Anyone using the Foreign Bond asset class?

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gavinsiu
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Anyone using the Foreign Bond asset class?

Post by gavinsiu »

Vanguard Life Strategy seems to employ a good chunk of international bonds. There's a lot of debate over the inclusion of whether international stock, This is mostly because international stock has been a drag on the portfolio in the past two decade or so. However, international bonds seems to be actually be a benefit. The following is from a 50/50 portfolio of stocks/bond from 1999 to June 2024. The first portfolio is 50 Total Stock/50 Total bond. The second portfolio has half of the bond replaced with unhedged Global Bond (90% international). The 3nd portfolio is the same as 2nd but with hedge global bond. Here's the link

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So it does appear that the inclusion of a hedged foreign bond result in a higher return, but no reduction in stdev. It would seem that there is some benefit at least in the past 20 or so years unlike international equity. What do you feel is the benefits an detractor? It seems like that if you want to use international bond, hedging would be the better way to go based on the data. Do you have international bond if so how much and is it hedged?
pennsylvania211
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Re: Anyone using the Foreign Bond asset class?

Post by pennsylvania211 »

I use it, indirectly, in my vanguard target date fund. I *believe* all of it is hedged. I personally would've not paid a price for hedging and rather let ride out the currency fluctuations. But from target date fund manager's perspective, they are doing the right thing because the average customer prefers less volatility closer to the target date.

But as always
1) No one knows the future. Not sure if the performance will continue just because of last 20 years. If that were the case, and could be applied to any time scenario, then nothing in markets would ever change.
2) Diversification generally helps with preservation of wealth, sometimes (and sometimes not) at the expense of outsized/concentrated returns.
Mike Scott
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Re: Anyone using the Foreign Bond asset class?

Post by Mike Scott »

I would not have bought it directly but there is some in one of our balanced funds. It's probably not enough to matter either way. It is a basic component of many target date and life strategy balanced funds.
Mr. Rumples
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Re: Anyone using the Foreign Bond asset class?

Post by Mr. Rumples »

Several years ago, I made a "play" portfolio which I still follow. Eaton Vance Glbl Macr Absolute Return A EAGMX is part of that. Alas, given my age and holdings, I don't see a place for it now.

https://www.eatonvance.com/Global-Macro ... -EAGMX.php
https://www.morningstar.com/funds/XNAS/EAGMX/quote
"History is the memory of time, the life of the dead and the happiness of the living." Captain John Smith 1580-1631
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retired@50
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Re: Anyone using the Foreign Bond asset class?

Post by retired@50 »

gavinsiu wrote: Tue Jul 09, 2024 8:44 am ... Do you have international bond if so how much and is it hedged?
I do, and have had since the inception of VTABX in 2013. It's been between 20% - 25% of my fixed income during that time frame.

VTABX is hedged, and always has been as far as I know.
Vanguard wrote:The fund 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.
Regards,
"All of us would be better investors if we just made fewer decisions." - Daniel Kahneman
invest4
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Re: Anyone using the Foreign Bond asset class?

Post by invest4 »

My portfolio:

VTI (Total US Stocks) - 80%
VXUS (Total Intl Stocks) - 20%

BND (Total US Bond) - 80%
BNDX (Total Intl Bond) - 20%

I believe in the potential diversification Intl offers. It doesn’t matter to me how it has performed in the past and I have no idea what the future holds.

My choice of 80/20 was simply what resonated for me. Only in hindsight will I know if it will be better or worse than a different one.

Like many investors, I used to spend quite some time in search of the “optimal” portfolio via backtesting, etc.

I eventually learned that it’s just guessing and hoping and you could make your portfolio worse vs better.

My portfolio is boring and I continue to make contributions year after year and decade after decade. It takes awhile, but like a river through rock, I believe I will get where I want to be.
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bertilak
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Re: Anyone using the Foreign Bond asset class?

Post by bertilak »

80% BND ETF (US bonds)
20% BNDX ETF (Intl bonds, hedged)

Percentages are of overall bond allocation.

