Going Overseas For Fixed Income Exposure

When fixed income investors typically think about geography, they usually focus on U.S. bonds, whether it be Treasuries or corporate debt issued by US-based firms. Flows to exchange-traded funds confirm as much as many of the largest bond ETFs are domestically focused.

While investors clearly display a preference for domestic bond funds, that does not mean international bond funds are not attractive. The opposite is true, particularly for income-starved investors looking to bolster portfolio yield without taking on excessive risk in terms of credit quality.

“According to Fran Kinniry, a principal in Vanguard Investment Strategy Group, the asset manager recommends investors have 30 percent of their fixed income assets in non-U.S. investments if availability in tax qualified plans are ample and is a currency hedged approach,” said CFRA Research director of ETF & Mutual Fund Research Todd Rosenbluth in a note out Tuesday. “Yet he notes the average investor has less than 10% in the investment style, and much of it is unhedged.”

An Interesting Option

The Vanguard Total International Bond ETFBNDX, the international cousin to the popular Vanguard Total Bond ETF BND, is a compelling idea for bond investors looking to expand their geographic horizons.

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BNDX tracks the Bloomberg Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index (USD Hedged), indicating it is a currency hedged ETF. BNDX holds over 4,500 bonds, over 71 percent of which have maturities ranging from one to 10 years. Credit quality is not a concern with BNDX as about 90 percent of its holdings are rated Aaa, Aa or A.

BNDX has an average duration of 7.8 years. The ETF competes with the SPDR Bloomberg Barclays International Treasury Bond ETF BWX. BWX has an adjusted duration of 7.9 years.

“a 0.12 percent expense ratio. Relative to their ETF and mutual fund peers, Vanguard Total International Bond Index has a significantly lower three-year standard deviation of 2.9,” said Rosenbluth. “For example, SPDR Bloomberg Barclays International Treasury Bond (BWX), which invests in similar developed market bonds without employing hedging, has a three-year standard deviation of 7.5; the international income mutual fund peer average has an average 6.22 standard deviation.”

An Emerging Idea

Emerging markets bonds ETFs are increasingly popular with investors because these funds typically sporting significantly higher yields than their U.S. counterparts. The iShares J.P. Morgan USD Emerging Markets Bond ETF EMB has a 30-day SEC yield of 4.35 percent, about double what investors find on 10-year Treasuries.

EMB, the world's largest emerging markets bond fund of any variety, has an effective duration of 7.3 years. CFRA has a Market-Weight rating on EMB and an Underweight rating on BNDX.

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