[Wiki] Bond basics for non-US investors - seeking feedback and contributions

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DJN
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[Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Tue Jun 25, 2019 10:24 pm

Hi,
I have spent some time trying to lay out simply the basic bond information and sources for non-US investors in order to supplement the information available on Wiki. I have restricted my study mainly to EU investors which includes the UK. I would appreciate feedback, comments, corrections and input to the paper which is a work in progress draft and can be accessed here: https://www.bogleheads.org/wiki/User:DJ ... _investors
The paper is not specifically aimed at any country within the EU and differences will emerge and country specific approaches could assist in giving a better overall picture. The content will likely also be applicable to many other non-US countries apart from EU and UK.
Tell me what's missing.
thanks for your help,
DJN
Yah shure

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Wed Jun 26, 2019 7:28 am

Any interest on this one?
Yah shure

TedSwippet
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by TedSwippet » Wed Jun 26, 2019 7:54 am

DJN wrote:
Wed Jun 26, 2019 7:28 am
Any interest on this one?
I just committed a change with a few tweaks. Bit limited on time just now, but should be able to revisit it later. Thanks for putting this together.

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Wed Jun 26, 2019 9:18 am

Thanks Ted,
you are a star.
I was thinking it would be nice to put together a Morningstar style box type section on choosing any particular bond fund.
DJN
Yah shure

finrod_2002
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by finrod_2002 » Mon Jul 01, 2019 2:18 am

I myself rely on CD ladders a this moment for the fixed income part of my portfolio, but for European investors I think Xtrackers (Deutsche Bank) has some interesting products.

For example

Xtrackers II Global Government Bond

is hedged to different currencies, here the Euro version:

http://www.morningstar.nl/nl/etf/snapsh ... 0P0000M84I

Also, there are accumulating and distributing versions of each. Even though I somehow personally trust more Vanguard and Blackrock as providers vs Deutsche Bank, but that is a very personal gut feeling without real objective arguments.

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Mon Jul 01, 2019 3:50 am

Hi Finrod,
good feedback.
Would you share with us the type of CD's that you have. Where are they domiciled? US or Europe? I am not sure if you are US tax payer?
Xtrackers certainly have interesting etf's. I have just added one (DBZB) as a choice to the EU investor sample portfolio for accumulating versions: https://www.bogleheads.org/wiki/EU_investing
I am just wondering about the tax position for them?
In addition the TER is higher than the equivalent Vanguard and iShares aggregate but nearly the same as the equivalent Vanguard government world bond etf.
DJN
Yah shure

LHRAdam
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by LHRAdam » Wed Jul 10, 2019 2:33 pm

Thank you very much for writing the wiki which is very clear and bridges a gap that I encountered when trying to understand how the BH 3-fund portfolio would work from Europe.
The way I suppose I see it now is that the 3-fund portfolio becomes a 2-fund portfolio in Europe with the stock component a passive globally weighted index and the bond component according to the options you clearly set out.
I guess that the bond questions for me were
1. Why have bonds at all?
2. What percentage of my portfolio?
3. Which bonds to buy?
And then the BH advice to take the risk on the equity side means that there was a further question whether to invest in government bonds only or split the investment somehow between government & corporate bonds.
Your point about the absolute need for currency hedging on the bond side can’t be emphasized enough. Otherwise, as you say, the stability provided by bonds both in absolute terms and by regular coupon payments is hijacked by currency exchange volatility. Obviously for US investors (and within the majority of BH posts) this doesn’t apply (because the bonds invested in are in USD). This was a point I completely missed when I was new to BH.
Thank you very much.

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Thu Jul 11, 2019 2:33 am

Hi,
Thanks for your helpful feedback on the new Wiki page.
LHRAdam wrote:
Wed Jul 10, 2019 2:33 pm
1. Why have bonds at all?
I have bonds for stability and safety. I want to try and protect my money in the first place. I am less concerned about earning but obviously addressing inflation is also important. In regards to safety I want to be conservative with bonds and this lead me to question the automatic selection of the aggregate bond fund as a default non-US suggestion for the fixed income side of the simplest two or three fund approach. The global aggregate includes corporate assets and this may be riskier and I would like to know that I can substitute or add different more specific bonds to the mix hence the new page on bonds basics for non-US investors.
DJN
Yah shure

LHRAdam
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by LHRAdam » Thu Jul 11, 2019 3:29 pm

That was exactly my conclusion - aggregate bonds contain corporate bonds as well as treasuries, so I chose treasuries only.

I might not put this quite right but I’ve been thinking about how to summarize my decision ...

If I am investing for stability and safety on the fixed income side (which I am), then why include corporate bonds, when treasuries or government bonds are widely available and can easily be hedged? Is it because I am really chasing higher return?

What is great about the wiki is you cover this from a neutral perspective. It would have been significantly valuable when I was making a decision and has allowed me to review that decision again today from a place of more knowledge. Thank you again.

