How to determine hedged bond expected yield?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
mrwhitepe
Posts: 26
Joined: Tue Mar 14, 2017 11:17 pm

How to determine hedged bond expected yield?

Post by mrwhitepe » Thu Apr 27, 2017 11:37 pm

For local currency bonds, the best guide what yield to expect is the yield to maturity (YTM) metric. But according to this vanguard research paper: https://personal.vanguard.com/pdf/ISGHC.pdf the following is valid:

"comparing the yield to maturity of domestic versus hedged international investments, no matter how similar the underlying investment characteristics might be, is not useful."

and

" Effectively, the hedge return has tended to push international bond returns closer to an investor’s domestic market return, adjusting for the differences in yield between markets over long time periods. This has reduced the differences in long-term average returns between those of international bonds and an investor’s local bond market. As a result, longterm returns of international bonds, when accounting for currency hedging, become more local in character."

Now my question is, as an EU investor, what yield should I expect when investing in hedged global bonds? If the above is valid, then we can take a look at a diversified euro bond ETF, like iShares € Aggregate Bond UCITS ETF - it has currently a YTM of 0,58%. Does it mean that the db x-trackers Barclays Global Aggregate Bond UCITS ETF 5C (global aggregate bonds from 75 countries hedged to EUR, this ETF has currently an YTM of 1,64%) or the db x-trackers iBoxx USD Treasuries UCITS ETF DR 2D (US treasuries hedged to EUR, currently an YTM of 2,44%) will both have actually an YTM of 0,58%, same as the local euro bonds?

Is there a way to calculate this or determine it with certainty? As otherwise all hedged bond investors are essentially buying a pig in a poke when they cannot reasonably forecast what the YTM of the bonds is/will be.

Topic Author
mrwhitepe
Posts: 26
Joined: Tue Mar 14, 2017 11:17 pm

Re: How to determine hedged bond expected yield?

Post by mrwhitepe » Fri Apr 28, 2017 2:39 pm

any ideas?

lack_ey
Posts: 6701
Joined: Wed Nov 19, 2014 11:55 pm

Re: How to determine hedged bond expected yield?

Post by lack_ey » Fri Apr 28, 2017 3:26 pm

Do you mean total return or what? For a bond? A fund? Over which period, the short term or until maturity of the bond?

These funds generally hedge with short-term contracts. In the short term the return might be the estimated by the YtM and then adjusting for the fund costs and hedge return. Hedge return is determined by the short-term rates for the currencies. If hedging a global or US fund back to EUR, your local currency is lower returning (lower short-term rates) so this gives up return. Hopefully simplified explanation for those who don't deal with this—may be very familiar to you specifically, and hopefully I don't screw this up...

Currently for EUR/USD the exchange rate (spot) is 1.0893. Sell 1,089.30 USD to buy 1,000 EUR. But a 1-month forward contract (in a month, sell USD to buy EUR) would have you agreeing to sell over 1,089.30 USD to get 1,000 EUR then. Around 1,091.17 if I didn't misread the charts.

If looking at longer-term return you have to consider that the hedge return will vary over time as short-term rates change. So this is less obvious. For a fund you need to check across all the currencies.

I don't think that should exactly equalize the returns back to local currency bonds but most of the time it shouldn't be wildly different and on average you should get about the same before costs.

Post Reply