Unhedged International Bond Funds

[charlie]

Scott Burns mentioned the other day that the
American Century International Bond Fund has
a pretty good track record and is unhedged
against the US dollar. He suggests that it
might be a way to hedge against continuing
fall of the dollar and rising inflation.

It is a high quality, intermediated term fund
that is pretty volatile in US dollars.

I am thinking about reducing my International
stock exposure (which also hedges against the
dollar) and buying the above fund.

Specifically, my "coffeehouse" IRA has 7 stock
funds with equal allocation. Two of those funds
are Total International and International Explorer.
I am considering substituting the international
bond fund for the Total International Stock Fund.

What do you think? Is this a good idea? Do
you think this would increase or decrease the
overall risk of my portfolio? Is is likely to provide
any extra total return?

Thanks for your comments.

Cheers,

Charlie

 

[charlie]

Here is a link to the Scott Burns column:

http://www.dallasnews.com/sharedcon...s/2005/stories/012505dnbusburns.3faac5fa.html

 

[haha]

What do you think?  Is this a good idea?  Do
you think this would increase or decrease the
overall risk of my portfolio?  Is is likely to provide
any extra total return?Charlie  

Hi Charlie,
Since stocks effectively have a very long duration, and intermediate bonds fairly short duration, on that fact alone you should decrease risk. As to increasing return, by the creed professed on this board, that can't be done at the same time as decreasing risk.

You know the boilerplate. If you are properly agnostic about the future, all you can do is make sure that you have a portfolio that is efficient and reflects your own risk/reward tradeoffs.

If you are into making bets, then you need more information as to what is contained in the funds, just what currencies, etc.

Mikey

 

[Hyperborea]

Scott Burns mentioned the other day that the
American Century International Bond Fund has
a pretty good track record and is unhedged
against the US dollar.  He suggests that it
might be a way to hedge against continuing
fall of the dollar and rising inflation.

Have you looked at GIM - Templeton Global Income?  It's also unhedged, the ER is lower - 0.77%, and the yield is higher.  It can theoretically hold US bonds or preferred shares but it currently has little if any.

http://finance.yahoo.com/q?s=GIM&d=t

http://www.etfconnect.com/select/fundPages/global.asp?MFID=3854

http://www.templeton.com/

 

[Cut-Throat]

As to increasing return, by the creed professed on this board, that can't be done at the same time as decreasing risk.

Mikey,

You are probably correct for this specific example, but I remember seeing in Berstein's books that adding some international stocks to a portfoilo, Increases Return and Decreases risk at the same time.

 

[Bob_Smith]

Charlie's question is an interesting one. I have a big slice of international stocks, but no foreign bonds. I guess I just prefer to take my biggest risks in equities. Plus, I don't understand all the risks that foreign bonds pose. Do others include foreign bonds in their allocation? If so, why (or why not)?

 

[Marshac]

Currency exposure.

 

[Cut-Throat]

Do others include foreign bonds in their allocation? If so, why (or why not)?

Bob,

Just not sure I understand them. - When Vanguard comes out with a Retirement Fund that encompasses these other asset classes, I may just simplify like Unclemick and go fishing.

 

[Bob_Smith]

Right Cut-Throat. I haven't seen foreign bonds included in most model portfolios I've seen either. Having currency exposure makes sense, but don't we already get that in our unhedged international stock funds?

 

[Jarhead*]

Right Cut-Throat. I haven't seen foreign bonds included in most model portfolios I've seen either. Having currency exposure makes sense, but don't we already get that in our unhedged international stock funds?

Hey Bob: Absolutely, as long as they aren't hedged.
Depending on the individual Mut. Funds that you have, some of them also carry small exposures to international stock.
I recently cut my exposure to equities down to about 30% (Age thing), but have continued to carry about 30% of that amount in international stocks.
I have carried about 30% international since the late 80's, and because of the strength of the dollar, etc, etc. they have underperformed until a couple years ago, so I figure they're due. (That should be the kiss of death)
Like you, I have never carried foreign bonds. Might not be a bad idea, but figure I've already got some hedging with the inter. stocks.
Wish I had a nice big fat cola'd pension
Take Care, Jarhead

 

[charlie]

Jarhead, me too on the cola pension.

Charlie

 

[haha]

Do others include foreign bonds in their allocation? If so, why (or why not)?

