Do people in the forum hold foreign bonds?

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Valuethinker
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Re: Do people in the forum hold foreign bonds?

Post by Valuethinker » Mon Apr 30, 2018 6:02 pm

nisiprius wrote:
Mon Jan 15, 2018 10:38 am
With regard to emerging markets bonds, I don't want to over emphasize this, but: 1998. It's important because it has dropped out of the ten-year time window through which people often look. EMB, for example, only had its inception in 2007.

FMNIX, Fidelity New Markets Income, is an emerging markets bond mutual fund that has existed for long enough to show what happened in 1998.

Source

Image

That is a -40% percent drop.

In six months.

In a "bond" fund.

By comparison, in 2008-2009 stocks dropped -52%, but it took about nine months.

Choose your interpretation.
  • That was a very exceptional, ten sigma event. A one-in-100,000,000,000,000,000,000,000-year event. Probably won't happen for another 100,000,000,000,000,000,000,000 but, come the year 100,000,000,000,000,000,001,998, oh boy, watch out!
  • Yeah, but so what? It did really well since then, and made all of it back.
  • Anything that has actually happened must be possible.
But at least know that it did happen... a long long ago, in a galaxy far away.
EM bonds no longer yield 12 to 15 per cent of say 800 bps above long Treasuries. The scope for future outperformance is limited by that unless you assume they move to negative yields.

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Lauretta
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Re: Do people in the forum hold foreign bonds?

Post by Lauretta » Mon Apr 30, 2018 6:20 pm

Valuethinker wrote:
Mon Apr 30, 2018 5:59 pm
Lauretta wrote:
Mon Apr 30, 2018 2:13 pm
PolarInvest wrote:
Wed Jan 17, 2018 1:44 pm
nisiprius wrote:
Mon Jan 15, 2018 10:38 am
With regard to emerging markets bonds, I don't want to over emphasize this, but: 1998. It's important because it has dropped out of the ten-year time window through which people often look. EMB, for example, only had its inception in 2007.

FMNIX, Fidelity New Markets Income, is an emerging markets bond mutual fund that has existed for long enough to show what happened in 1998.

Source

Image

That is a -40% percent drop.

In six months.

In a "bond" fund.

By comparison, in 2008-2009 stocks dropped -52%, but it took about nine months.

Choose your interpretation.
  • That was a very exceptional, ten sigma event. A one-in-100,000,000,000,000,000,000,000-year event. Probably won't happen for another 100,000,000,000,000,000,000,000 but, come the year 100,000,000,000,000,000,001,998, oh boy, watch out!
  • Yeah, but so what? It did really well since then, and made all of it back.
  • Anything that has actually happened must be possible.
But at least know that it did happen... a long long ago, in a galaxy far away.

Maybe this is not quite on topic for the current thread, but I'd venture that your graph shows a compelling reason to own emerging markets bond as part of one's "equity" allocation. They provide equity-like returns with equity-like risks, but their risks are different from those in the US stock market dominated by tech companies such as Apple, Microsoft, etc. While emerging markets bonds tumbled in 1998 and stocks didn't, they also only had a 22% drawdown at their lowest point during the 2008-2009 financial crisis, which is not too shabby for something with equity-like returns.

On Portfolio Visualizer you can compare two portfolios:
Portfolio 1: 100% VTSMX
Portfolio 2: 50% VTSMX and 50% PREMX (T. Rowe Price Emerging Markets Bond; my personal choice)

From 1995-2017 (what there is data for), you get the following stats:

Portfolio 1: 10.02% return, 14.94 st. dev., 50.89% max drawdown, 0.56 Sharpe Ratio
Portfolio 2: 10.66% return, 12.32 st. dev., 36.07% max drawdown, 0.70 Sharpe Ratio

So emerging market bonds give you a much more efficient portfolio added to one's risky asset allocation. You have more drawdowns since there are more types of risks that can go south in a hurry, but the drawdowns aren't as bad due to the diversification.

One could argue that returns on emerging market bonds have come down in the past 20 years as markets have matured and yields have gone down, but I could make similar arguments about lower future expected returns for US stocks as well.
That's an interesting point. I hadn't thought of that since I had gone with the idea that bonds should be for the safe part of your portfolio, so I don't have any EM bonds at the moment, but what you say is interesting.
Concerning the fund, may I ask why you chose an active one? Is there evidence that active beats passive in EM bonds? And why T. Rowe Price? I noticed that a fund domiciled in Europe (where I live) has recenty been opened, managed by the same manager (Conelius) but in Europe all money managers seem to advice clients to buy the Templeton fund managed by Hasenstab for EM bonds).
See my question re expected future returns on EM bonds.
just saw it thanks. :happy However not sure I understand: you say the bond yields have to decrease in order to get higher returns and match those of equities? My understanding is that if yields stay constant at 4 or 5% (and there's no default) then that corresponds to the expected return of US stocks. Siegel forecasts 5%/yr over the next 10 or 15 yrs, by doing the inverse of the PE ratio which he takes to be 20 because he uses operating earnings (and aussumes there won't be a multiples contraction). Most other forecasts for US stocks are lower than that.
When everyone is thinking the same, no one is thinking at all

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permport
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Re: Do people in the forum hold foreign bonds?

