30%. The current inflation rate appears to be something like 0.6% (not sure if that's correct or not). So it would seem that I'm now paying Vanguard 0.30% per year to continue holding VTABX.
Well for one thing, that yield does not take into account the additional return from the currency hedge (and judging by some responses, it appears some don't even know it's currency hedged).
Any chance you or someone else can explain how additional returns are derived from currency hedging on these funds?
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Re: What to do with International Bonds?

Post by Steve Reading »

EnjoyIt wrote: Fri Aug 07, 2020 2:30 pm
Steve Reading wrote: Fri Aug 07, 2020 1:38 pm
Nightowl99 wrote: Fri Aug 07, 2020 12:31 pm As Vanguard's Portfolio Watch recommends, about 20% of my bond allocation is in the International Bond fund (VTABX), which is currently showing an SEC yield of 0.30%. The current inflation rate appears to be something like 0.6% (not sure if that's correct or not). So it would seem that I'm now paying Vanguard 0.30% per year to continue holding VTABX.
Well for one thing, that yield does not take into account the additional return from the currency hedge (and judging by some responses, it appears some don't even know it's currency hedged).
Any chance you or someone else can explain how additional returns are derived from currency hedging on these funds?
Yeah sure. Here's a very simplified example:

Right now you get 1.18 USD for every Euro you have. But go into the Forward Rates market and look at what the market offers a year from today:
https://www.barchart.com/forex/quotes/% ... ward-rates

The 1-YR quote (midpoint) is "91.54". To interpret that, divide it by 10,000 and add it to the current spot (1.18 as shown above) and you get the exchange rate you can lock in, for free, in Euros. So that's 1.18 + 91.54/10,000 = 1.189.

So, provided you purchase the proper hedge contracts, you can lock in the ability to obtain an exchange rate of 1.189 USD for each Euro in a year from today.

So VTABX will grab, say $1000 of your dollars today, exchange to Euros today at 1.18, invest in a Euro-denominated bond that yields 0.3% and also lock-in an exchange rate in the future that is more attractive than 1.18. So if VTABX were to return your money once the bond matures, you would get the 0.3% bond return plus the additional, more attractive exchange rate (which comes out to about an additional 0.7%, or 1.189/1.18).
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Re: What to do with International Bonds?

Post by Steve Reading »

jrbdmb wrote: Fri Aug 07, 2020 2:02 pm
vineviz wrote: Fri Aug 07, 2020 12:55 pm
Vanguard's published SEC yield for Vanguard Total International Bond Index Fund (VTABX) is misleading, and understates the "true" yield of the fund. It confuses a lot of people.

US investors can profitably own such international bonds because of the way that Vanguard manages the currency risk in the VTABX. In short, there are two sources of "yield" (the bonds themselves, and the currency hedging contracts) but the SEC yield only includes the former.

Its' a reasonable assumption that the total yield for VTABX is equal to or greater than Vanguard Total Bond Market Index Fund (VBTLX), and I think the current total yield of VTABX is about 1.3% to 1.4%.
Why? There is no guarantee that the currency hedging contracts will add to the yield of VTABX. (Or perhaps I misunderstand how these contracts work.)
Depends on the currency of course but both the Euro and the Yen are selling at a premium in the forward exchange markets, so it is assured that the Yen and Euro currency-hedge contracts VTABX holds will add to the yield.
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Re: What to do with International Bonds?

Post by vineviz »

Steve Reading wrote: Fri Aug 07, 2020 2:56 pm Right now you get 1.18 USD for every Euro you have. But go into the Forward Rates market and look at what the market offers a year from today:
https://www.barchart.com/forex/quotes/% ... ward-rates

The 1-YR quote (midpoint) is "91.54". To interpret that, divide it by 10,000 and add it to the current spot (1.18 as shown above) and you get the exchange rate you can lock in, for free, in Euros. So that's 1.18 + 91.54/10,000 = 1.189.
FWIW, https://www.fxempire.com/currencies/eur ... ward-rates shows the market implied forward rates directly which I find easier to use.
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Re: What to do with International Bonds?