[My AA is 50/50]

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Thu Jul 11, 2019 9:52 pm

H,
the interesting thing about the world government bond (and one of the only two accumulating etfs cited now on Wiki for non-US investors is: SGLU which is brand new), has a risk level according to the provider which is greater than the aggregate version. This might be because of its age. The returns on government only bonds is an issue.
LHRAdam wrote:
Wed Jul 10, 2019 2:33 pm
2. What percentage of my portfolio?
I think that this question is key for me, and the simple answer of your age in bonds seems like as good as any way to start off. I am finished major accumulation this year or next and I work to a much more conservative approach with a combination of bond funds (global aggregate, world government, treasuries and short term inflation linked), cash and cash equivalents. I spent more than one year working that question through and am much happier taking the more conservative road including hedging. Buying more of a global aggregate bond fund doesn't reduce the risk of that fund! I suppose the range which is sometimes quoted here of from no less than 25% to no more than 75% in stocks also helps me to put limits on the debate.
DJN
Yah shure

me81
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by me81 » Fri Jul 12, 2019 5:15 am

Hi DJN and thank you for the terrific resource you have put together.

That and all the work on EU-versions of Bogleheads-style investing is much needed, now that finally it looks that Europeans are waking up to the stock market. Being late to the party might actually mean avoiding passing through the stock-picking and high-cost mutual fund stages of one's investing life..

On your WIKI and in general on the Bond portion of a portfolio for a EU-based investor, points I consider important are, roughly in order of importance: My reasoning behind the above points have been already mostly described in this thread and various other sources, but in summary:
  • Having Government Only (and in an extreme case, AAA-AA Government Only) does kill my current returns on the bond portion, but provides the highest level of safety. This is indeed the role of the bond-component in my specific case. This allows me to have a higher equity allocation that I would otherwise have, if I were to use an aggregate bond fund. To those questioning why not keeping it in cash-like alternatives, my argument is that at times of major equity stresses, capitals flow to safe assets... My cash-like term-deposit or similar would not move in any opposite direction the same way a short-term (AAA-AA) Government bond will (or should)..
  • Hedging seems useful in terms of including a broader spectrum of bonds, but it has been shown that the return would end up being the same as the return on the hedged currency equivalent. So, considering the global market, a hedged global government bond fund would be made mostly of Euro Gov bonds, US, Japanese and UK Bonds. Hedging would simply make the return of such a fund, the same as the Eur Gov bond fund, while keeping hedging costs.. Again, any safety concern would make me think of a AAA-AA Euro Gov bond fund, rather than expanding the geographical catchment area to then hedge the currency.
  • Duration has again been vastly discussed. Inflation-risk and Interest-rate risk seem to be the main factors to consider when deciding about duration. In general, Euro Bond funds have an average maturity of roughly 8 years, so I personally prefer to deviate from the 2 or 3-fund portfolio to have two bond funds in my portfolio
To cut it short, I currently hold both the Xtrackers Eurozone Government Bond UCITS (0.15% TER, Acc, 367 constituents, avg mat 7.93yrs, mostly Fra, Ita, Ger and Spa) and the iShares 1-3yr (0.2% TER, Acc, 11 constituents, avg mat 1.82yrs, only Fra, Ger, Ita and Spa).

What do you think? Did I make enough sense and / or have I missed / messed something?

Thanks again for your work,

Cheers

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Fri Jul 12, 2019 5:26 am

Hi me81,
thanks for you supporting comments and the inputs. You make a lot of sense.
I have hesitated so far to put together a commentary or too much "advice" on bond choice other than to lay out the main options. However I agree with your comments on the priorities for a bond choice for a non-US or more accurately an EU domiciled person. I have enquired directly of Vanguard regarding their research and the basis of their build up of bonds for non-US investors and their stock answer is to "look at their websites". More work, happy days!
I might try and put together a short note on the reasoning that a non-US investor might use to choose their bonds and look for some more feedback.
DJN
Yah shure

Laurizas
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by Laurizas » Fri Jul 12, 2019 5:57 am

me81 wrote:
Fri Jul 12, 2019 5:15 am
Hedging would simply make the return of such a fund, the same as the Eur Gov bond fund, while keeping hedging costs..
Where does this argument derives from?

glorat
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by glorat » Fri Jul 12, 2019 6:02 am

Laurizas wrote:
Fri Jul 12, 2019 5:57 am
me81 wrote:
Fri Jul 12, 2019 5:15 am
Hedging would simply make the return of such a fund, the same as the Eur Gov bond fund, while keeping hedging costs..
Where does this argument derives from?
It comes from the no-arbitrage principle but indeed the quote is imprecise. Assuming no-arbitrage, a EUR hedged global bond fund will earn the same as a EUR risk-free gov bond fund PLUS the credit risk premium of the global bonds.