I do, and have for many years. Overall they have been big winners, due to generally good performance against the dollar over the entire time span (with some big ups and downs) and to generally falling interest rates since the early 80s.

IMO high quality (mostly G-7 government) bonds are a more focused currency play than foreign stocks, because given relatively short duration, you have nothing to worry about other than currency.

Imagine for a moment that the Euro goes to $1.70. A short term high quality bond fund will capture most or all of that movement. But many European stocks could have their competitive positions badly damaged. How many Volkswagens will be bought in the US? Will we prefer Chilean or California or Washington Wines to the output of Burgundy or Bordeaux?

So what you make on currency, you could easily lose on stock price.

I do have some long term Euro and Asian stock holdings, but I won't be adding to them anytime soon.

Mikey

 

[Bob_Smith]

Hi Jarhead,

You and I have a similar allocation. I'm about 1/3 stocks, and about 1/3 of that is international.

 

[Bob_Smith]

Mikey, thanks.

 

[indymom]

OK, I was hoping to pick this up by observing context. Didn't work. What, exactly, is "hedged"?

 

[Marshac]

Don't worry, when I emailed the company who manages my 401k for work and asked if their international fund was hedged.... they wrote me back saying "the international fund is not a hedge fund".

Hedged means that the fund is trying to remove currency value fluctuations from their fund, unhedged means that they take the fluctuations as they come. I believe that a very common way to hedge is to buy currency futures contracts. I'm sure someone will provide a better response than I

 

[brewer12345]

Just a couple of comments:

- Unhedged foreign bonds are a good diversifier, especially versus domestic equities. Even better, in times of trouble when domestic and overseas stock markets tend to move (down) together, high grade foreign bonds typically retain their low correlation. This is an asset class I will be adding to my portfolio.

- GIM is my vehicle of choice for owning unhedged, unleveraged foreign bonds. Unfortunately, it has been trading at the top end of its premium/discount historical range for a while now, so I wouldn't be eager to buy it until it backs down to at least equality with NAV (if not an actual discount).

 

[soupcxan]

I hold some BEGBX in my account...one argument I've heard against owning unhedged foreign bond funds is that over the long term, gains and losses from FX fluctuations are net zero because any currency that appreciates has to be offset by another currency depreciating. These people claim that you're going to get a real return of zero once inflation is factored in. I believe their point is that (in theory) every equity market in the world could continue to appreciate over time without any other market losing value - but this is not the case for FX values. Brewer knows more about this than I do, I'm sure...I see their point but I'm not sure I buy 100% of it.

 

[brewer12345]

I hold some BEGBX in my account...one argument I've heard against owning unhedged foreign bond funds is that over the long term, gains and losses from FX fluctuations are net zero because any currency that appreciates has to be offset by another currency depreciating. These people claim that you're going to get a real return of zero once inflation is factored in. I believe their point is that (in theory) every equity market in the world could continue to appreciate over time without any other market losing value - but this is not the case for FX values. Brewer knows more about this than I do, I'm sure...I see their point but I'm not sure I buy 100% of it.

You could say pretty much the same thing about domestic treasuries, yet lots of people own them. The idea is low correlation and dampening volatility, not necessarily return on bonds. Naturally, a good manager can add alpha in bonds and you could probably make nice money by exploiting PPP-related imbalances in the currency markets via foreign bonds as well.

 

[Nords]

I want to invest in stocks, not currencies.

Tweedy, Browne has a good article on hedging at http://www.tweedy.com/library_docs/papers/hedging_foreign_stock_currency.html . Here's a quote:

"At Tweedy, Browne, we pick stocks; we do not pretend to understand currency valuations. We can read a company's balance sheet but we cannot read a country's balance sheet. Our conclusion is to be as close to currency agnostic as is practicable. We count our net worth in U.S. dollars and so we hedge what we believe to be our portfolio's exposure to foreign currencies back into U.S. dollars. While this presents an additional cost to investing abroad, the cost over long periods is not so great as to negate the investment values we see."

As of last month, their Global Value (TBGVX) fund was 17% Netherlands and 14% Switzerland. 13% of the fund was in cash and another 6% represented the value of hedging contracts.

This is our last mutual fund and we've been redeeming it for our annual living expenses for over two years. Even despite withdrawals it's risen in value. The ER is 1.37% and I'd love to have it at 0.4% or lower, but I'm just not ready to make the leap to an unhedged international ETF (EFA).