Post by EnjoyIt »

Steve Reading wrote: Fri Aug 07, 2020 2:56 pm
EnjoyIt wrote: Fri Aug 07, 2020 2:30 pm
Steve Reading wrote: Fri Aug 07, 2020 1:38 pm
Nightowl99 wrote: Fri Aug 07, 2020 12:31 pm As Vanguard's Portfolio Watch recommends, about 20% of my bond allocation is in the International Bond fund (VTABX), which is currently showing an SEC yield of 0.30%. The current inflation rate appears to be something like 0.6% (not sure if that's correct or not). So it would seem that I'm now paying Vanguard 0.30% per year to continue holding VTABX.
Well for one thing, that yield does not take into account the additional return from the currency hedge (and judging by some responses, it appears some don't even know it's currency hedged).
Any chance you or someone else can explain how additional returns are derived from currency hedging on these funds?
Yeah sure. Here's a very simplified example:

Right now you get 1.18 USD for every Euro you have. But go into the Forward Rates market and look at what the market offers a year from today:
https://www.barchart.com/forex/quotes/% ... ward-rates

The 1-YR quote (midpoint) is "91.54". To interpret that, divide it by 10,000 and add it to the current spot (1.18 as shown above) and you get the exchange rate you can lock in, for free, in Euros. So that's 1.18 + 91.54/10,000 = 1.189.

So, provided you purchase the proper hedge contracts, you can lock in the ability to obtain an exchange rate of 1.189 USD for each Euro in a year from today.

So VTABX will grab, say $1000 of your dollars today, exchange to Euros today at 1.18, invest in a Euro-denominated bond that yields 0.3% and also lock-in an exchange rate in the future that is more attractive than 1.18. So if VTABX were to return your money once the bond matures, you would get the 0.3% bond return plus the additional, more attractive exchange rate (which comes out to about an additional 0.7%, or 1.189/1.18).

Fascinating topic (because it is new learning for me.)
To follow up, what if the exchange rate in the future is higher than 1.189. Doesn't that mean this hedging created a lower return if there was no hedging to begin with?

Maybe a more important question, why is an exchange of currency somehow more favorable 3 months from now than it is today? Isn't money more valuable now than in the future? Maybe this is what stems my confusion.
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Re: What to do with International Bonds?

Post by unclescrooge »

EnjoyIt wrote: Fri Aug 07, 2020 12:34 pm To be honest, I am not a fan of international bonds. I do not see the point in taking on foreign sovereign risk on top of currency risk. It does not make sense to me and therefore I only hold domestic bonds. Some may agree with me, while others prefer more diversification.
I partially agree with you. But I have a sliver of my bonds in local currency EM bonds. Higher yields than treasuries, but comes with currency risk.
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Re: What to do with International Bonds?

Post by Valuethinker »

EnjoyIt wrote: Fri Aug 07, 2020 4:19 pm
Steve Reading wrote: Fri Aug 07, 2020 2:56 pm
EnjoyIt wrote: Fri Aug 07, 2020 2:30 pm
Steve Reading wrote: Fri Aug 07, 2020 1:38 pm
Nightowl99 wrote: Fri Aug 07, 2020 12:31 pm As Vanguard's Portfolio Watch recommends, about 20% of my bond allocation is in the International Bond fund (VTABX), which is currently showing an SEC yield of 0.30%. The current inflation rate appears to be something like 0.6% (not sure if that's correct or not). So it would seem that I'm now paying Vanguard 0.30% per year to continue holding VTABX.
Well for one thing, that yield does not take into account the additional return from the currency hedge (and judging by some responses, it appears some don't even know it's currency hedged).
Any chance you or someone else can explain how additional returns are derived from currency hedging on these funds?
Yeah sure. Here's a very simplified example:

Right now you get 1.18 USD for every Euro you have. But go into the Forward Rates market and look at what the market offers a year from today:
https://www.barchart.com/forex/quotes/% ... ward-rates

The 1-YR quote (midpoint) is "91.54". To interpret that, divide it by 10,000 and add it to the current spot (1.18 as shown above) and you get the exchange rate you can lock in, for free, in Euros. So that's 1.18 + 91.54/10,000 = 1.189.

So, provided you purchase the proper hedge contracts, you can lock in the ability to obtain an exchange rate of 1.189 USD for each Euro in a year from today.

So VTABX will grab, say $1000 of your dollars today, exchange to Euros today at 1.18, invest in a Euro-denominated bond that yields 0.3% and also lock-in an exchange rate in the future that is more attractive than 1.18. So if VTABX were to return your money once the bond matures, you would get the 0.3% bond return plus the additional, more attractive exchange rate (which comes out to about an additional 0.7%, or 1.189/1.18).

Fascinating topic (because it is new learning for me.)
To follow up, what if the exchange rate in the future is higher than 1.189. Doesn't that mean this hedging created a lower return if there was no hedging to begin with?

Maybe a more important question, why is an exchange of currency somehow more favorable 3 months from now than it is today? Isn't money more valuable now than in the future? Maybe this is what stems my confusion.
Ignoring the bid-ask spead the cost of a currency forward is simply the difference in interest rates between the 2 currencies at that maturity.