I have the same percentages for Total US vs Intl stocks.
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AlohaBill
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Re: Anyone using the Foreign Bond asset class?

Post by AlohaBill »

They are in my vanguard Target Retirement Fund (VTINX).
JackoC
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Re: Anyone using the Foreign Bond asset class?

Post by JackoC »

gavinsiu wrote: Tue Jul 09, 2024 8:44 am Vanguard Life Strategy seems to employ a good chunk of international bonds. There's a lot of debate over the inclusion of whether international stock, This is mostly because international stock has been a drag on the portfolio in the past two decade or so. However, international bonds seems to be actually be a benefit. The following is from a 50/50 portfolio of stocks/bond from 1999 to June 2024. The first portfolio is 50 Total Stock/50 Total bond. The second portfolio has half of the bond replaced with unhedged Global Bond (90% international). The 3nd portfolio is the same as 2nd but with hedge global bond. Here's the link
Judging based on short (20 yrs is very short) histories of past returns isn't worth a lot IMO. I typically just scroll past short past return history graphical posts here and I don't think I'm being stubborn (show me a few 100 yr relationship, there are some, and my interest is piqued).

On a more fundamental basis though I find currency hedged DM bond funds to be of little use for 2 main reasons:
1. In normal times, non-transparent expected return. The funds hold baskets of bonds of various DM issuers, relatively straightforward to determine the *foreign currency* yield and by inference for 'credit riskless' (if you deem them approximately so) the expected return, ballpark. The main problem is the effect of currency hedging on return. Some may imagine that each cashflow of each bond is hedged back to USD but this isn't what they do at all. You can see reading from hedge inventory in the annual reports that they do rolling short term (days) FX trades selling forward the present value of the fund in each relevant currency. Hence the 'hedge carry', an important component of return in such a fund, is a function not of the interest rate differential between term US and DM bonds, but the prevailing very short term interest rates in each currency in the FX market. Those two things only track one another in broad, noisy terms. And by definition short term FX pricing is varying constantly, and not necessarily easy to see as retail investor anyway. You might on average be 'harvesting' diversified risk premia (differential term premia between govt bond curves in the different currencies, differential credit premia on the FX interest rate in each currency v its govt bond curve, etc) but it's back to noisy past data with few non-overlapping periods as long as a long term forward view.

2. In unprecedented times, namely a future credit crisis revolving around the US federal debt situation, the USD's FX value would likely go down sharply also, big losses on the hedges offsetting big FX gains on the DM bonds, and you wouldn't really be diversifying away from complete concentration in US federal debt as 'riskless'. Which I believe one might think about at this point, no prediction of what *will* happen, rather I believe the window for what plausibly *could* happen has widened. These funds wouldn't help much in that tail risk case, and diversifying from US credit would be the main reason to have them IMO.

But unhedged DM bond exposure, potential real benefit in case of US debt credit meltdown, would be noisy in FX risk in normal times, and lower yielding if you don't assume the term interest rate differential creates a true expected return of USD depreciation. No easy solution.

I wouldn't avoid Vanguard package funds just because of this component though. I don't see major harm in hedged DM bond funds.
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gavinsiu
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Re: Anyone using the Foreign Bond asset class?

Post by gavinsiu »

JackoC wrote: Tue Jul 09, 2024 10:05 am Judging based on short (20 yrs is very short) histories of past returns isn't worth a lot IMO. I typically just scroll past short past return history graphical posts here and I don't think I'm being stubborn (show me a few 100 yr relationship, there are some, and my interest is piqued).