 

[ESRBob]

I carry about 10% international bonds in my portfolio, and have just switched from a mixture of various hedged funds to a single Pimco Foreign Bond (unhedged) position (PFUIX). It is a medium term bond with .5% fees.

The nice thing about foreign bonds as an asset class is their low correlation with anything else. They range from basically zero correlation with international large equities to .33% correlation with US bonds. (These are 1-year correlation coefficients). And their average returns are attractive for med term international bonds: about 8% over the past 10-20 years.

I got unhedged foreign bonds for the reasons stated in previous posts: I felt I was wasting my $ paying for hedges when what I really wanted was diversification into other currencies, so why would I want to pay for hedges?

I also dropped my previous hedged 2-year global bond fund from DFA, since all the return seemed to be eaten up in hedging costs,. There is no unhedged 2-year bond fund, so thinking about it I just said "Go Penfed CD" and now am locking in some cash yields that way.

with only pulling out 4% a year from the portfolio, I am not one of those who worries a lot about having everything in my base currency. I want diversification into good asset classes that move differently, so I can have low volatility and a reasonable return. (overall my portfolio produces historical returens of about 9% with standard deviation of about 7%, ie SP500 returns with half the volatility.)

This notion of a little more yield and no more risk (or less risk at the same yield) is the basis for the whole efficient frontier discussion, and is made possible through Modern Portfolio Theory benefits of diversification. (Bernstein, Armstrong). It is the closest I've found to investment alchemy and it works for me.

 

[Hyperborea]

I carry about 10% international bonds in my portfolio, and have just switched from a mixture of various hedged funds to a single Pimco Foreign Bond (unhedged) position (PFUIX).  It is a medium term bond with .5% fees.

So, how are you getting the institutional version of the Pimco fund? The non-institutional ones (PFUAX, PFRCX, and PFBDX) have combinations of 12b-1 and redemption fees out the wazoo. You're not investing $5M in PFUIX are you? Or is it some sort of agglomeration through a planner?

 

[ESRBob]

Hyper,
Yes, I have access to this fund through my fee-only DFA planner at less than the normal institutional minimum. It has worked for all the Pimco funds as well as things like QRAAX (commodiites).

 

[LEX]

I thought about buying either a foreign currency position or a bond fund.  I thought it through and felt I would just be setting myself up for the same monetary devaluation problem that I am seeking to avoid leaving dollars for Euros, yen, pounds and so forth.  Every county spends too much and uses its currency and its international floating exchange as a form of operating capital.  Sooner or latter the currency will become subject to fiat decisions that crash its value.

I opted instead to invest in international commodity based funds and global equity market based funds as a way to counter the sell off of US soverignty.  All governments can print and collapse their curency, like the US is doing today, but global enterprise and especially global commodities are much truer residuals to value and will survive the enevitable collapse of any fiat currency.  (By the way, gold is not the answer...its a tool for con men and bunko artists)  

The dollars drop is really just another iterations of a much larger national agenda and is part of a process to make the US a "free trade" zone, and includes NAFTA, a no border policy, off shoring the industrial base and so on.  When the process finds its equilibrium we will wake up to find we live in the "new second world" economic phase of US history.  Global corporations will be, if they are not already, the real proxy for the power of nations.

My favorite "dollar proof" funds:

PCRDX (PIMCO REAL RETURN)
UMESX (EXCELSIOR NATURAL RESOURCES)
VHGEX (Vanguard Global Equity)

Check them out, they done well in real terms against any number of currencies.

LEX

 

[soupcxan]

I opted instead to invest in international commodity based funds and global equity market based funds as a way to counter the sell off of US soverignty.  All governments can print and collapse their curency, like the US is doing today, but global enterprise and especially global commodities are much truer residuals to value and will survive the enevitable collapse of any fiat currency.  (By the way, gold is not the answer...its a tool for con men and bunko artists)  

1) Isn't a commodity based fund going to hold gold and other metals? Seems contradictory to your last statement.
2) How can global enterprise have "truer" value when the entire financial reporting system that we have set up depends on these fiat currencies? Sure, corporations have assets that should be fairly valued regardless of what the local currency is doing, but that still doesn't mean that they can always outlast currency manipulations by the government. Without a stable underlying currency to act as a store of value, I think corporations are going to have a tough time, regardless of how well the business itself is doing.