For example, a USD corporate bond fund that earns USD treasury+2% would now earn EUR govt+2% (give or Euro vs US govt credit spreads and other minor effects, before the detailed people get me)

Laurizas
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by Laurizas » Fri Jul 12, 2019 6:11 am

glorat wrote:
Fri Jul 12, 2019 6:02 am
For example, a USD corporate bond fund that earns USD treasury+2% would now earn EUR govt+2% (give or Euro vs US govt credit spreads and other minor effects, before the detailed people get me)
Could you illustrate this by real data? ANd can it be stated that there is no need for hedged bond funds? Excuse me, if my questions seem naive.

glorat
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by glorat » Fri Jul 12, 2019 6:37 am

Laurizas wrote:
Fri Jul 12, 2019 6:11 am
glorat wrote:
Fri Jul 12, 2019 6:02 am
For example, a USD corporate bond fund that earns USD treasury+2% would now earn EUR govt+2% (give or Euro vs US govt credit spreads and other minor effects, before the detailed people get me)
Could you illustrate this by real data? ANd can it be stated that there is no need for hedged bond funds? Excuse me, if my questions seem naive.
There are broadly two schools of thoughts being promoted around bond fund portfolios.
1) Bonds should be high quality of minimal risk, ideally in your home country (if your country is stable)
People choose this because such bonds have negative correlation to stocks. (I.e. if stocks crash, high quality bonds tend to go up - good diversification)

2) A global bond fund hedged back to home currency - includes governments and companies with different risk profiles

In the US, highest quality bonds are called Treasuries, from the US government. They determine the so called risk free rate of interest. Let's say treasuries are offering you 2%. If you are a corporation issuing debt, you can't issue for 2% because noone will buy it due to your higher risk of default. Thus bonds are often quoted as the premium over the risk free rate. E.g. Treasury+3%. A similar profile company in Europe it might be "EONIA" (Euro govt) +3%.

In simplified terms, when you hedge, that US company that borrowed at Treasury+2% is now earning you Eonia+3%.

If you didn't hedge, you'd be earning EUR/USD + 3%

With hedging, you're just getting the EUR govt rate, which is stable, plus the credit spreads, which are relatively stable

If you don't hedge, you get govt rate, credit spreads AND the EUR/USD FX rate, which is relatively very volatile. For this extra risk, you get no benefit, it is best to hedge it.

For more detail on this, I defer back to the Vanguard paper referred above. I'm just spouting a simplified version interest rate theory here :) (For the knowledgeable, don't kill me on missing out details on yield curves, fx currency basis and relative government credit ratings)

me81
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by me81 » Sat Jul 13, 2019 10:04 am

Laurizas wrote:
Fri Jul 12, 2019 5:57 am
me81 wrote:
Fri Jul 12, 2019 5:15 am
Hedging would simply make the return of such a fund, the same as the Eur Gov bond fund, while keeping hedging costs..
Where does this argument derives from?
Hi Laurizas,
While I am sure you can find some more detailed explanations around, the main thing for me is indeed the arbitrage-opportunity that would be left otherwise...
The ECB is now in negative territory, the FED is at 2.5% (give or take 0.25%).. Imagine if I could buy US Treasuries at 2.5% and hedge them to the EUR, keeping the same 2.5% (or even just 1%) yield... Good luck to anyone trying to sell EUR Gov Bonds...! It is an economist dream to make money that easy...

You can see with a graph more than with 1000 words... (sorry, I could not put the picture here - is there a way?? - but had to link to drive...)
Here is a graph showing the returns in EUR of:
  • US Treasuries 1-3yr in USD (blue, flying off the chart)
    US Treasuries 1-3yr hedged to EUR (black)
    EUR Gov Bonds 1-3yr (green)
https://drive.google.com/file/d/1FcJYva ... sp=sharing

Hope that helps and if there is any evidence against the argument, I am all ears..

Cheers

me81
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by me81 » Sat Jul 13, 2019 10:15 am

glorat wrote:
Fri Jul 12, 2019 6:02 am
Laurizas wrote:
Fri Jul 12, 2019 5:57 am
me81 wrote:
Fri Jul 12, 2019 5:15 am
Hedging would simply make the return of such a fund, the same as the Eur Gov bond fund, while keeping hedging costs..
Where does this argument derives from?
It comes from the no-arbitrage principle but indeed the quote is imprecise. Assuming no-arbitrage, a EUR hedged global bond fund will earn the same as a EUR risk-free gov bond fund PLUS the credit risk premium of the global bonds.

For example, a USD corporate bond fund that earns USD treasury+2% would now earn EUR govt+2% (give or Euro vs US govt credit spreads and other minor effects, before the detailed people get me)
Hi glorat and thanks for the correction..
Surely, I meant that a global bond fund hedged to EUR would have the same return as an equal risk EUR bond fund...
Considering that all my post was about using safe government bonds, my point was only relative to similarly "risk-free" Gov Bond funds, being global hedged to EUR or EU Gov (ok, I accept also that right now the EU as a whole is more risky than the US, but I would avoid the minutiae, for the sake of a general post)...
Is that a fair statement now?

