In November of 2011, Vanguard announced plans to create two new bond index funds: a Total International Bond Index Fund and an Emerging Markets Government Bond Index Fund. Then, for whatever reason, things got put on hold.
Last week, however, Vanguard announced that their Total International Bond Index Fund is going to be open to investors sometime in the second quarter of this year.
In addition, they announced that the new fund will be added to all of their Target Retirement and LifeStrategy funds. (Specifically, 20% of the bond allocation of each fund-of-funds will go to the new international bond fund.)
For the new Total International Bond Index Fund, Vanguard anticipates a 0.20% expense ratio for Admiral shares and ETF shares and a 0.23% expense ratio for investor shares.
In other words, international diversification for your bonds will cost you approximately 0.10% per year (calculated as the new fund’s 0.20% expense ratio, minus the 0.10% expense ratio of the domestic Total Bond Market Index Fund). That’s roughly on par with the cost of international diversification for stocks (given a 0.12% difference in expense ratios between Vanguard’s Total International Stock Index Fund and Total Stock Market Index Fund).
Do International Bonds Improve a Portfolio?
The following is what I wrote when the funds were first announced. I think it’s still applicable.
My initial thought — and please note that this is just average-Joe commentary here, as I am not an economist — is that international bonds could offer a diversification benefit, with the simple reason that interest rates in the U.S. are largely affected by the actions of the Federal Reserve, whereas rates in other countries are going to be more heavily impacted by the actions of their own respective governments.
A 2011 research paper from Vanguard offers us some historical data that supports the idea that international bonds offer a bit of a diversification benefit.
The paper showed that the monthly returns of international bonds (as measured by the Barclays Capital Global Aggregate ex-USD Hedged Index) had a 60% correlation to the monthly returns of U.S. bonds (as measured by the Barclays Capital U.S. Aggregate Bond Index) from 1988-2010. That’s significant correlation, but it’s still low enough to suggest that international bonds could be helpful.
The paper also showed that from 1985-2010, for a 60% stock, 40% bond portfolio, as you move more of the bonds from domestic to international, the portfolio’s overall monthly volatility decreases very slightly.
While these two data points do give some indication that holding international bonds is likely helpful, they’re not exactly overwhelming. And as always when using historical data, we must remember that it’s just that — historical. We don’t know whether international bond diversification will be more helpful, less helpful, or even detrimental going forward.
One important point about the fund is that it will be currency-hedged. That is, the fund will use currency exchange contracts to reduce the volatility that would otherwise be caused as a result of the U.S. dollar fluctuating in value as compared to the various currencies in which the fund’s international bond holdings are denominated.
The result of this hedging is that currency risk for this fund should be minimal.
So Should You Buy The New Fund?
The flip side of the decision to currency-hedge the Total International Bond Index Fund is that its performance will be much more closely correlated to the performance of U.S. bond funds than would be the case if the fund were not currency-hedged. In other words, the decision of whether or not to include this fund in your portfolio will probably not be on the list of most important investing decisions you’ll ever make.
As a general rule, I think it’s wise to watch something for a few years — long enough to have a good handle on how it tends to behave — before putting a large portion of your portfolio into it.
Because my wife and I currently use the Vanguard LifeStrategy Growth fund (with its 80% stock, 20% bond allocation) for our retirement savings, that means 4% of our retirement portfolio (20% of the 20% bond allocation) will be put into this new fund. That’s a pretty modest allocation — not enough to cause me any worry whatsoever.
That said, if we instead used a DIY portfolio of individual index funds, I would probably be inclined to wait and watch the fund for some years before moving anything into it.
There’s no need to rush.