Post by permport » Mon Apr 30, 2018 7:19 pm

Count me as another weirdo with international bonds!

25% - total global stock market
50% - total global bond market
25% - precious metals

:beer
Buy right and hold tight.

Valuethinker
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Joined: Fri May 11, 2007 11:07 am

Re: Do people in the forum hold foreign bonds?

Post by Valuethinker » Mon Apr 30, 2018 9:31 pm

Lauretta wrote:
Mon Apr 30, 2018 6:20 pm
Valuethinker wrote:
Mon Apr 30, 2018 5:59 pm
Lauretta wrote:
Mon Apr 30, 2018 2:13 pm
PolarInvest wrote:
Wed Jan 17, 2018 1:44 pm
nisiprius wrote:
Mon Jan 15, 2018 10:38 am
With regard to emerging markets bonds, I don't want to over emphasize this, but: 1998. It's important because it has dropped out of the ten-year time window through which people often look. EMB, for example, only had its inception in 2007.

FMNIX, Fidelity New Markets Income, is an emerging markets bond mutual fund that has existed for long enough to show what happened in 1998.

Source

Image

That is a -40% percent drop.

In six months.

In a "bond" fund.

By comparison, in 2008-2009 stocks dropped -52%, but it took about nine months.

Choose your interpretation.
  • That was a very exceptional, ten sigma event. A one-in-100,000,000,000,000,000,000,000-year event. Probably won't happen for another 100,000,000,000,000,000,000,000 but, come the year 100,000,000,000,000,000,001,998, oh boy, watch out!
  • Yeah, but so what? It did really well since then, and made all of it back.
  • Anything that has actually happened must be possible.
But at least know that it did happen... a long long ago, in a galaxy far away.

Maybe this is not quite on topic for the current thread, but I'd venture that your graph shows a compelling reason to own emerging markets bond as part of one's "equity" allocation. They provide equity-like returns with equity-like risks, but their risks are different from those in the US stock market dominated by tech companies such as Apple, Microsoft, etc. While emerging markets bonds tumbled in 1998 and stocks didn't, they also only had a 22% drawdown at their lowest point during the 2008-2009 financial crisis, which is not too shabby for something with equity-like returns.

On Portfolio Visualizer you can compare two portfolios:
Portfolio 1: 100% VTSMX
Portfolio 2: 50% VTSMX and 50% PREMX (T. Rowe Price Emerging Markets Bond; my personal choice)

From 1995-2017 (what there is data for), you get the following stats:

Portfolio 1: 10.02% return, 14.94 st. dev., 50.89% max drawdown, 0.56 Sharpe Ratio
Portfolio 2: 10.66% return, 12.32 st. dev., 36.07% max drawdown, 0.70 Sharpe Ratio

So emerging market bonds give you a much more efficient portfolio added to one's risky asset allocation. You have more drawdowns since there are more types of risks that can go south in a hurry, but the drawdowns aren't as bad due to the diversification.

One could argue that returns on emerging market bonds have come down in the past 20 years as markets have matured and yields have gone down, but I could make similar arguments about lower future expected returns for US stocks as well.
That's an interesting point. I hadn't thought of that since I had gone with the idea that bonds should be for the safe part of your portfolio, so I don't have any EM bonds at the moment, but what you say is interesting.
Concerning the fund, may I ask why you chose an active one? Is there evidence that active beats passive in EM bonds? And why T. Rowe Price? I noticed that a fund domiciled in Europe (where I live) has recenty been opened, managed by the same manager (Conelius) but in Europe all money managers seem to advice clients to buy the Templeton fund managed by Hasenstab for EM bonds).
See my question re expected future returns on EM bonds.
just saw it thanks. :happy However not sure I understand: you say the bond yields have to decrease in order to get higher returns and match those of equities? My understanding is that if yields stay constant at 4 or 5% (and there's no default) then that corresponds to the expected return of US stocks. Siegel forecasts 5%/yr over the next 10 or 15 yrs, by doing the inverse of the PE ratio which he takes to be 20 because he uses operating earnings (and aussumes there won't be a multiples contraction). Most other forecasts for US stocks are lower than that.
Poster says you get equity returns for equity risk out of em bonds.