Cheers

glorat
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by glorat » Sat Jul 13, 2019 10:46 am

me81 wrote:
Sat Jul 13, 2019 10:15 am
I meant that a global bond fund hedged to EUR would have the same return as an equal risk EUR bond fund...
Considering that all my post was about using safe government bonds, my point was only relative to similarly "risk-free" Gov Bond funds, being global hedged to EUR or EU Gov (ok, I accept also that right now the EU as a whole is more risky than the US, but I would avoid the minutiae, for the sake of a general post)...
Is that a fair statement now?
Very fair! I think your point about equal risk answers the person you were replying too.

If I may digress to some minutiae, I wonder if it is also fair to say that a global bond fund (of 1500+ bonds is typical) will have a higher risk-adjusted return compared to a portfolio of EUR only bonds with the same risk because the portfolio effect allows you to get higher risk-adjusted returns on a broad portfolio that isn't highly correlated. My assumption, which I believe to be true, is that credit spreads of global bonds are not strongly correlated.

If one believes all that, this supports the theoretical argument that global diversified bonds hedged back to local currency provide a beneficial risk-adjusted return than a single currency bond portfolio of similar risk.

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Sat Jul 13, 2019 10:59 am

Hi,
thanks for the interest.
My hope with this new draft page was to stimulate discussion about the awareness of consequences of:

- age of the investor
- their risk appetite
- the lack of readiness to discuss more specific bond solutions other than the straightforward global aggregate.

The new page is trying to help in this by adding in world government bonds and then suggesting other more specific bond solutions. I personally have AGGH and world government as well as ITPE and IBCI + some euro govt bond funds. I also have some short term bonds and ultra short term for cash equivalents.
A sort of bond smorgasbord!
great debate happening.
DJN
Yah shure

me81
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by me81 » Sat Jul 13, 2019 1:48 pm

glorat wrote:
Sat Jul 13, 2019 10:46 am
me81 wrote:
Sat Jul 13, 2019 10:15 am
I meant that a global bond fund hedged to EUR would have the same return as an equal risk EUR bond fund...
Considering that all my post was about using safe government bonds, my point was only relative to similarly "risk-free" Gov Bond funds, being global hedged to EUR or EU Gov (ok, I accept also that right now the EU as a whole is more risky than the US, but I would avoid the minutiae, for the sake of a general post)...
Is that a fair statement now?
Very fair! I think your point about equal risk answers the person you were replying too.

If I may digress to some minutiae, I wonder if it is also fair to say that a global bond fund (of 1500+ bonds is typical) will have a higher risk-adjusted return compared to a portfolio of EUR only bonds with the same risk because the portfolio effect allows you to get higher risk-adjusted returns on a broad portfolio that isn't highly correlated. My assumption, which I believe to be true, is that credit spreads of global bonds are not strongly correlated.

If one believes all that, this supports the theoretical argument that global diversified bonds hedged back to local currency provide a beneficial risk-adjusted return than a single currency bond portfolio of similar risk.
Once again, I would probably agree in the global bond market context... However I see less of a benefit when considering safe Government Bond Funds (which are my focus, as discussed earlier). It is true, even looking at the Vanguard paper, that there is increased diversification, but:
  • for UCITS ETFs, the hedged version of a bond fund tend to be around 0.05% more expensive than the un-hedged counterpart... In fact, when looking in detail, despite the reported TER being 0.05% different, in the breakdown of total costs, it comes to 0.06% (0.282% vs 0.222% - Thanks MIfID II for the insght)
Here is the performance comparison of the Global Gov Bond fund hedged to EUR vs the Eurozone Gov Bond fund in EUR currency:
https://drive.google.com/file/d/1e3yAS- ... sp=sharing

I did not break down the differences in the characteristics of the constituents, so surely something else can explain the marked difference in performance.. But the result is quite clear.. And 0.11% a year might have played its role (although surely not all, I was quite surprised at the gap!)...

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Sat Jul 13, 2019 7:06 pm

Hi,
for the global government bond fund you have shown an LU domiciled version. There are Ireland domiciled versions also:
- IGLH (h to £) distributing
- SGLU (h to Euro) accumulating
Correction: SGLU is hedged back to dollar
DJN
Last edited by DJN on Sun Jul 14, 2019 11:40 pm, edited 1 time in total.
Yah shure

me81
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by me81 » Sun Jul 14, 2019 2:40 am