On a more fundamental basis though I find currency hedged DM bond funds to be of little use for 2 main reasons:
1. In normal times, non-transparent expected return. The funds hold baskets of bonds of various DM issuers, relatively straightforward to determine the *foreign currency* yield and by inference for 'credit riskless' (if you deem them approximately so) the expected return, ballpark. The main problem is the effect of currency hedging on return. Some may imagine that each cashflow of each bond is hedged back to USD but this isn't what they do at all. You can see reading from hedge inventory in the annual reports that they do rolling short term (days) FX trades selling forward the present value of the fund in each relevant currency. Hence the 'hedge carry', an important component of return in such a fund, is a function not of the interest rate differential between term US and DM bonds, but the prevailing very short term interest rates in each currency in the FX market. Those two things only track one another in broad, noisy terms. And by definition short term FX pricing is varying constantly, and not necessarily easy to see as retail investor anyway. You might on average be 'harvesting' diversified risk premia (differential term premia between govt bond curves in the different currencies, differential credit premia on the FX interest rate in each currency v its govt bond curve, etc) but it's back to noisy past data with few non-overlapping periods as long as a long term forward view.

2. In unprecedented times, namely a future credit crisis revolving around the US federal debt situation, the USD's FX value would likely go down sharply also, big losses on the hedges offsetting big FX gains on the DM bonds, and you wouldn't really be diversifying away from complete concentration in US federal debt as 'riskless'. Which I believe one might think about at this point, no prediction of what *will* happen, rather I believe the window for what plausibly *could* happen has widened. These funds wouldn't help much in that tail risk case, and diversifying from US credit would be the main reason to have them IMO.

But unhedged DM bond exposure, potential real benefit in case of US debt credit meltdown, would be noisy in FX risk in normal times, and lower yielding if you don't assume the term interest rate differential creates a true expected return of USD depreciation. No easy solution.

I wouldn't avoid Vanguard package funds just because of this component though. I don't see major harm in hedged DM bond funds.
I apologized that I probably lack the technical knowledge to completely understand your post, but I think what you are saying is that one primary benefit for a international bond would be hedge against a US credit issue such as US defaulting on their bonds, but if the bond is hedging then we lose that benefit. During normal uneventful time though, none hedged bonds brings unwanted volatility, the sort that might spook a bond investor.
JackoC
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Re: Anyone using the Foreign Bond asset class?

Post by JackoC »

gavinsiu wrote: Tue Jul 09, 2024 10:17 am
JackoC wrote: Tue Jul 09, 2024 10:05 am Judging based on short (20 yrs is very short) histories of past returns isn't worth a lot IMO. I typically just scroll past short past return history graphical posts here and I don't think I'm being stubborn (show me a few 100 yr relationship, there are some, and my interest is piqued).

On a more fundamental basis though I find currency hedged DM bond funds to be of little use for 2 main reasons:
1. In normal times, non-transparent expected return. The funds hold baskets of bonds of various DM issuers, relatively straightforward to determine the *foreign currency* yield and by inference for 'credit riskless' (if you deem them approximately so) the expected return, ballpark. The main problem is the effect of currency hedging on return. Some may imagine that each cashflow of each bond is hedged back to USD but this isn't what they do at all. You can see reading from hedge inventory in the annual reports that they do rolling short term (days) FX trades selling forward the present value of the fund in each relevant currency. Hence the 'hedge carry', an important component of return in such a fund, is a function not of the interest rate differential between term US and DM bonds, but the prevailing very short term interest rates in each currency in the FX market. Those two things only track one another in broad, noisy terms. And by definition short term FX pricing is varying constantly, and not necessarily easy to see as retail investor anyway. You might on average be 'harvesting' diversified risk premia (differential term premia between govt bond curves in the different currencies, differential credit premia on the FX interest rate in each currency v its govt bond curve, etc) but it's back to noisy past data with few non-overlapping periods as long as a long term forward view.

2. In unprecedented times, namely a future credit crisis revolving around the US federal debt situation, the USD's FX value would likely go down sharply also, big losses on the hedges offsetting big FX gains on the DM bonds, and you wouldn't really be diversifying away from complete concentration in US federal debt as 'riskless'. Which I believe one might think about at this point, no prediction of what *will* happen, rather I believe the window for what plausibly *could* happen has widened. These funds wouldn't help much in that tail risk case, and diversifying from US credit would be the main reason to have them IMO.

But unhedged DM bond exposure, potential real benefit in case of US debt credit meltdown, would be noisy in FX risk in normal times, and lower yielding if you don't assume the term interest rate differential creates a true expected return of USD depreciation. No easy solution.