Do markets really expect that em equities will 5 per cent nominal returns?

You are confusing real and nominal returns I think. If Us stocks only return 5 per cent that is 2.5 to 3 per cent real. Is Siegel really forecasting that?

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Lauretta
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Re: Do people in the forum hold foreign bonds?

Post by Lauretta » Tue May 01, 2018 2:00 am

Valuethinker wrote:
Mon Apr 30, 2018 9:31 pm
Lauretta wrote:
Mon Apr 30, 2018 6:20 pm
Valuethinker wrote:
Mon Apr 30, 2018 5:59 pm
Lauretta wrote:
Mon Apr 30, 2018 2:13 pm
PolarInvest wrote:
Wed Jan 17, 2018 1:44 pm



Maybe this is not quite on topic for the current thread, but I'd venture that your graph shows a compelling reason to own emerging markets bond as part of one's "equity" allocation. They provide equity-like returns with equity-like risks, but their risks are different from those in the US stock market dominated by tech companies such as Apple, Microsoft, etc. While emerging markets bonds tumbled in 1998 and stocks didn't, they also only had a 22% drawdown at their lowest point during the 2008-2009 financial crisis, which is not too shabby for something with equity-like returns.

On Portfolio Visualizer you can compare two portfolios:
Portfolio 1: 100% VTSMX
Portfolio 2: 50% VTSMX and 50% PREMX (T. Rowe Price Emerging Markets Bond; my personal choice)

From 1995-2017 (what there is data for), you get the following stats:

Portfolio 1: 10.02% return, 14.94 st. dev., 50.89% max drawdown, 0.56 Sharpe Ratio
Portfolio 2: 10.66% return, 12.32 st. dev., 36.07% max drawdown, 0.70 Sharpe Ratio

So emerging market bonds give you a much more efficient portfolio added to one's risky asset allocation. You have more drawdowns since there are more types of risks that can go south in a hurry, but the drawdowns aren't as bad due to the diversification.

One could argue that returns on emerging market bonds have come down in the past 20 years as markets have matured and yields have gone down, but I could make similar arguments about lower future expected returns for US stocks as well.
That's an interesting point. I hadn't thought of that since I had gone with the idea that bonds should be for the safe part of your portfolio, so I don't have any EM bonds at the moment, but what you say is interesting.
Concerning the fund, may I ask why you chose an active one? Is there evidence that active beats passive in EM bonds? And why T. Rowe Price? I noticed that a fund domiciled in Europe (where I live) has recenty been opened, managed by the same manager (Conelius) but in Europe all money managers seem to advice clients to buy the Templeton fund managed by Hasenstab for EM bonds).
See my question re expected future returns on EM bonds.
just saw it thanks. :happy However not sure I understand: you say the bond yields have to decrease in order to get higher returns and match those of equities? My understanding is that if yields stay constant at 4 or 5% (and there's no default) then that corresponds to the expected return of US stocks. Siegel forecasts 5%/yr over the next 10 or 15 yrs, by doing the inverse of the PE ratio which he takes to be 20 because he uses operating earnings (and aussumes there won't be a multiples contraction). Most other forecasts for US stocks are lower than that.
Poster says you get equity returns for equity risk out of em bonds.

Do markets really expect that em equities will 5 per cent nominal returns?

You are confusing real and nominal returns I think. If Us stocks only return 5 per cent that is 2.5 to 3 per cent real. Is Siegel really forecasting that?
You are right, I was confusing the 2 when I wrote that. Still, Siegel's 5% real seems to be optimistic, most other people interviewed here gave lower guesses
https://abnormalreturns.com/2018/04/02/ ... l-returns/
And I think RA and GMO have close to zero or negative expectations of 10yr returns for the US - though of course nobody really knows...
PS I am comparing EM bonds returns to those of US stocks, not of EM stocks (as you mentioned above), since the poster used VTSMX as a comparison
When everyone is thinking the same, no one is thinking at all

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Lauretta
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Re: Do people in the forum hold foreign bonds?

Post by Lauretta » Thu May 03, 2018 2:42 pm

Valuethinker wrote:
Mon Apr 30, 2018 9:31 pm
Lauretta wrote:
Mon Apr 30, 2018 6:20 pm
Valuethinker wrote:
Mon Apr 30, 2018 5:59 pm
Lauretta wrote:
Mon Apr 30, 2018 2:13 pm
PolarInvest wrote:
Wed Jan 17, 2018 1:44 pm



Maybe this is not quite on topic for the current thread, but I'd venture that your graph shows a compelling reason to own emerging markets bond as part of one's "equity" allocation. They provide equity-like returns with equity-like risks, but their risks are different from those in the US stock market dominated by tech companies such as Apple, Microsoft, etc. While emerging markets bonds tumbled in 1998 and stocks didn't, they also only had a 22% drawdown at their lowest point during the 2008-2009 financial crisis, which is not too shabby for something with equity-like returns.