DJN wrote:
Sat Jul 13, 2019 7:06 pm
Hi,
for the global government bond fund you have shown an LU domiciled version. There are Ireland domiciled versions also:
- IGLH (h to £) distributing
- SGLU (h to Euro) accumulating
DJN
Two things here:
  • The XTrackers is the only one I could find hedged to Euro (SGLU should be in USD, right? and IGLH is in GBP)
  • Are the implications in a world government bond fund for LU-domicile vs IE-domicile the same as for a world equity fund? I have not delved deep enough into the taxation of bond coupons, so I am not sure if there is an equal tax treaty US-IE, if the same (15%) applies or not..
    More light on this would be very welcome indeed!
Cheers

glorat
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by glorat » Sun Jul 14, 2019 3:56 am

me81 wrote:
Sun Jul 14, 2019 2:40 am
Two things here:
  • The XTrackers is the only one I could find hedged to Euro (SGLU should be in USD, right? and IGLH is in GBP)
  • Are the implications in a world government bond fund for LU-domicile vs IE-domicile the same as for a world equity fund? I have not delved deep enough into the taxation of bond coupons, so I am not sure if there is an equal tax treaty US-IE, if the same (15%) applies or not..
    More light on this would be very welcome indeed!
Cheers
By your very own correct argument, if you are using your Bond allocation just for safety and negative correlation to stocks, you don't need a global bond portfolio. A low cost EUR bond portfolio will do fine. Check out IEGA

Now in terms of withholding tax, this is where the details matter greatly
  • Afaik, only Ireland has the favourable 15% withholding tax benefit, not Luxembourg
  • Theoretically speaking, the 30% US withholding tax does NOT apply to fixed income coupons (it applies to equity dividends). Therefore, theoretically, the domicile of your fixed income provider doesn't matter! It should be zero percent withheld, no matter the domicile.
  • In practice, even the best companies have trouble parsing the 30% US withholding tax rule and may withhold the 30% anyway. The better ones that do may refund this later. As for non-IRL funds, who knows how well they handle this - you'd need to dig deep into the prospectus. There is a whole thread somewhere on this forum about this...
  • To action the last point, avoid US domiciled fixed income funds/etfs but probably any other country is fine. (The reason is your broker may probably simply be over conservative and withhold 30% on a US fund/etf. A non-US domiciled ETF/fund will probably do the right thing given how important it is)
In short, if I were you and I believed in bonds just for quality, I'd probably look closely at IEGA.

me81
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by me81 » Sun Jul 14, 2019 7:22 am

Thanks glorat for the insight.

To further dig into the fund domicile issue, considering that my focus is on Eurozone bonds, the US withholding tax rule becomes completely irrelevant.
The choice between DBXN or IEGA was towards DBXN as it is Acc, while IEGA is Dist... I also think at the time IEGA had a 0.2% TER (I might be wrong), which I just see now being at 0.09% (DBXN is 0.15%)..
I also just noticed that DBXN has accumulated over 2.75Bn EUR AUM, against the 1.78Bn of IEGA (both huge, but following the biggest herd in this should be fine).
Lastly, a line-graph comparison between the two funds show a near-perfect overlap (a 1% difference in total returns since 2009, possibly due to the 0.06% TER difference).. This should also confirm that tax withholding is not a factor between the two funds...

Great insight and a lot of thinking here, thanks for the contributions!

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Sun Jul 14, 2019 7:49 am

me81 wrote:
Sun Jul 14, 2019 2:40 am
DJN wrote:
Sat Jul 13, 2019 7:06 pm
  • The XTrackers is the only one I could find hedged to Euro (SGLU should be in USD, right? and IGLH is in GBP)
Hi me81,
you are absolutely correct, SGLU is hedged back to the dollar which suits me fine for some part of my portfolio. I imagine that iShares will bring out one hedged back to the euro soon enough.
DJN
Yah shure

steveyg50
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by steveyg50 » Sun Jul 14, 2019 11:15 am

(Newish UK investor)

I am new to bonds and struggle to understand them at all ! I have read most of this thread and will have to read it again to be any the wiser ! But thanks for the information in the UK investing WIKI, thats great, very useful.

I am struggling to reconcile what seems to be conflicting information, regarding index-linked bonds.
I have just read The Bogleheads Guide to Investing and this suggests (middle-aged investor and older) 50% of your bond portfolio should be in Inflation-protected securities. I know this is aimed at US investor but doesn't it apply to UK also?
Since being new to bonds, and wanting to be mostly invested in bonds at the moment, I thought for my bond allocation I can simply use VG Lifestrategy 20% equity. Seems like a good plan, its 80% in bonds looks widely distributed. But I notice this fund has only 7.6% in total in index linked bonds (inflation-linked gilts), I can see no other index-linked bonds?
How come this fund has far lower allocation to index-linked bonds than recommended in the BH book?
Similarly the Target Retirement funds have low % in index-linked bonds.
Is it the case that these blended funds will change the % in index-linked bonds to suit the situation, and at the moment see no need for high index-linked %?

Also - regarding the '3 fund portfolio' - the bond allocation is to Vanguard Total Bond Market Index Fund VBTLX; this seems to have no inflation-linked components either ?

I am rather confused as to what % of index-linked bonds I should have :confused

TedSwippet
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by TedSwippet » Sun Jul 14, 2019 12:15 pm

steveyg50 wrote:
Sun Jul 14, 2019 11:15 am
...But I notice this fund has only 7.6% in total in index linked bonds (inflation-linked gilts), I can see no other index-linked bonds? How come this fund has far lower allocation to index-linked bonds than recommended in the BH book?
It's a reasonable question to ask, but there probably isn't any answer that is useful to you.

