It's getting rough out there for fixed income investors because, well, the “income” part of the proposition is taking a beating. Yields on 10-year U.S. Treasuries slumped 1.52% at Thursday's close. That's 35 basis points below the dividend yield on the S&P 500, an unusual occurrence .
And with approximately $14 trillion in negative-yielding debt (bonds that eat your money) around the world, some fixed income investors may not be thinking internationally. The Vanguard Total International Bond Index Fund ETF (BNDX) may give them reasons to reconsider. BNDX hit an all-time high (again) on Thursday and is up nearly 9.1% year-to-date, an advantage of more than 220 basis points over the widely followed Bloomberg Barclays Aggregate Bond Index.
BNDX yields 2.84%. These days, that's pretty good for a bond fund where nearly three-quarters of the holdings are rated AAA, AA or A. In other words, most the risk associated with BNDX is rate risk, not that of the credit variety. The Vanguard ETF has an average duration of 8.1 years , skewing toward the higher end of intermediate-term.
On the rate risk front, the good news for investors considering BNDX is that that risk is minimal. Japanese bonds account for nearly 20% of the fund's while European debt represents nearly 57%. Japan won't be raising interest rates anytime and the European Central Bank (ECB) is pushing for easier monetary policy.
Nearly 40 countries are represented in the Vanguard ETF at weights ranging from 0.10% to 19.80%. A quick look at BNDX's geographic exposures indicates none of any consequence to the fund's investors are credible raisers of interest rates anytime soon.
Obviously, BNDX is soaring this year because sovereign debt is proving to be a strong asset class, but that's only part of the reason for the Vanguard ETF's strength. The other reason is the oft-overlooked currency hedge component, meaning the fund is positively levered to the still strong U.S. dollar.
“Currency hedging gives the fund cleaner exposure to local bond returns, though its performance won’t match the local market returns,” said Morningstar in a recent note . “Interest-rate differentials are baked into the forward rates the fund uses to hedge its currency exposure. For example, if interest rates are higher in the eurozone than in the U.S., the forward exchange rate will be lower than the spot rate, meaning that currency hedgers are locking in that currency depreciation (which presumably would be offset by the higher interest rate investors can earn in the eurozone).”
Bottom line: if BNDX didn't have the currency hedge, the dollar's price action would be a larger determinant of the fund's price action than many investors might realize.
A Solid Bet
For investors looking to diversify US-heavy bond portfolios while getting some added yield without much more risk, BNDX makes a lot of sense and data suggest the Vanguard fund has been a solid long-performer, a key selling point for fixed income investors.
“From its inception in May 2013 through August 2018, the fund beat the world bond Morningstar Category average by 2.3 percentage points annually, with slightly lower volatility,” said Morningstar. “This performance edge was primarily thanks to its currency hedge.”
And is par for the course with many Vanguard ETFs, BNDX is cheap. It charges just 0.09% per year, or $9 on a $10,000 investment. That's another positive trait for long-term investors.