On Portfolio Visualizer you can compare two portfolios:
Portfolio 1: 100% VTSMX
Portfolio 2: 50% VTSMX and 50% PREMX (T. Rowe Price Emerging Markets Bond; my personal choice)

From 1995-2017 (what there is data for), you get the following stats:

Portfolio 1: 10.02% return, 14.94 st. dev., 50.89% max drawdown, 0.56 Sharpe Ratio
Portfolio 2: 10.66% return, 12.32 st. dev., 36.07% max drawdown, 0.70 Sharpe Ratio

So emerging market bonds give you a much more efficient portfolio added to one's risky asset allocation. You have more drawdowns since there are more types of risks that can go south in a hurry, but the drawdowns aren't as bad due to the diversification.

One could argue that returns on emerging market bonds have come down in the past 20 years as markets have matured and yields have gone down, but I could make similar arguments about lower future expected returns for US stocks as well.
That's an interesting point. I hadn't thought of that since I had gone with the idea that bonds should be for the safe part of your portfolio, so I don't have any EM bonds at the moment, but what you say is interesting.
Concerning the fund, may I ask why you chose an active one? Is there evidence that active beats passive in EM bonds? And why T. Rowe Price? I noticed that a fund domiciled in Europe (where I live) has recenty been opened, managed by the same manager (Conelius) but in Europe all money managers seem to advice clients to buy the Templeton fund managed by Hasenstab for EM bonds).
See my question re expected future returns on EM bonds.
just saw it thanks. :happy However not sure I understand: you say the bond yields have to decrease in order to get higher returns and match those of equities? My understanding is that if yields stay constant at 4 or 5% (and there's no default) then that corresponds to the expected return of US stocks. Siegel forecasts 5%/yr over the next 10 or 15 yrs, by doing the inverse of the PE ratio which he takes to be 20 because he uses operating earnings (and aussumes there won't be a multiples contraction). Most other forecasts for US stocks are lower than that.
Poster says you get equity returns for equity risk out of em bonds.

Do markets really expect that em equities will 5 per cent nominal returns?

You are confusing real and nominal returns I think. If Us stocks only return 5 per cent that is 2.5 to 3 per cent real. Is Siegel really forecasting that?

Another argument I've just seen in favour of EM bonds is that EM currencies are generally very undervalued (based e.g. on the Big Mac argument I guess), at least that's what thinks Clémence Dachicourt from Mrningstar who manages portfolio for retail investors. She considers EM bonds the most promising class (and seems to have more EM bonds than US equities in her managed portfolios for her European clients).
Here's a link to her analysis; the text is in French though
http://public.message-business.com/file ... 202018.pdf
When everyone is thinking the same, no one is thinking at all

Valuethinker
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Re: Do people in the forum hold foreign bonds?

Post by Valuethinker » Fri May 04, 2018 1:23 pm

Lauretta wrote:
Thu May 03, 2018 2:42 pm
Valuethinker wrote:
Mon Apr 30, 2018 9:31 pm
Lauretta wrote:
Mon Apr 30, 2018 6:20 pm
Valuethinker wrote:
Mon Apr 30, 2018 5:59 pm
Lauretta wrote:
Mon Apr 30, 2018 2:13 pm

That's an interesting point. I hadn't thought of that since I had gone with the idea that bonds should be for the safe part of your portfolio, so I don't have any EM bonds at the moment, but what you say is interesting.
Concerning the fund, may I ask why you chose an active one? Is there evidence that active beats passive in EM bonds? And why T. Rowe Price? I noticed that a fund domiciled in Europe (where I live) has recenty been opened, managed by the same manager (Conelius) but in Europe all money managers seem to advice clients to buy the Templeton fund managed by Hasenstab for EM bonds).
See my question re expected future returns on EM bonds.
just saw it thanks. :happy However not sure I understand: you say the bond yields have to decrease in order to get higher returns and match those of equities? My understanding is that if yields stay constant at 4 or 5% (and there's no default) then that corresponds to the expected return of US stocks. Siegel forecasts 5%/yr over the next 10 or 15 yrs, by doing the inverse of the PE ratio which he takes to be 20 because he uses operating earnings (and aussumes there won't be a multiples contraction). Most other forecasts for US stocks are lower than that.
Poster says you get equity returns for equity risk out of em bonds.

Do markets really expect that em equities will 5 per cent nominal returns?

You are confusing real and nominal returns I think. If Us stocks only return 5 per cent that is 2.5 to 3 per cent real. Is Siegel really forecasting that?