That is called Covered Interest Parity.

If it did not hold arbitrageurs could make money *right now* by putting their money in the highest yielding currency forcs year say and at the time buying a contract to sell that currency in s year's time for dollars. In effect a money machine- risk free money.

So in practice it does hold most of the time. The c 3 trillion dollars a day of FX trades that take place (London has the largest share) make sure that it happens.
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Re: What to do with International Bonds?

Post by Actin »

Sell them and don't buy them again. Vanguard has a strong anti-US bias.
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Re: What to do with International Bonds?

Post by luckyducky99 »

EnjoyIt wrote: Fri Aug 07, 2020 2:30 pm Any chance you or someone else can explain how additional returns are derived from currency hedging on these funds?
Vanguard talks about the hedge return here: https://static.vgcontent.info/crp/intl/ ... return.pdf
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Re: What to do with International Bonds?

Post by Steve Reading »

EnjoyIt wrote: Fri Aug 07, 2020 4:19 pm To follow up, what if the exchange rate in the future is higher than 1.189. Doesn't that mean this hedging created a lower return if there was no hedging to begin with?
That's right. By hedging back to the USD, you know exactly what exchange rate you'll get and now currency fluctuations don't affect you at all. If the exchange rate is more or less favorable in the future, you still get that 1.189 exchange and hence, the additional 0.7% return. If you don't hedge, you could get more, less or the same.

By the way, this might make you believe hedging is ideal or better than not hedging. This isn't true. There are no free lunches here. Hedging eliminates one risk (foreign currency) and introduces another (USD inflation risk).

What we can say is the following:
1) If you see a foreign bond fund that hedges, the SEC yield is not the full story. But you can get very near to the full story by checking out forward rates. Since it hedges, you should expect to receive very nearly what those contracts show.
2) If the fond does not hedge, the SEC still isn't the full story. But now, you don't really know what you might receive in the future. It should be close to a hedged position on average, so you can approximate it by looking at the forward rates as well.
EnjoyIt wrote: Fri Aug 07, 2020 4:19 pm Maybe a more important question, why is an exchange of currency somehow more favorable 3 months from now than it is today? Isn't money more valuable now than in the future? Maybe this is what stems my confusion.
Ok here's the intuition:
1) Currency is almost always more valuable today than in the future. How much more valuable? It depends on the interest rate of the currency. If USD interest rates are 1%, the future value of 1 USD today is 1.01 USD. Put another way, 1.01 USD in the future is really worth more like 1 USD today. You discount based on the interest rate.
2) The lower the interest rate, the smaller that difference. If interest rates are negative, future currency actually is worth more.

So the difference in the value of two currencies in the future (their future exchange rate) stems from the difference of their discount rates (i.e. interest rates).

USD interest rates are at 0% so the future value of a dollar is about the same as a current dollar. But Euro interest rates are negative, so the value of a future Euro is greater than a current Euro. So if USD in a year from today are as valuable as today, but Euros a year from today are more valuable than today, then the exchange rate of the Euro offered in the future market would have to be more attractive than the exchange rate today.

This relationship is maintained by arbitrage as someone else mentioned.
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Re: What to do with International Bonds?

Post by Northern Flicker »

There are some inaccuracies above about hedge contract yield, which is not the return due to differences in currency values. Hedge contracts do provide for that, but is not fund yield. That is best thought of as just eliminating currency fluctuations from the NAV.

Additionally, currency hedge forward contracts have a yield that is an additional return or cost based on the difference between the two sovereign yield curves corresponding to the term of the hedge contract.

In the recent past, US short rates were a fair bit higher than non-US short rates, leading to additional yield from the difference in short rates. This not only boosted the de facto yield of the fund, but shortened the de facto duration because hedge contract yields are short duration cash flows.

At present US short (30-90 day) rates, the spread is very thin, and these effects would be quite muted by comparison. I think the current quoted yield and duration of VTABX is much closer to what the de facto yield and duration will be.
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Re: What to do with International Bonds?

Post by Al the Knife »

This is my limited understanding understanding of hedged international bond funds :

Through the magic of currency hedging I get to lend US Dollars to governments and companies borrowing in Euros and Yen. Awesome!

Is it just me, or does this sound like the beginning of a sad cautionary tale?
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Re: What to do with International Bonds?

Post by vineviz »

Al the Knife wrote: Sat Aug 08, 2020 10:38 am This is my limited understanding understanding of hedged international bond funds :

Through the magic of currency hedging I get to lend US Dollars to governments and companies borrowing in Euros and Yen. Awesome!