I wouldn't avoid Vanguard package funds just because of this component though. I don't see major harm in hedged DM bond funds.
I apologized that I probably lack the technical knowledge to completely understand your post, but I think what you are saying is that one primary benefit for a international bond would be hedge against a US credit issue such as US defaulting on their bonds, but if the bond is hedging then we lose that benefit. During normal uneventful time though, none hedged bonds brings unwanted volatility, the sort that might spook a bond investor.
Right. Making the straightforward assumption (no guarantee) a serious US federal debt crisis would sharply lower the value of the USD v other Developed Market currencies, much of the diversification effect of having bought those foreign bonds would be lost via the FX hedges. To really diversify away from US, it must be something that also gains USD value if the USD crashes in value v other currencies IMO. Among other aspects where a foreign asset could actually turn out connected back to the US in very bad situations. Some people conclude there is no investment which wouldn't tank if the US really tanked though I don't agree with that. Non-FX hedged DM bonds wouldn't necessarily, but FX risk in the (presumed) much more likely case of muddling along is a real issue. There are a few non-FX hedged DM bond funds, not at Vanguard.
Topic Author
gavinsiu
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Re: Anyone using the Foreign Bond asset class?

Post by gavinsiu »

JackoC wrote: Tue Jul 09, 2024 11:23 am Right. Making the straightforward assumption (no guarantee) a serious US federal debt crisis would sharply lower the value of the USD v other Developed Market currencies, much of the diversification effect of having bought those foreign bonds would be lost via the FX hedges. To really diversify away from US, it must be something that also gains USD value if the USD crashes in value v other currencies IMO. Among other aspects where a foreign asset could actually turn out connected back to the US in very bad situations. Some people conclude there is no investment which wouldn't tank if the US really tanked though I don't agree with that. Non-FX hedged DM bonds wouldn't necessarily, but FX risk in the (presumed) much more likely case of muddling along is a real issue. There are a few non-FX hedged DM bond funds, not at Vanguard.
I wonder though if you already have international equity, you probably don't need foriegn bonds, but they won't hurt either. I don't know what would happen if the US tanks if this mean all of the other countries will fall.

In the case of bond though, I feel that whether to include international bond or not seems to be a blip. Unlike international equity, the difference in return may be like 0.5% over the long term. May be it just smooths out the income a bit?
intendi
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Re: Anyone using the Foreign Bond asset class?

Post by intendi »

I'm sure you've read through this but I'll post it here just in case:
https://institutional.vanguard.com/insi ... bonds.html

When I was researching the topic, I found this graphic (from the Vanguard publication above) interesting and it helped solidify my investing plan:

Image
JackoC
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Re: Anyone using the Foreign Bond asset class?

Post by JackoC »

gavinsiu wrote: Tue Jul 09, 2024 3:44 pm
JackoC wrote: Tue Jul 09, 2024 11:23 am Right. Making the straightforward assumption (no guarantee) a serious US federal debt crisis would sharply lower the value of the USD v other Developed Market currencies, much of the diversification effect of having bought those foreign bonds would be lost via the FX hedges. To really diversify away from US, it must be something that also gains USD value if the USD crashes in value v other currencies IMO. Among other aspects where a foreign asset could actually turn out connected back to the US in very bad situations. Some people conclude there is no investment which wouldn't tank if the US really tanked though I don't agree with that. Non-FX hedged DM bonds wouldn't necessarily, but FX risk in the (presumed) much more likely case of muddling along is a real issue. There are a few non-FX hedged DM bond funds, not at Vanguard.
I wonder though if you already have international equity, you probably don't need foriegn bonds, but they won't hurt either. I don't know what would happen if the US tanks if this mean all of the other countries will fall.
Swiss govt bonds promise to pay you X CHF in interest and principal. Nestle shares are listed in CHF but represent a claim on profits from a business w/ 5% of sales in Switzerland. Extreme example but foreign company stocks and bonds denominated in foreign currencies are different animals when it comes to FX rates. There is some differential FX exposure between shares of foreign big caps and US big caps (listed in $'s but w/ typically lots of non-$ profit sources), and probably more between small cap US and small cap foreign stocks (since smaller companies as a general rule do a higher % of business in their own country or currency zone). But neither can be compared to the FX difference in a straight up promise to pay a nominal number of $'s vs a nominal numbers of foreign currency units.