My guess would be that it's somehow down to the relative sizes of the index linked gilts and ordinary gilts markets, but even that's just speculation. It could simply be that Vanguard feels this is somehow the right measure, in the same way that they feel that their LifeStrategy fund range should have a UK stocks bias relative to world market cap. There's no golden rule that says that Vanguard funds have to follow The BH Guide to Investing for asset allocations (nor any that says that the BH guide has to follow Vanguard's funds). All we're left with then, is a judgement call.

I have 50:50 index linked and ordinary gilts because for me that ratio is generally the point of 'regret minimisation'.

As for struggling to understand bonds, me too. I have managed to internalise the idea that their value goes up when interest rates fall, and vice-versa, and that like stocks, the bond market is somewhat expectation-based, but that's about it. And even that seems incomplete for index linked bonds, which fluctuate depending not only on interest rates but also on actual inflation and on expected inflation (whether or not it materialises).

In the end, I decided to just take it on trust that having some bonds is safer than not. The portfolio equivalent of broccoli. Unexciting, but healthy.

steveyg50
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by steveyg50 » Sun Jul 14, 2019 3:34 pm

TedSwippet wrote:
Sun Jul 14, 2019 12:15 pm
It could simply be that Vanguard feels this is somehow the right measure, in the same way that they feel that their LifeStrategy fund range should have a UK stocks bias relative to world market cap. There's no golden rule that says that Vanguard funds have to follow The BH Guide to Investing for asset allocations (nor any that says that the BH guide has to follow Vanguard's funds). All we're left with then, is a judgement call.

I have 50:50 index linked and ordinary gilts because for me that ratio is generally the point of 'regret minimisation'.


Thanks Ted. You preempted my next question, though wasn't going to ask here. The blended funds have approx 20% of their equity in UK, seems excessive to say the least.

Well I may use the 20% Equity blended fund as a base and just add some inflation linked gilt. Or perhaps the VG global aggregate bond fund, since I don't really like this UK equity bias.

May I ask - have you only got UK gilt and index linked gilt?

Yes I must eat plenty of greens, am sure they are good for me!

TedSwippet
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by TedSwippet » Sun Jul 14, 2019 5:24 pm

steveyg50 wrote:
Sun Jul 14, 2019 3:34 pm
Well I may use the 20% Equity blended fund as a base and just add some inflation linked gilt. Or perhaps the VG global aggregate bond fund, since I don't really like this UK equity bias.
Unless you want the precise allocation of one of the LifeStrategy range, trying to blend something else in with it can become messy pretty quickly, especially if you are trying to balance SIPPs, ISAs and unwrapped trading accounts all against each other as a single portfolio. LifeStrategy is designed to be a one-fund portfolio all within itself.

Rather than struggle with that, I'd suggest just building your own instead, using separate pieces. Three funds or ETFs should cover you nicely -- world stocks, gilts, and index linked gilts -- though there's nothing wrong with using more if appropriate (at the extreme, perhaps UK, US, Japan, Pacific, EU and Emerging Markets for stocks, say). This can often also work out slightly cheaper than a single LifeStrategy holding, too.
steveyg50 wrote:
Sun Jul 14, 2019 3:34 pm
May I ask - have you only got UK gilt and index linked gilt?
Mostly. Around 12% corporate bonds and the rest split down the middle, half ordinary and half index linked gilt.

I worry that corporate bonds will be somewhat equity-like when the next crunch comes, but ordinary gilts are plodding and dull and feel exposed to interest rate rises, and index linked have nearly matched stock over the decade or so I've held them, and that makes me uneasy too (there's no pleasing some people!). I keep meaning to switch some of this into a global bond fund for a bit more diversification, but haven't yet got round to it.

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DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Mon Jul 15, 2019 12:17 am

Hi,

all of the inputs are excellent material for further inclusion in the non-US section.
If you look at the Bond basics for non-US investors in the section entitled: Comparison of bond fund options it notes that you can consider mixing and matching your bond choice to your own preference and risk tolerance. See: https://www.bogleheads.org/wiki/Bond_ba ... _investors
Comparison of bond fund options
If you look at varying your fixed income with additions and alternatives to a simple global government or global aggregate UCITS ETF approach then you should review the help that is available in Bond basics on the Wiki here: Bond basics § Role in a portfolio and Bond basics § Style boxes.
It provides a link to the main Wiki website section on Bond basics & Role in a portfolio that then provides the tools to choose your assets. (Rationale, style box etc)

Perhaps some suggested reasoning for the choice of options and / or a range of options could be included in the non-US section? Keeping in mind the premise that all should at least in theory comply with the BH approach.
Any suggestions for packages of DIY bond options for non-US investors?
DJN
Yah shure

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Wed Jul 17, 2019 4:14 am

Hi,
digging a little deeper into the allocation within fixed income for an EU investor a paper published in 2018 https://prodapp.epra.com/media/Asset_al ... 242692.pdf
provides insights into how defined benefit pension providers across some EU countries divided their fixed income allocation.