Is it just me, or does this sound like the beginning of a sad cautionary tale?
What’s the cautionary tale supposed to be? Virtually every company in your equity portfolio is hedging currency in one form or another as a routine part of their day-to-day business, and it is likely one of the least risky things they do.

It’s not more risky when Vanguard does it, nor should investors think there’s a risk in it merely because they recently saw it discussed.
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Re: What to do with International Bonds?

Post by Al the Knife »

vineviz wrote: Sat Aug 08, 2020 11:59 am [quote="Al the Knife" post_id=5420589 time=<a href="tel:1596901111">1596901111</a> user_id=14665]
This is my limited understanding understanding of hedged international bond funds :

Through the magic of currency hedging I get to lend US Dollars to governments and companies borrowing in Euros and Yen. Awesome!

Is it just me, or does this sound like the beginning of a sad cautionary tale?
What’s the cautionary tale supposed to be? Virtually every company in your equity portfolio is hedging currency in one form or another as a routine part of their day-to-day business, and it is likely one of the least risky things they do.

It’s not more risky when Vanguard does it, nor should investors think there’s a risk in it merely because they recently saw it discussed.
[/quote]

If every US retirement investor, pension fund, and university endowment holds a globally diversified hedged bond portfolio, and the value of the US Dollar rises sharply relative to other currencies, where will the counterparties of the currency contracts find enough US dollars to honor their obligations without driving the value of the Dollar even higher, creating a vicious cycle? Maybe I am inventing things to worry about because of my naïveté, but if I had a satisfactory answer to this question, I would gladly hold international bonds.
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Re: What to do with International Bonds?

Post by Al the Knife »

vineviz wrote: Sat Aug 08, 2020 11:59 am
Al the Knife wrote: Sat Aug 08, 2020 10:38 am This is my limited understanding understanding of hedged international bond funds :

Through the magic of currency hedging I get to lend US Dollars to governments and companies borrowing in Euros and Yen. Awesome!

Is it just me, or does this sound like the beginning of a sad cautionary tale?
What’s the cautionary tale supposed to be? Virtually every company in your equity portfolio is hedging currency in one form or another as a routine part of their day-to-day business, and it is likely one of the least risky things they do.

It’s not more risky when Vanguard does it, nor should investors think there’s a risk in it merely because they recently saw it discussed.
If every US retirement investor, pension fund, and university endowment holds a globally diversified hedged bond portfolio, and the value of the US Dollar rises sharply relative to other currencies, where will the counterparties of the currency contracts find enough US dollars to honor their obligations without driving the value of the Dollar even higher, creating a vicious cycle? Maybe I am inventing things to worry about because of my naïveté, but if I had a satisfactory answer to this question, I would gladly hold international bonds.
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Steve Reading
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Re: What to do with International Bonds?

Post by Steve Reading »

Al the Knife wrote: Sat Aug 08, 2020 12:31 pm If every US retirement investor, pension fund, and university endowment holds a globally diversified hedged bond portfolio, and the value of the US Dollar rises sharply relative to other currencies, where will the counterparties of the currency contracts find enough US dollars to honor their obligations without driving the value of the Dollar even higher, creating a vicious cycle?
Well, a large number of counterparties are foreign investors who are investing in USD and hedging back to their own currencies (the mirror image of the USA investor with VTABX). So there's no risk on those. They don't need to "find the dollars", they already have them.

That said, there are counterparties that aren't hedged. When the contract is due, they'll have to buy the dollars at a significant price to cover the contract. And given a large enough scale for this, maybe it would be a problem.

Counterparty risk is a risk, I certainly can't tell you otherwise. From VTABX's prospectus:
"The Fund's use of foreign currency exchange forward
contracts also subjects the Fund to counterparty risk, which is the chance that the
counterparty to a currency forward contract with the Fund will be unable or unwilling
to meet its financial obligations. Counterparty risk is low for the Fund."

Every BH will make their choice based on the above. Personally, I believe the risk is so low to be basically insignificant. I think Vanguard puts it in the prospectus for legal reasons. And I think the ability to diversify your bond holdings internationally is far, far more important. The scenario where USA rates go up, but International ones don't as much seems far more likely to me than a massive, global-scale currency crunch that you hint at. So IMO the benefits of VTABX far outweigh this counterparty risk.

You will come to your own conclusions :)
"... so high a present discounted value of wealth, it is only prudent for him to put more into common stocks compared to his present tangible wealth, borrowing if necessary" - Paul Samuelson
EnjoyIt
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Re: What to do with International Bonds?

