For this Guest Post Wednesday, frequent commenter MossySF writes about international bonds. I have to admit that because of my age and risk tolerance, I haven’t put too much thought into bonds – much less international bonds. This is another reason why this guest post Wednesday, can be helpful. It fills the gaps of areas that I wouldn’t have otherwise thought about. Enough of the intro, here’s the article:
If you’ve read up before about asset allocation, one topic often mentioned is international exposure. The conventional wisdom says anywhere from 15% to 50% of your equities should be international. But what about bonds? If you are at that stage of life where you need the lower volatility bonds give your portfolio, do you also need to diversify bonds against domestic inflation/currency/interest rate risks? A small minority of asset allocation advice say yes but the remainder usually stay silent on this topic. With my interest perked up about this subject, I decided to explore the international bond investments available. My first stop was of course index funds. As a firm believer in keeping expenses down, I checked out Vanguard to see if they had anything in this category. No dice. Fidelity? Nope. T.Rowe Price? Nada. What about ETFs? The only company even offering bond ETFs of any kind is Barclay iShares (although Vanguard will have Bond ETFs soon) and they’re all domestic.With the index fund avenue closed, I next looked at actively managed funds. After a few unproductive searches, I found list of foreign bond funds at Yahoo. Unfortunately, the options listed turned out rather depressing. You either pay load + high expenses or need an extremely high dollar amount to buy in. Here’s a sampling of the funds I encountered:
Fund Yield Load ER Min Invest
------------------------------------- ----- ----- ----- ----------
Alliance Bernstein Global Strat Inc I 3.69% 0% 1.41% 10,000,000
Alliance Bernstein Global Gov Inc A 5.25% 4.25% 1,34% 2,500
Delaware Pooled Global Fixed-Income 4.27% 0% 0.60% 1,000,000
GMO International Bond III 5.45% 0% 0.39% 10,000,000
Henderson Worldwide Income A 5.69% 4.75% 1.55% 500
Merk Hard Currency Inv 2.55% 0% 1.55% 2,500
Oppenheimer International Bond A 3.58% 4.75% 1.22% 1,000
Templeton Global Bond A 5.65% 4.25% 1.28% 1,000
Templeton Global Bond Adv 5.92% 0% 0.78% 100,000
At this point, I had given up on the idea of picking up the international bond asset class. Maybe this is why people rarely talk about it? Then I remembered a blog post at 1stMillionAt33 about tax-free closed-end bond funds. Perhaps closed-end funds is the place to look. Following the steps in the blog, I went to etfconnect.com and searched for global fixed income — 40 funds found. 40 is a rather big number to decide on so I arbitrarily applied the following filters.
- Avoid funds trading at high premiums. Closed-end funds can trade higher or lower than the daily calculated NAV price due to market irrationality.
- Avoid funds with high expenses. ETFconnect shows the yields after expenses and in theory, you get the same return whether it’s 10%+3% expenses or 8%+1% expenses. However, you are taking extra risk to pay for higher returns just to cover expenses.
- Avoid funds with > 20% US fixed equities. I like to keep my asset class picks as pure as possible for easier allocation calculations. Plus with so many options for US bonds, it doesn’t make sense to to combine foreign+US together in one investment.
After filtering the results, I ended up with the following options:
Fund Yield ER Prem Region Duration
------------------------------------- ----- ----- ------- --------- --------
CMK - Colonial Intermarket Income 6.44% 1.11% -9.01% Developed Medium-Long
JGG - Nuveen Global Gov Enh Inc 8.07% 1.09% 4.86% Developed Long
TEI - Templton Emerg Mkt Income 6.99% 1.22% -5.54% Emerging Medium
MSD - Morgan Stanley Emerg Mkt Debt 5.92% 1.34% -7.59% Emerging Medium-Long
ESD - Western Asset Emerg Mkt Debt 6.86% 1.02% -14.29% Emerging Medium-Long
EDF - Western Asset Emerg Mkt Debt II 7.97% 1.28% -12.06% Emerging Long
* as of 4/7/07
At this point, it was a shrug of the shoulders moment. I have no idea whether 20% Russian + 15% Mexico is better than 15% Russia + 20% Mexico. So again I looked at expenses. ESD is the definite winner in the Emerging Market bond segment while CMK and JGG are relatively equal for Developed Markets. JGG has a higher yield but with instruments with longer maturity dates also has more risk. In the end, I picked all three in roughly equal percentages and I am now periodically adding to these positions. It’ll may take 5 years before I reach my target goal of 50% domestic, 35% developed intl, 15% emerging market as I only have my IRA/Roth IRA money (tax-sheltered brokerage) to devote to this. I hope by that time, Vanguard or iShares will have low-cost funds or ETFs to cover this market segment.
Thanks once again, MossySF.Â If you want to read more by him, leave some comments and maybe he’ll write again.