What's The Bull Case For International Bond ETFs?

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This week’s ETF column was spawned by a thought-provoking statement on Twitter from one of my favorite follows @econompic.  He deftly pointed out the disparity in current yield between a risk-free savings account in the United States versus the paltry income derived from broad-based international bond ETFs. 

For example, one can now easily earn 1.25% (or greater) in a savings or money market account versus the 0.73% current yield of the Vanguard International Bond ETF (BNDX).  This exchange-traded fund is considered one share class of the broader Vanguard International Bond mutual fund series, which combined house over $94 billion in total assets. 

What makes this comparison interesting is that BNDX owns nearly 4,600 individual fixed-income securities with an average duration of 7.8 years.  That’s a fair amount of interest rate risk with very little marginal income in today’s global credit markets.  Over the last year, BNDX has achieved a modest total return (dividends and capital appreciation) of +2.91%. 

I’ll admit that comparing the two asset classes can easily be disparaged by the apples and oranges argument.  They are entirely different subsets of the investment spectrum that share few similar qualities.  Yet, many investors do evaluate these types of trade-offs in the real world every single day.  They should fully understand what each brings to the table to make an informed decision with their money.  

So the natural question is what type of investor would choose lower yield and put capital at risk just to own international bonds?

The easy answer are portfolios structured with specific investment mandates regardless of fundamentals.  Many institutions, endowments, mutual funds, or simple advisory models choose to place a portion of their asset allocation in international bonds irrespective of their current price or yield.  This may be the result of a broader diversification plan or passive investment methodology with foreign holdings as a key component.  Fixed-income can be an effective tool to offset various risks in equities or alternative investments in a highly diversified portfolio.  

Another reason investors choose foreign stocks or bonds is for the embedded currency exposure.  It may be used as an indirect way to capitalize on a falling U.S. dollar or other specific foreign exchange dynamic.  Conventional mutual funds and ETFs that own these assets receive a tailwind from strengthening local currencies versus that the U.S. dollar.

The dilemma that more flexible income investors now face is whether the potential for capital appreciation in a fund like BNDX outweighs the risks of rising interest rates.  Many would surely prefer the absolute stable value of a savings or money market account with a favorable pickup in yield over the uncertainty of capital fluctuation.  Yet they are also forgoing the diversification benefits of placing money in foreign investments and riding the associated currency trends. 

Additionally, it’s worth pointing out that the U.S. equivalent to BNDX in the Vanguard Total Bond Market ETF (BND) offers a current yield of 2.48%.  Roughly three times the annual income of its international peer with a similar effective duration. 

The Bottom Line

Markets often experience periods of dislocation or seemingly inefficient risk pricing.  This may very well be one of those instances that drive the need for further reflection over appropriate global asset allocation guidelines.  Furthermore, it’s an opportunity to evaluate your risk-free savings vehicles to determine if they are producing to their fullest potential. 

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , ETFs , Bonds , World Markets
Referenced Symbols: BNDX , BND

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David Fabian

David Fabian


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