Post by EnjoyIt »

Steve Reading wrote: Sat Aug 08, 2020 12:53 pm
Al the Knife wrote: Sat Aug 08, 2020 12:31 pm If every US retirement investor, pension fund, and university endowment holds a globally diversified hedged bond portfolio, and the value of the US Dollar rises sharply relative to other currencies, where will the counterparties of the currency contracts find enough US dollars to honor their obligations without driving the value of the Dollar even higher, creating a vicious cycle?
Well, a large number of counterparties are foreign investors who are investing in USD and hedging back to their own currencies (the mirror image of the USA investor with VTABX). So there's no risk on those. They don't need to "find the dollars", they already have them.

That said, there are counterparties that aren't hedged. When the contract is due, they'll have to buy the dollars at a significant price to cover the contract. And given a large enough scale for this, maybe it would be a problem.

Counterparty risk is a risk, I certainly can't tell you otherwise. From VTABX's prospectus:
"The Fund's use of foreign currency exchange forward
contracts also subjects the Fund to counterparty risk, which is the chance that the
counterparty to a currency forward contract with the Fund will be unable or unwilling
to meet its financial obligations. Counterparty risk is low for the Fund."

Every BH will make their choice based on the above. Personally, I believe the risk is so low to be basically insignificant. I think Vanguard puts it in the prospectus for legal reasons. And I think the ability to diversify your bond holdings internationally is far, far more important. The scenario where USA rates go up, but International ones don't as much seems far more likely to me than a massive, global-scale currency crunch that you hint at. So IMO the benefits of VTABX far outweigh this counterparty risk.

You will come to your own conclusions :)
Let me make sure I understand you. One of the reasons you believe VTABX is a good purchase is because you believe interest rates will go up sooner in US bonds as compared to international bonds therefor price will not decrease as soon or as quickly in VTABX as compared to VTBLX?
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Re: What to do with International Bonds?

Post by Blue456 »

EnjoyIt wrote: Fri Aug 07, 2020 12:34 pm To be honest, I am not a fan of international bonds. I do not see the point in taking on foreign sovereign risk on top of currency risk. It does not make sense to me and therefore I only hold domestic bonds. Some may agree with me, while others prefer more diversification.
OP is buying international bond fund so he is spreading his sovereign risk among many countries. It is highly unlikely that most of them would default on their debt.
You sir on the other hand are taking greater sovereign risk. Your entire bond fund belongs to a single market. It takes one country in your bond fund to default for you to have huge losses.
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Re: What to do with International Bonds?

Post by retired@50 »

Nightowl99 wrote: Fri Aug 07, 2020 2:27 pm Thanks. Obviously this subject is above my paygrade....
Since you already own the fund, maybe you should read more about it before abandoning the ship.

See links:
https://personal.vanguard.com/pdf/ISGGLBD.pdf

https://personal.vanguard.com/pdf/inter ... income.pdf

For what it's worth, I'm also in investor in the VTABX fund. I'm staying put and re-investing dividends.

Regards,
This is one person's opinion. Nothing more.
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Re: What to do with International Bonds?

Post by Steve Reading »

EnjoyIt wrote: Sat Aug 08, 2020 2:51 pm
Steve Reading wrote: Sat Aug 08, 2020 12:53 pm
Al the Knife wrote: Sat Aug 08, 2020 12:31 pm If every US retirement investor, pension fund, and university endowment holds a globally diversified hedged bond portfolio, and the value of the US Dollar rises sharply relative to other currencies, where will the counterparties of the currency contracts find enough US dollars to honor their obligations without driving the value of the Dollar even higher, creating a vicious cycle?
Well, a large number of counterparties are foreign investors who are investing in USD and hedging back to their own currencies (the mirror image of the USA investor with VTABX). So there's no risk on those. They don't need to "find the dollars", they already have them.

That said, there are counterparties that aren't hedged. When the contract is due, they'll have to buy the dollars at a significant price to cover the contract. And given a large enough scale for this, maybe it would be a problem.

Counterparty risk is a risk, I certainly can't tell you otherwise. From VTABX's prospectus:
"The Fund's use of foreign currency exchange forward
contracts also subjects the Fund to counterparty risk, which is the chance that the
counterparty to a currency forward contract with the Fund will be unable or unwilling
to meet its financial obligations. Counterparty risk is low for the Fund."

Every BH will make their choice based on the above. Personally, I believe the risk is so low to be basically insignificant. I think Vanguard puts it in the prospectus for legal reasons. And I think the ability to diversify your bond holdings internationally is far, far more important. The scenario where USA rates go up, but International ones don't as much seems far more likely to me than a massive, global-scale currency crunch that you hint at. So IMO the benefits of VTABX far outweigh this counterparty risk.