Dutch funds fixed income asset classes:
- 52% Euro,
- 16% global
- approximately 5% each for emerging, inflation indexed, high yield, mortgages and cash with the remainder spread across other fixed income asset classes.

For other Euro area funds
- 38% Euro
- 27% global
- approximately 10% to “other” and cash with the remainder spread across other public equity asset classes.

For U.K. funds the fixed income distribution:
- 32% U.K.
- 31% global
- 15% inflation indexed
- 16% percent cash with the remainder spread
across other fixed income asset classes.

Blackrock's iShares AGGH breaks down as follows:
- 43% US
- 50% rest of devt. world
- 7% other

Definitely not an apples to apples comparison but there are some distinctly different approaches. Putting to one side that the defined benefit pensions will be very risk averse and assuming that some proportion of the "others" mentioned for the DB funds are probably Euro bonds of some sort then the weighting looks to be different to the global aggregate.
Blackrock has also published a report on the Asset allocation and trends within EMEA portfolios. Worth a read for any scholars of investing in Europe.

I am not sure what is actionable, but the concept of investing in fixed income products in your home territory (spending currency) cannot be entirely satisfied using a global aggregate. In addition the very low rates of return in the EU countries is another factor. Perhaps in looking for guidelines: go global aggregate hedged + tilt towards Euro bonds (or gilts for UK) and safer short term bonds + cash?
DJN
Yah shure

andrew99999
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by andrew99999 » Wed Jul 17, 2019 10:05 pm

Hi DJN,

I have a question where it says that managing interest rate risk can be done by by creating a portfolio of bonds with maturities staggered over one, three, five and ten years.

Once you weighted the maturities, would a combo of the above weighted at 7 years differ from just holding 7 year bonds?

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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by glorat » Wed Jul 17, 2019 10:13 pm

andrew99999 wrote:
Wed Jul 17, 2019 10:05 pm
Once you weighted the maturities, would a combo of the above weighted at 7 years differ from just holding 7 year bonds?
It differs because the market doesn't say there is just one interest rate for a country's currency. There is a thing called a yield curve that is the market expectation of the government or risk-free rate of interest over a time horizon from buying a bond expiring tomorrow to one expiring 40+ years ahead.

If the yield curve generally moves up or down, no difference.

If the yield curve changes shape, you'll get different results. This can happen for a variety of reasons.

The best practice if you are going to be a very advanced investor and choose your bond maturities is to time your maturities to match when you will actually sell out and spend the cash (e.g. across your retirement). If you do this precisely by lining up maturity and spending, you essentially remove all interest rate risk in the sense you hold all bonds/cds to maturity so you know on the day you invest exactly what cash you are getting when, irrespective of any interest rate movements.

Personally, even though I'm a fixed income expert and could look to do all that, simplicity and laziness wins - I'd rather dump it all in a pre-made diversified index and not worry about these small details

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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by glorat » Wed Jul 17, 2019 10:20 pm

DJN wrote:
Mon Jul 15, 2019 12:17 am
Perhaps some suggested reasoning for the choice of options and / or a range of options could be included in the non-US section? Keeping in mind the premise that all should at least in theory comply with the BH approach.
Any suggestions for packages of DIY bond options for non-US investors?
DJN
I've been keeping a bit quiet on this thread in terms of what to recommend on wiki so far. Here's what I actually think.

Like much of the bogleheads forum (the "investment theory" section in particular), people love discussing all the advanced and complex ways in which you can invest. Especially for the fixed income piece, where a boglehead isn't looking for big returns, I think a wiki should be recommending only the simplest possible options. Any advanced options (like CD ladders, bond maturities, DIY etc) should be separated to an advanced page. A basic page should have *at most* these strategies
  • Global bonds (AGG) hedged to local
  • Local currency bonds only (e.g. Gilts for UK)
  • Government bonds hedged back to local, if available (IUAG etc.)
I would say those are the top 3 simplest strategies and any one of them is probably likely a "good" strategy for a non-US country. There are other "good" strategies but I'd challenge anyone to tell me the above is not "good enough" for a beginner who will get lost in the murkiness of all the advanced options. I think a beginner faced with the above 3 will already get confused, frankly

andrew99999
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by andrew99999 » Wed Jul 17, 2019 11:28 pm

glorat wrote:
Wed Jul 17, 2019 10:13 pm
The best practice if you are going to be a very advanced investor and choose your bond maturities is to time your maturities to match when you will actually sell out and spend the cash (e.g. across your retirement). If you do this precisely by lining up maturity and spending, you essentially remove all interest rate risk in the sense you hold all bonds/cds to maturity so you know on the day you invest exactly what cash you are getting when, irrespective of any interest rate movements.