Another argument I've just seen in favour of EM bonds is that EM currencies are generally very undervalued (based e.g. on the Big Mac argument I guess), at least that's what thinks Clémence Dachicourt from Mrningstar who manages portfolio for retail investors. She considers EM bonds the most promising class (and seems to have more EM bonds than US equities in her managed portfolios for her European clients).
Here's a link to her analysis; the text is in French though
http://public.message-business.com/file ... 202018.pdf
Normal ly em bonds are issued paying in USD. Thus no currency gain or loss for USD investor.

Holding em local currency bonds is another layer of risk and a pretty big one. Becomes a currency play. Also different legal systems v Eurobonds (the latter are issued under English law) in default etc.

Biggest em currency, the renimbi, is probably overvalued at this point.

Comparing em bond returns to US stocks us a real stretch. I remember 1994 Commander Zero and Mexico. Too much event risk. Note another US Treasury bailout would now be impossible.

lack_ey
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Re: Do people in the forum hold foreign bonds?

Post by lack_ey » Fri May 04, 2018 1:36 pm

Valuethinker wrote:
Fri May 04, 2018 1:23 pm
Normal ly em bonds are issued paying in USD. Thus no currency gain or loss for USD investor.
Are you sure? IIRC these days most EM bonds are local currency by issuance, not USD (or other hard currencies), and it's been like that and increasing on that trend for a couple decades.

A quick search turns up this from 2014 from the World Bank:
http://treasury.worldbank.org/documents ... ion2_1.pdf

And in any case, I think a number of people are making the case for local currency debt to play on FX, at least as a tactical move. Research Affiliates's forecast tool shows higher expected returns (note: just using as an example of what some people think, not necessarily endorsing a view) on EM local cash than global stocks.

https://interactive.researchaffiliates. ... allocation

Valuethinker
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Re: Do people in the forum hold foreign bonds?

Post by Valuethinker » Tue May 08, 2018 9:15 am

lack_ey wrote:
Fri May 04, 2018 1:36 pm
Valuethinker wrote:
Fri May 04, 2018 1:23 pm
Normal ly em bonds are issued paying in USD. Thus no currency gain or loss for USD investor.
Are you sure? IIRC these days most EM bonds are local currency by issuance, not USD (or other hard currencies), and it's been like that and increasing on that trend for a couple decades.

A quick search turns up this from 2014 from the World Bank:
http://treasury.worldbank.org/documents ... ion2_1.pdf

And in any case, I think a number of people are making the case for local currency debt to play on FX, at least as a tactical move. Research Affiliates's forecast tool shows higher expected returns (note: just using as an example of what some people think, not necessarily endorsing a view) on EM local cash than global stocks.

https://interactive.researchaffiliates. ... allocation
Thsnk you. Interesting. Mostly familiar w their USD debt. Concentration in 3 issued countries is also a risk.

Issuer dang autocorrect!

Angst
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Re: Do people in the forum hold foreign bonds?

Post by Angst » Tue May 08, 2018 9:46 am

bklyn96 wrote:
Mon Jan 15, 2018 11:50 am
Always passive wrote:
Mon Jan 15, 2018 7:19 am
Do people in the forum hold foreign bonds?....in which fund(s) and what percent of total bonds?
Two of our three core holdings include foreign bonds: Total Bond Market Index is 5% foreign and Wellington's bond portfolio is 7% foreign.
Do people in the forum hold foreign bonds?
You bet they do, even if they don't know it.

Let alone the Total Bond Market fund and Wellington, anyone who holds a Vanguard Target Retirement fund has roughly 1/3 of their bonds as Internationals. But do we care much either way about holding a portion of FI in Int'l Bonds? I have the impression that few people here care to go beyond what the Total Bond, or Wellington or even the TR funds put you into with respect to Int'l Bonds. To me, it's not worth bothering over, but I'm not really sold on the need for any International bonds in the first place.

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Gort
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Re: Do people in the forum hold foreign bonds?

Post by Gort » Tue May 08, 2018 10:01 am

Yes, in same allocation as the Life Strategy Moderate Fund. Using the same argument from folks who say they can't see a strong enough reason to hold them, I can't find a strong enough reason not to.

Calygos
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Re: Do people in the forum hold foreign bonds?

Post by Calygos » Tue May 15, 2018 7:57 am

I'm in the middle of reconsidering how much of my AA is in bonds and International equities and it got me thinking about International bonds as well. I've seen a lot of people here argue for holding anywhere from the Bogle/Vanguard 20% through the market cap of ~51% for Int'l equities, so why not the same argument for whatever the market of Int'l bonds is via Vanguard Total Int'l Bond Fund, for example?

