Matter/scatter, Part 3: International bonds

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Matter/scatter, Part 3: International bonds

Post by nisiprius »

Part 1: Introduction, Part 2, Bond fund choices Brief notes: 1) In these Monte Carlo simulations in which the return for a given month is varied by randomly choosing the actual historical return or the actual historic return for an adjacent month. 2) They show the final value from $100 monthly contributions made over the whole time period. 4) Green and red crosses mark actual historical values. 5) Green and red bars show the 10% percentile, median, and 90% percentile of the range of outcomes. 5) The actual data source is, Backtest Portfolio, Monthly Returns; this is used as calculation input; and no PV content or numeric values are directly reproduced.

In 2012, Vanguard published a paper, Global fixed income: Considerations for U.S. investors. I found this paper data-rich, interesting--and unconvincing. The paper says that if a US investor is going to use an international bond fund, it should be one that is dollar-hedged--that is to say, one that insulates the investor against the effects of currency fluctuation, so that the investment really behaves like a bond investment, not like a FOREX investment. I found that convincing. The paper then argues for a paper-thin diversification benefit from including international bonds as part of the bond allocation.

In 2013, Vanguard launched the Vanguard International Bond Index Fund, VTIBX (Investor shares), VTABX (Admiral shares), and BNDX (ETF). It also began including them in its mainstream "all-in-one" Target Retirement and LifeStrategy funds. In these funds, Vanguard now splits the stock allocation 60% US (VTSMX), 40% international (VGSTX), and the bond 70% US (VBMFX), 30% international (VTIBX). Thus, if the overall stock/bond balance is 60/40, as in Vanguard LifeStrategy Moderate (VSMGX), the portfolio composition is:
60% of 60% = 36% VTSMX (Total Stock)
40% of 60% = 24% VGTSX (Total International)
70% of 40% = 28% VBMFX (Total Bond)
30% of 40% = 12% VTIBX (Total International Bond)

In this posting, I use the scatter methodology to explore the results of that 12% allocation to international bonds. For the baseline, in each case, I use 36% VTSMX, 24% VGTSX, 40% VBMFX. That is, I use Vanguard's standard amount of US stock internationalization--close to but not quite global cap weight. For the baseline, I use only US bonds. For the comparison, I replace 40% VBMFX with 28% VBMFX, 12% VTBIX.

I make comparisons using three different international bond funds for the 12% allocation.

First, I use VTIBX itself. VTIBX is Vanguard's own fund and thus the one most likely to accord with the results in their paper, but has was only launched in 2013 and we thus have only five years of data to look at, the shortest period of time we will look at in any chart in this series.

Second, I will use PIMCO's dollar-hedged international bond fund, PGBIX, which gives us over twenty years of history, as long as our typical comparisons. It has been quite similar to Vanguard's, except for its an expense ratio of 0.55%.

Finally, some forum members have expressed disappointment that Vanguard's bond fund is US-dollar hedged, saying that they personally want currency exposure in their bond fund for "currency diversification." I don't personally agree with this idea, but nevertheless think it is worth seeing how far this moves the needle, so our third comparison is to a portfolio with a 12% exposure to PIGLX, the PIMCO Global Bond Fund (unhedged).

I don't think any of these comparisons shows much difference, which is not surprising. We've already seen that in a 60/40 portfolio, changes in the kind of bonds used for all 40% of the portfolio haven't made a big difference, because the volatility of the stock allocation dominates so strongly. So it makes sense that a 12% allocation to a different kind of bond would have even less effect.

Vanguard's own international bond fund, (the period here is only five years)


PIMCO's similar dollar-hedged international bond fund (available for twenty years)


PIMCO's unhedged international bond fund, which includes currency fluctuations ("currency diversification," those who want it say)

Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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