Personally, even though I'm a fixed income expert and could look to do all that, simplicity and laziness wins - I'd rather dump it all in a pre-made diversified index and not worry about these small details
Thanks glorat.

If you had a decades long horizon, it would make it difficult.
Plus from what I understand, even if you held to maturity, the value of your fund is still affected by interest rates is it not to make up for the different yield for the rest of the time you hold it? The only difference is you just did not sell to see the actual price but the value has still changed.

One question though - lets say you had 2 bond funds both with weighted duration of 8 years, but one with staggered durations and one with all within 7-9 years, would the one including shorter duration bonds have a lower interest rate risk as it rolls over or would that be nullified by the longer duration bonds in there?

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Wed Jul 17, 2019 11:41 pm

andrew99999 wrote:
Wed Jul 17, 2019 10:05 pm
Hi DJN,

I have a question where it says that managing interest rate risk can be done by by creating a portfolio of bonds with maturities staggered over one, three, five and ten years.

Once you weighted the maturities, would a combo of the above weighted at 7 years differ from just holding 7 year bonds?
Hi andrew99999,
that's a great question, in fact as far as I know owning a bond fund or etf of bonds isn't the same as owning the bonds directly. The bonds will expire at the end of the period and you get your principal back, however the funds or etf just keep going and will dispose of the bonds in accordance with the aims of the fund. This opens you up to some loss of principal. There are pros and cons for both approaches.
DJN
Yah shure

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Wed Jul 17, 2019 11:59 pm

glorat wrote:
Wed Jul 17, 2019 10:20 pm

I've been keeping a bit quiet on this thread in terms of what to recommend on wiki so far. Here's what I actually think.

Like much of the bogleheads forum (the "investment theory" section in particular), people love discussing all the advanced and complex ways in which you can invest. Especially for the fixed income piece, where a boglehead isn't looking for big returns, I think a wiki should be recommending only the simplest possible options. Any advanced options (like CD ladders, bond maturities, DIY etc) should be separated to an advanced page. A basic page should have *at most* these strategies
  • Global bonds (AGG) hedged to local
  • Local currency bonds only (e.g. Gilts for UK)
  • Government bonds hedged back to local, if available (IUAG etc.)
I would say those are the top 3 simplest strategies and any one of them is probably likely a "good" strategy for a non-US country. There are other "good" strategies but I'd challenge anyone to tell me the above is not "good enough" for a beginner who will get lost in the murkiness of all the advanced options. I think a beginner faced with the above 3 will already get confused, frankly
Hi glorat,
thanks for your inputs. I agree with what you suggest for the basis of a BH approach and that is what is implied currently in this new section of the Wiki. What the Wiki doesn't do yet is provide some dialogue on the reasoning behind that, and that's all I would like to get to.
You know its also true that where someone outside the US investment environment is investing large sums of money then they need to know a little bit about the sea that they are swimming in. There is next to no guidance anywhere that I can find as to what is appropriate and your suggestion is as good as any. If a person cannot get to grips with those concepts its probably best for them to talk to a financial adviser and pay the fees. The fact is that the simple BH two or three fund approach doesn't easily or precisely fit a non-US investor, what we get is a type of parallel model.
DJN
Yah shure

glorat
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by glorat » Thu Jul 18, 2019 12:47 am

andrew99999 wrote:
Wed Jul 17, 2019 11:28 pm
If you had a decades long horizon, it would make it difficult.
Plus from what I understand, even if you held to maturity, the value of your fund is still affected by interest rates is it not to make up for the different yield for the rest of the time you hold it? The only difference is you just did not sell to see the actual price but the value has still changed.

One question though - lets say you had 2 bond funds both with weighted duration of 8 years
Ah... bond fund. Different story because per DJN's point, a fund may sell bonds as the maturity shortens and buy longer maturity bonds. My previous answer was about just bonds (or CD ladders) since they don't roll over.

glorat
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by glorat » Thu Jul 18, 2019 12:52 am

DJN wrote:
Wed Jul 17, 2019 11:59 pm
What the Wiki doesn't do yet is provide some dialogue on the reasoning behind that, and that's all I would like to get to.
I'd be happy to write up the reasoning behind different strategies, particularly those 3. I'm a bit nervous to put it on wiki (although a personal page is just fine) because if I do a write up, it would be a mixture of
  • Facts about fixed income products
  • Boglehead forum general recommendations, and
  • My own opinions or fixed income theory that isn't generally talked about in these forums
I'm a bit worried I may end up convoluting the 3 and confuse people.

Give me some time, I'll write something up somewhere and you'll be free to use as you like.

Topic Author
DJN
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Re: [Wiki] Bond basics for non-US investors - seeking feedback and contributions

Post by DJN » Thu Jul 18, 2019 2:16 am

Hi glorat,
thanks for your response. It would be really great to get some input just as you describe. We can then discuss here and include in Wiki following any feedback, amendments and additions.
DJN
Yah shure

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