Valuethinker
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Re: Do people in the forum hold foreign bonds?

Post by Valuethinker » Tue May 15, 2018 11:26 am

Calygos wrote:
Tue May 15, 2018 7:57 am
I'm in the middle of reconsidering how much of my AA is in bonds and International equities and it got me thinking about International bonds as well. I've seen a lot of people here argue for holding anywhere from the Bogle/Vanguard 20% through the market cap of ~51% for Int'l equities, so why not the same argument for whatever the market of Int'l bonds is via Vanguard Total Int'l Bond Fund, for example?
If the bond fund hedges its currency exposure back to USD you will get returns close to that of US Treasury bonds + any credit risk spread (some foreign government bonds have a higher risk of default than comparable US Treasury bonds).

The process of currency hedging will give you approximately the US government bond return* -- at the moment, Japanese government bonds yield less than 1.0% and some German government bonds yield 0.0% or lower. But the currency hedging will work in your favour and raise returns closer to the US Treasury yield (say 2.6%).

From my own (UK) perspective it's not a particularly attractive bet. The biggest government bond market in Europe is the Italian one, and the market is assigning a non-zero probability of Italy defaulting/ leaving the Euro. In that Italian government bonds yield c. 1.6% more than German govt bonds (the risk free bond in the Eurozone). Of course Japan looks even more indebted, but Japan can always print yen (in effect a devaluation of the currency) to pay its debts. But I believe the UK government will make good on its debts, I believe that the US government will, and US Treasury bonds are paying nearly 3.0%. So if I was a USD based investor, why would I want to take risk on other developed country bonds?

If you invest in bonds without currency hedging, what you have is really a speculation on the USD vs. foreign currencies. The exchange rate volatility will drown out any interest return the fund pays. That may work in your favour, it may not. But it will add a lot of volatility and we generally hold here that you are not rewarded for taking on currency risk.

(the assumption we make about foreign equity investing is that it all evens out in the long run. This may or may not be valid-- within say 10 years of planning to spend the money you should worry about exchange rate volatility but otherwise we just tend to wear it - use unhedged funds and accept the volatility.)

* the forward exchange rates for currency forwards and futures, the primary form of hedging, are driven by the difference in risk-free interest rates between the 2 currencies. If I hedge my USD bond exposure into EUR, I am going to get approximately 0% return in EUR + whatever additional credit risk I might be taking on.

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Lauretta
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Re: Do people in the forum hold foreign bonds?

Post by Lauretta » Tue May 15, 2018 4:28 pm

Valuethinker wrote:
Tue May 15, 2018 11:26 am
Calygos wrote:
Tue May 15, 2018 7:57 am
I'm in the middle of reconsidering how much of my AA is in bonds and International equities and it got me thinking about International bonds as well. I've seen a lot of people here argue for holding anywhere from the Bogle/Vanguard 20% through the market cap of ~51% for Int'l equities, so why not the same argument for whatever the market of Int'l bonds is via Vanguard Total Int'l Bond Fund, for example?
If the bond fund hedges its currency exposure back to USD you will get returns close to that of US Treasury bonds + any credit risk spread (some foreign government bonds have a higher risk of default than comparable US Treasury bonds).

The process of currency hedging will give you approximately the US government bond return* -- at the moment, Japanese government bonds yield less than 1.0% and some German government bonds yield 0.0% or lower. But the currency hedging will work in your favour and raise returns closer to the US Treasury yield (say 2.6%).

From my own (UK) perspective it's not a particularly attractive bet. The biggest government bond market in Europe is the Italian one, and the market is assigning a non-zero probability of Italy defaulting/ leaving the Euro. In that Italian government bonds yield c. 1.6% more than German govt bonds (the risk free bond in the Eurozone). Of course Japan looks even more indebted, but Japan can always print yen (in effect a devaluation of the currency) to pay its debts. But I believe the UK government will make good on its debts, I believe that the US government will, and US Treasury bonds are paying nearly 3.0%. So if I was a USD based investor, why would I want to take risk on other developed country bonds?

If you invest in bonds without currency hedging, what you have is really a speculation on the USD vs. foreign currencies. The exchange rate volatility will drown out any interest return the fund pays. That may work in your favour, it may not. But it will add a lot of volatility and we generally hold here that you are not rewarded for taking on currency risk.

(the assumption we make about foreign equity investing is that it all evens out in the long run. This may or may not be valid-- within say 10 years of planning to spend the money you should worry about exchange rate volatility but otherwise we just tend to wear it - use unhedged funds and accept the volatility.)