You will come to your own conclusions :)
Let me make sure I understand you. One of the reasons you believe VTABX is a good purchase is because you believe interest rates will go up sooner in US bonds as compared to international bonds therefor price will not decrease as soon or as quickly in VTABX as compared to VTBLX?
Well, no. If I believed that, I would recommend only using VTABX. I do believe that is one possibility in the future, however. Since the market does not reward for concentrating your interest rate risk all in US bonds, then you can, for free, diversify that risk away with VTABX. That is one of many reasons to diversify with VTABX.
"... so high a present discounted value of wealth, it is only prudent for him to put more into common stocks compared to his present tangible wealth, borrowing if necessary" - Paul Samuelson
EnjoyIt
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Re: What to do with International Bonds?

Post by EnjoyIt »

Blue456 wrote: Sat Aug 08, 2020 3:48 pm
EnjoyIt wrote: Fri Aug 07, 2020 12:34 pm To be honest, I am not a fan of international bonds. I do not see the point in taking on foreign sovereign risk on top of currency risk. It does not make sense to me and therefore I only hold domestic bonds. Some may agree with me, while others prefer more diversification.
OP is buying international bond fund so he is spreading his sovereign risk among many countries. It is highly unlikely that most of them would default on their debt.
You sir on the other hand are taking greater sovereign risk. Your entire bond fund belongs to a single market. It takes one country in your bond fund to default for you to have huge losses.
Although I realize that I am taking on single country risk. I am very comfortable with that 1 country. I figure if the US can't pay its debt, the rest of the world is going to be far worse off. Let's look at some of those holdings in VTABX. Many of those purchased bonds are from nations who have had significant financial troubles over the decades. They are at a far higher risk of default than the US is. Are we being compensated extra for taking on the extra risk? I don't know the answer to that though I would guess the market thinks so if we are to believe in an efficient market for sovereign debt.
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Re: What to do with International Bonds?

Post by Steve Reading »

EnjoyIt wrote: Sat Aug 08, 2020 4:56 pm Although I realize that I am taking on single country risk. I am very comfortable with that 1 country. I figure if the US can't pay its debt, the rest of the world is going to be far worse off. Let's look at some of those holdings in VTABX. Many of those purchased bonds are from nations who have had significant financial troubles over the decades. They are at a far higher risk of default than the US is. Are we being compensated extra for taking on the extra risk? I don't know the answer to that though I would guess the market thinks so if we are to believe in an efficient market for sovereign debt.
I don't know the likelihood of many of these cases. I don't know if US government debt will be downgraded in the future (just like it was downgraded a few years ago). I don't know if debt from other DMs will be downgraded. I don't know where rates will rise or fall. And VTABX and VBTLX hold plenty of corporate bonds too. I don't know what companies or sectors will default or get downgraded. I don't know which bond markets will experience credit crunches and get sold off. I just don't know.

Thankfully, I don't have to know. I can just diversify as widely as humanly possible and forget about it.

But diversification isn't for everyone. Some people are happier to lose or make less money as long as they only buy US bonds. These people would be very annoyed if VTABX lost money (they'd think "why the heck did I do that?! I knew US bonds were better"). These same people probably wouldn't derive that much happiness from VTABX outperforming (which it has since inception btw). If that describes you, you probably should stay concentrated in your US bond holdings. Nothing wrong with that. It's important to acknowledge ourselves as humans and invest in a way we feel confident in.
"... so high a present discounted value of wealth, it is only prudent for him to put more into common stocks compared to his present tangible wealth, borrowing if necessary" - Paul Samuelson
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Re: What to do with International Bonds?

Post by EnjoyIt »

Steve Reading wrote: Sat Aug 08, 2020 5:43 pm
EnjoyIt wrote: Sat Aug 08, 2020 4:56 pm Although I realize that I am taking on single country risk. I am very comfortable with that 1 country. I figure if the US can't pay its debt, the rest of the world is going to be far worse off. Let's look at some of those holdings in VTABX. Many of those purchased bonds are from nations who have had significant financial troubles over the decades. They are at a far higher risk of default than the US is. Are we being compensated extra for taking on the extra risk? I don't know the answer to that though I would guess the market thinks so if we are to believe in an efficient market for sovereign debt.
I don't know the likelihood of many of these cases. I don't know if US government debt will be downgraded in the future (just like it was downgraded a few years ago). I don't know if debt from other DMs will be downgraded. I don't know where rates will rise or fall. And VTABX and VBTLX hold plenty of corporate bonds too. I don't know what companies or sectors will default or get downgraded. I don't know which bond markets will experience credit crunches and get sold off. I just don't know.