IOW FX and stocks is complicated, FX and nominal bonds less so. If the USD crashes in value, first order effect on high quality foreign currency bonds is big increase in USD value. That's less clear for foreign stocks. As to whether such a scenario is plausible (enough to do anything about) there's some room for debate IMO. But saying Switzerland (37% debt to GDP) would have to default if the US ever did is clearly silly. The plausible argument in this regard is that the chance of a US default (or highly unstable market conditions based on fear of one) remains too unlikely to consider in investment planning. I no longer agree with that though a) I don't think it's outright likely either, b) I recognize that diversifying significantly* away from US govt debt as the 'riskless' component is not easy.

*an FDIC/NCUA insured CD is a *little* bit diversified, since while the normal scenario is bank/CU fails govt pays, the bank/CU is not released from its obligation to you by a US govt default. And the blanket statement 'a ('real') federal default would be preceded or immediately followed by a failure of all US financial institutions' while not as preposterous as the same statement is wrt all foreign govts IMO, is still questionable. Russia defaulted on own currency domestic debt in 1996 and took measures so no major bank failed on its deposits.
Topic Author
gavinsiu
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Re: Anyone using the Foreign Bond asset class?

Post by gavinsiu »

JackoC wrote: Wed Jul 10, 2024 10:31 am Swiss govt bonds promise to pay you X CHF in interest and principal. Nestle shares are listed in CHF but represent a claim on profits from a business w/ 5% of sales in Switzerland. Extreme example but foreign company stocks and bonds denominated in foreign currencies are different animals when it comes to FX rates. There is some differential FX exposure between shares of foreign big caps and US big caps (listed in $'s but w/ typically lots of non-$ profit sources), and probably more between small cap US and small cap foreign stocks (since smaller companies as a general rule do a higher % of business in their own country or currency zone). But neither can be compared to the FX difference in a straight up promise to pay a nominal number of $'s vs a nominal numbers of foreign currency units.

IOW FX and stocks is complicated, FX and nominal bonds less so. If the USD crashes in value, first order effect on high quality foreign currency bonds is big increase in USD value. That's less clear for foreign stocks. As to whether such a scenario is plausible (enough to do anything about) there's some room for debate IMO. But saying Switzerland (37% debt to GDP) would have to default if the US ever did is clearly silly. The plausible argument in this regard is that the chance of a US default (or highly unstable market conditions based on fear of one) remains too unlikely to consider in investment planning. I no longer agree with that though a) I don't think it's outright likely either, b) I recognize that diversifying significantly* away from US govt debt as the 'riskless' component is not easy.

*an FDIC/NCUA insured CD is a *little* bit diversified, since while the normal scenario is bank/CU fails govt pays, the bank/CU is not released from its obligation to you by a US govt default. And the blanket statement 'a ('real') federal default would be preceded or immediately followed by a failure of all US financial institutions' while not as preposterous as the same statement is wrt all foreign govts IMO, is still questionable. Russia defaulted on own currency domestic debt in 1996 and took measures so no major bank failed on its deposits.
Yes, I suppose just like in the domestic stock vs bond, you get a better chance of collecting if you are a bond holder. I think that is what you are saying.

I do remember that currency has an effect on international equity return. For funds that don't hedge, a fall dollar grants you extra return and vice versa.

Your last statement is intriguing. I think you are right that if there is a default in the current environment, it will be more of a temporary issue (I am being vague to avoid being label a political discussion) and won't result in Armageddon where everything melt down, but a lost in confidence. FDIC won't implode. However, this would be uncharted territory, so I hope I never find out.

The question I was trying to answer is mostly if foreign bond is a good asset to add. The censuses so far is that it is neither significantly beneficial or detrimental.
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