* the forward exchange rates for currency forwards and futures, the primary form of hedging, are driven by the difference in risk-free interest rates between the 2 currencies. If I hedge my USD bond exposure into EUR, I am going to get approximately 0% return in EUR + whatever additional credit risk I might be taking on.
This is a relatively small point but since I've read an article on the subject today I thought I'd share it here. As a US investor buying EU bonds, if you currency hedge you can still profit from the steeper yield curve.
Here's a quote from the Robeco piece I've read:
hedging European FX currently yields a premium of 3% on a yearly basis. Buying a German Bund (or better still an Italian BTP) and hedging the FX offers you a starting yield of 3.6%, as well as a much steeper yield curve
leaving aside the BTP where you have default risk, you can also profit from a German Bund.
And here's the link to the whole piece; I hope it works:
https://www.robeco.com/en/insights/2018 ... ields.html
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Dead Man Walking
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Re: Do people in the forum hold foreign bonds?

Post by Dead Man Walking » Tue May 15, 2018 7:19 pm

Vanguard chose to include international bonds in their Life Strategy Funds about the time that I was considering investing in one to simplify my portfolio. I read the Vanguard paper cited above and decided further investigation was warranted before I invested. My research lead me to papers that pointed out that negative interest rates in the international bond market could end badly. (I can't provide links because I deleted them.) That information in addition to the tepid endorsement by many here led me to the conclusion that my heirs could make the move if they didn't understand my investment plan. It probably won't hurt, it's the largest asset class, etc. aren't convincing arguments.

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Lieutenant.Columbo
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Re: Do people in the forum hold foreign bonds?

Post by Lieutenant.Columbo » Tue May 15, 2018 8:51 pm

whodidntante wrote:
Mon Jan 15, 2018 8:13 am
Ex-US bonds are the world's largest asset class. And you're saying you don't want to own them? Yeah, me neither. It's all about the yield.
a fixed-income specialist I once corresponded with about short-term fixed income mutual funds with AAA or AA holdings from other major Developed countries (and hedged against currency risk) said:
These funds would still have interest rate risk. Hedging currency back to the US Dollar gives you exposure to the US yield curve (not foreign yield curve). Also, there is no way to perfectly hedge currency risk, so these portfolios will have some currency risk as well which adds to volatility. The hedge also adds cost which decreases return.
Me neither.
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Lauretta
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Re: Do people in the forum hold foreign bonds?

Post by Lauretta » Wed May 16, 2018 12:09 am

Lieutenant.Columbo wrote:
Tue May 15, 2018 8:51 pm
a fixed-income specialist I once corresponded with about short-term fixed income mutual funds with AAA or AA holdings from other major Developed countries (and hedged against currency risk) said:
These funds would still have interest rate risk. Hedging currency back to the US Dollar gives you exposure to the US yield curve (not foreign yield curve). Also, there is no way to perfectly hedge currency risk, so these portfolios will have some currency risk as well which adds to volatility. The hedge also adds cost which decreases return.
concerning the exposure to the yield curve, this article indicates that you do get exposure to the foreign yield curve and that you can actually benefit when it's steeper:
https://www.robeco.com/en/insights/2018 ... ields.html
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Re: Do people in the forum hold foreign bonds?

Post by Valuethinker » Wed May 16, 2018 7:33 am

Lauretta wrote:
Tue May 15, 2018 4:28 pm
Valuethinker wrote:
Tue May 15, 2018 11:26 am
Calygos wrote:
Tue May 15, 2018 7:57 am
I'm in the middle of reconsidering how much of my AA is in bonds and International equities and it got me thinking about International bonds as well. I've seen a lot of people here argue for holding anywhere from the Bogle/Vanguard 20% through the market cap of ~51% for Int'l equities, so why not the same argument for whatever the market of Int'l bonds is via Vanguard Total Int'l Bond Fund, for example?
If the bond fund hedges its currency exposure back to USD you will get returns close to that of US Treasury bonds + any credit risk spread (some foreign government bonds have a higher risk of default than comparable US Treasury bonds).

The process of currency hedging will give you approximately the US government bond return* -- at the moment, Japanese government bonds yield less than 1.0% and some German government bonds yield 0.0% or lower. But the currency hedging will work in your favour and raise returns closer to the US Treasury yield (say 2.6%).

From my own (UK) perspective it's not a particularly attractive bet. The biggest government bond market in Europe is the Italian one, and the market is assigning a non-zero probability of Italy defaulting/ leaving the Euro. In that Italian government bonds yield c. 1.6% more than German govt bonds (the risk free bond in the Eurozone). Of course Japan looks even more indebted, but Japan can always print yen (in effect a devaluation of the currency) to pay its debts. But I believe the UK government will make good on its debts, I believe that the US government will, and US Treasury bonds are paying nearly 3.0%. So if I was a USD based investor, why would I want to take risk on other developed country bonds?