Thankfully, I don't have to know. I can just diversify as widely as humanly possible and forget about it.

But diversification isn't for everyone. Some people are happier to lose or make less money as long as they only buy US bonds. These people would be very annoyed if VTABX lost money (they'd think "why the heck did I do that?! I knew US bonds were better"). These same people probably wouldn't derive that much happiness from VTABX outperforming (which it has since inception btw). If that describes you, you probably should stay concentrated in your US bond holdings. Nothing wrong with that. It's important to acknowledge ourselves as humans and invest in a way we feel confident in.
I agree with everything you said.
Just like to point out, the track record for VTABX is small. About 7 years. Recently VTLBX has out performed international. What will the future hold? Who knows.

We talk about diversification with bonds. Do you want to talk about factor diversification as well? Small/value outperformed total market when it was new and has been not so hot recently.

Who knows what will outperform in the future?

Don’t get me wrong. With your explanations I have a far greater understanding of why people choose international bonds. I respect that choice but it has not convinced me to follow.
A time to EVALUATE your jitters: | https://www.bogleheads.org/forum/viewtopic.php?f=10&t=79939&start=400#p5275418
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Re: What to do with International Bonds?

Post by jhawktx »

Actin wrote: Fri Aug 07, 2020 4:43 pm Sell them and don't buy them again.
+1 Bingo
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Steve Reading
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Re: What to do with International Bonds?

Post by Steve Reading »

EnjoyIt wrote: Sat Aug 08, 2020 6:07 pm Just like to point out, the track record for VTABX is small. About 7 years. Recently VTLBX has out performed international. What will the future hold?
It's small yes, but that wasn't my point. My point is that some investors are really annoyed when some assets underperform, but aren't that happy when those same assets outperform, due to their own personal biases.

Many investors hate that their Ex-USA stocks have underperformed the past decade. And then those same investors, when shown that International bonds have outperformed, will simply say "well it has been too short a time period". You can see there's an asymmetry here in how they see the performance of their assets. In that case, go with your instinct. Don't diversify because some anonymous person in the Internet tells you it's best. You'll be more annoyed if it backfires than you'll be happy if it helps.
EnjoyIt wrote: Sat Aug 08, 2020 6:07 pm Do you want to talk about factor diversification as well?
In my opinion, factor diversification is a harder pill to swallow (and one I personally don't fully believe in). The market as a whole has no value tilt. So if you do tilt, you must believe you can get higher benefits than the market portfolio itself. Since we know how hard it is to beat the market, it is good to be skeptical of factor diversification.

But asset diversification is a far more logical and sensible concept. The market DOES hold a lot of these bonds. Almost half of the world bond market is Ex-USA. They are part of the haystack. So why aren't you investing in them?
EnjoyIt wrote: Sat Aug 08, 2020 6:07 pm Don’t get me wrong. With your explanations I have a far greater understanding of why people choose international bonds. I respect that choice but it has not convinced me to follow.
Well, I'm not trying to convince any one. You'll make your own decisions.

We're all different and we come in with different backgrounds. I'm from the school of thought that diversification is a free lunch and a very good thing. I truly believe in "buy the haystack" and that the market portfolio is generally a great place to be at. So by default, I would include them. I don't need convincing to INclude them, like you. I need convincing to EXclude them.
"... so high a present discounted value of wealth, it is only prudent for him to put more into common stocks compared to his present tangible wealth, borrowing if necessary" - Paul Samuelson
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Re: What to do with International Bonds?

Post by jeffyscott »

Nightowl99 wrote: Fri Aug 07, 2020 12:31 pmI still like the idea of holding international bonds so that my bonds are diversified, but would like to exchange VTABX for something else that doesn't have a negative real return. What other international bond funds would you suggest?
Well if you are looking for something different, Dodge and Cox Global Bond (DODLX) is one that tends to avoid the low yielding government bonds and the ER is not bad for a managed fund. The M* analysis says: The strategy’s large corporate credit stake, typically near 50% of assets, makes it unique among world-bond peers, which tend to focus more on sovereign debt., while for VTABX they say: ...high-quality but low-yielding government debt accounts for most of the fund's assets.

SEC yield of DODLX was 3.05% as of June 30, that comes with far more credit risk than VTABX, of course. (D&C only updates SEC yield quarterly)
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Re: What to do with International Bonds?

Post by Nightowl99 »

Thanks a bunch! This summarizes my plan: "I can just diversify as widely as humanly possible and forget about it."