If you invest in bonds without currency hedging, what you have is really a speculation on the USD vs. foreign currencies. The exchange rate volatility will drown out any interest return the fund pays. That may work in your favour, it may not. But it will add a lot of volatility and we generally hold here that you are not rewarded for taking on currency risk.

(the assumption we make about foreign equity investing is that it all evens out in the long run. This may or may not be valid-- within say 10 years of planning to spend the money you should worry about exchange rate volatility but otherwise we just tend to wear it - use unhedged funds and accept the volatility.)

* the forward exchange rates for currency forwards and futures, the primary form of hedging, are driven by the difference in risk-free interest rates between the 2 currencies. If I hedge my USD bond exposure into EUR, I am going to get approximately 0% return in EUR + whatever additional credit risk I might be taking on.
This is a relatively small point but since I've read an article on the subject today I thought I'd share it here. As a US investor buying EU bonds, if you currency hedge you can still profit from the steeper yield curve.
Here's a quote from the Robeco piece I've read:
hedging European FX currently yields a premium of 3% on a yearly basis. Buying a German Bund (or better still an Italian BTP) and hedging the FX offers you a starting yield of 3.6%, as well as a much steeper yield curve
leaving aside the BTP where you have default risk, you can also profit from a German Bund.
And here's the link to the whole piece; I hope it works:
https://www.robeco.com/en/insights/2018 ... ields.html
Thank you for the very interesting point and reference.

Intuitively I can see why this is so (relative steepness of the yield curves) although I would have thought the cost of the FX hedging cancels that out.

I think that it is marginal, though, for most investors.

The problem with credit risk in international bonds is:

- it can be event risk. Greece defaults. SE Asia has a crash. (nightmare) Italy crashes out of the Eurozone. Then all your bonds could go down together. These are "random" events which are correlated with each other - so statistics won't necessarily tell you much about their probability (they don't happen often enough).

It's not the possibility of any one of billions of stars going nova, it's the chance that the Earth's Sun, Sol, goes nova that we have to worry about ;-).

- of course the Great Financial Crash was correlated credit risk in the US market, too. So you cannot escape credit risk (as a US investor) nor the theoretical possibility that your own country might default on its debt-- to date, any threat of that has been due to legislative manoeuvring, not an Argentina-like scenario.

Calygos
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Re: Do people in the forum hold foreign bonds?

Post by Calygos » Wed May 16, 2018 10:16 am

Wow, this whole discussion is over my head. Guess for me, considering simplicity and not investing in something I don't understand at least at a more basic level, the answer is to stay away from international bonds except for whatever is held in VBTLX (which makes int'l bonds about 1.74% of my entire portfolio according to Personal Capital).

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Re: Do people in the forum hold foreign bonds?

Post by lack_ey » Wed May 16, 2018 1:05 pm

Valuethinker wrote:
Wed May 16, 2018 7:33 am
Intuitively I can see why this is so (relative steepness of the yield curves) although I would have thought the cost of the FX hedging cancels that out.
Normally in this context FX hedging should be with rolling short-term forwards (if nothing else, that's how the funds tend to do it), so there is still yield curve diversification.
Lieutenant.Columbo wrote:
Tue May 15, 2018 8:51 pm
whodidntante wrote:
Mon Jan 15, 2018 8:13 am
Ex-US bonds are the world's largest asset class. And you're saying you don't want to own them? Yeah, me neither. It's all about the yield.
a fixed-income specialist I once corresponded with about short-term fixed income mutual funds with AAA or AA holdings from other major Developed countries (and hedged against currency risk) said:
These funds would still have interest rate risk. Hedging currency back to the US Dollar gives you exposure to the US yield curve (not foreign yield curve). Also, there is no way to perfectly hedge currency risk, so these portfolios will have some currency risk as well which adds to volatility. The hedge also adds cost which decreases return.
Me neither.
The cost is pretty low for USD to other major currencies. And this is more like an imputed spread than some kind of fee. There being no way to perfectly hedge doesn't mean that a fund can't hedge almost perfectly easily with low cost and pick up what's now a considerable hedge return.

Without hedging, a typical intermediate-term bond fund would be dominated by FX risk. After hedging, it's dominated by the term and credit risks, even if the hedging is not 100% perfect. The added volatility is close to zero as small-magnitude effects with low correlation with the major effects hardly add to overall vol.

I wonder what kind of specialist this is. Maybe this was thinking about hedging via maturity-matched forwards. Then some of these things would make some more sense, but this is not as typical, and certainly doesn't line up with what the big funds are doing, whether you look at Vanguard's huge index fund or actively managed funds like PIMCO Global Bond Fund (U.S. Dollar-Hedged).



At this point I'd consider at least partially currency hedging international stocks too.

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