Next I want to learn how to "tune out the noise" because there seems to be a lot of it out there lately. 8-)
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Re: What to do with International Bonds?

Post by Northern Flicker »

Al the Knife wrote: Sat Aug 08, 2020 12:40 pm
vineviz wrote: Sat Aug 08, 2020 11:59 am
Al the Knife wrote: Sat Aug 08, 2020 10:38 am This is my limited understanding understanding of hedged international bond funds :

Through the magic of currency hedging I get to lend US Dollars to governments and companies borrowing in Euros and Yen. Awesome!

Is it just me, or does this sound like the beginning of a sad cautionary tale?
What’s the cautionary tale supposed to be? Virtually every company in your equity portfolio is hedging currency in one form or another as a routine part of their day-to-day business, and it is likely one of the least risky things they do.

It’s not more risky when Vanguard does it, nor should investors think there’s a risk in it merely because they recently saw it discussed.
If every US retirement investor, pension fund, and university endowment holds a globally diversified hedged bond portfolio, and the value of the US Dollar rises sharply relative to other currencies, where will the counterparties of the currency contracts find enough US dollars to honor their obligations without driving the value of the Dollar even higher, creating a vicious cycle? Maybe I am inventing things to worry about because of my naïveté, but if I had a satisfactory answer to this question, I would gladly hold international bonds.
They don't have to find the dollars or whatever currency. Currency forward contracts are sold by forex banks who match up counterparties when the contract is sold. They may also exchange some of their own holdings to underwrite some of the exposure. VTABX is hedged with 30-day and 90-day contracts. The risk is that a skew in available counterparties could make it difficult to establish new contracts, but that would not effect established contracts.
Risk is not a guarantor of return.
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Re: What to do with International Bonds?

Post by Northern Flicker »

Nightowl99 wrote: Sun Aug 09, 2020 1:47 pm Thanks a bunch! This summarizes my plan: "I can just diversify as widely as humanly possible and forget about it."

Next I want to learn how to "tune out the noise" because there seems to be a lot of it out there lately. 8-)
If you look at the Vanguard LifeStrategy portfolios, 30% of bonds are in non-US bonds. Because holding non-US bonds is not required for US investors, we could consider allocations to non-US bonds in the range of 0-30% of bond allocation as reasonable.
Risk is not a guarantor of return.
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Re: What to do with International Bonds?

Post by EnjoyIt »

Nightowl99 wrote: Sun Aug 09, 2020 1:47 pm Thanks a bunch! This summarizes my plan: "I can just diversify as widely as humanly possible and forget about it."

Next I want to learn how to "tune out the noise" because there seems to be a lot of it out there lately. 8-)
Tune out the noise is on you.

Step one is to stop watching and reading financial news. It's much easier to tune out the noise if you aren't constantly bombarded with it.
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Re: What to do with International Bonds?

Post by Angst »

jeffyscott wrote: Sun Aug 09, 2020 8:08 am
Nightowl99 wrote: Fri Aug 07, 2020 12:31 pmI still like the idea of holding international bonds so that my bonds are diversified, but would like to exchange VTABX for something else that doesn't have a negative real return. What other international bond funds would you suggest?
Well if you are looking for something different, Dodge and Cox Global Bond (DODLX) is one that tends to avoid the low yielding government bonds and the ER is not bad for a managed fund. The M* analysis says: The strategy’s large corporate credit stake, typically near 50% of assets, makes it unique among world-bond peers, which tend to focus more on sovereign debt., while for VTABX they say: ...high-quality but low-yielding government debt accounts for most of the fund's assets.

SEC yield of DODLX was 3.05% as of June 30, that comes with far more credit risk than VTABX, of course. (D&C only updates SEC yield quarterly)
I don't hold this one, but perhaps you would want to look into VGACX, Vanguard's Global Credit Bond Fund. Mostly corporate bonds, includes North America and hedges currency risk. 30-day SEC yield as of 8/6 was 1.61%, average duration of 6.9 years.
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Re: What to do with International Bonds?

Post by abuss368 »

Nightowl99 wrote: Sun Aug 09, 2020 1:47 pm Thanks a bunch! This summarizes my plan: "I can just diversify as widely as humanly possible and forget about it."

Next I want to learn how to "tune out the noise" because there seems to be a lot of it out there lately. 8-)
Seems like a reasonable plan! I have become much more selective on what I spend time reading anymore. The internet (including financial information and websites) can be like a massive black hole and complete waste of time! This change has been much more rewarding.
John C. Bogle: “Simplicity is the master key to financial success."
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