As yields on high-quality bonds have slipped in the United States, more investors are turning to foreign bonds and foreign bond funds to boost portfolio yield potential and provide greater diversification.1 In the past decade, there’s been substantial growth and maturation of world bond markets. That, combined with the ongoing globalization of businesses and capital flow, can make foreign bonds a viable option for many investors. In fact, nearly 75 percent of the world’s sovereign debt is issued outside of the United States.2
Investing in foreign bonds has many advantages, including:
Over time, foreign bonds have produced competitive returns, even besting the equity market at times. In the ten years ended August 31, 2012, average total returns of foreign bonds have outperformed the Standard & Poor’s 500, and over the past five and ten year periods, have outpaced the U.S. bond market.
Citigroup Non-US Dollar World Government Bond Index
Barclays US Aggregate
Sources: Citigroup, Barclays, Standard & Poor’s. Data as of August 31, 2012. It is not possible to invest directly in an index. Past performance is no guarantee of future results.
One caveat: While the U.S. and foreign bond markets have not consistently moved in sync in the past, in recent years the correlation between them has increased. From 1986 through 1999, the correlation was 0.31 between international bonds and U.S. bonds. Between 2000 and 2011, the correlation rose to 0.55.3 The closer the correlation moves to 1, the more that U.S. and foreign markets have moved in tandem.
There are many types of foreign bonds, both from government entities as well as corporations. Here is an overview.
A eurobond is a bond issued and traded in a country other than the one in which its currency is denominated – not always a European nation. Eurobonds are attractive financing tools as they give issuers the flexibility to choose the country in which to offer their bond according to that country’s regulatory constraints. They are usually issued in more than one country of issue and traded across international financial markets. But they are unsecured, leaving bondholders without the first claim to the issuer’s assets in case of default.
Below are some common types of eurobonds.
A global bond is a type of bond that is issued in multiple markets in different currencies. There are three types of bonds:
By issuing global bonds, a government or corporation is able to attract funds from a wider set of investors and potentially reduce its cost of borrowing. Investing in global bonds opens up a whole new opportunity set of potential return sources in the form of different economies, yield curves, and currencies.
Issued by national governments, sovereign bonds are generally among the safest investments in most countries. Even if countries are not particularly creditworthy, their sovereign bonds are usually safer than their other domestic alternatives.
Sovereign debt comes in two general categories: those issued by the national governments of large, developed economies and those issued by emerging market countries.
Yankee bonds are U.S. dollar denominated bonds issued by foreign governments and corporations and sold in the United States. The benefit to American investors is that they can purchase the securities of foreign issuers without being subject to price swings caused by variations in currency exchange rates. As a result, Yankee bond prices are influenced primarily by changes in U.S. interest rates and the financial condition of the issuer. Additionally, they are regulated by the U.S. Securities and Exchange Commission (SEC) and are rated by American ratings agencies such as Moody's Investors Service and Standard & Poor's. As a result, Yankee bonds tend to be lower in risk than certain other foreign bonds.
As with all types of investments, there are a number of risks associated with foreign bonds, including the following.
Which foreign bonds or bond funds best complement your portfolio will depend on a number of factors, including your existing holdings and appetite for risk. Let me work with you to identify the investments that best suit your specific needs.
1Diversification does not ensure a profit or protect against a loss.
2Source: Bloomberg. Data as of December 31, 2011.
3Source: Standard & Poor's, 2011. Performance is for the period January 1, 1986, to December 31, 2011. Assumes a 60/40 allocation between stocks and bonds. Stocks are represented by the S&P 500 index. U.S. Bonds are represented by the Citigroup Broad Investment Grade Bond index. Foreign bonds are represented by the Citigroup Non-U.S. Dollar World Government Bond index.
Investments in foreign/international securities involve risks associated with interest-rate and currency-exchange-rate changes as well as market, economic, and political conditions of the countries where investments are made. .
Past performance is not a guarantee of future results. Index results do not take into account the fees and expenses associated with purchasing individual securities or fund shares, and individuals cannot invest directly in an index.
Bond Funds and bond holdings have the same interest rate, inflation and credit risks that are associated with the underlying bonds owned by the funds. The return of principal in bond funds, and in funds with significant bond holdings, is not guaranteed.
Investors should carefully consider the investment objectives and risks as well as charges and expenses of a mutual fund before investing. To obtain a prospectus, contact your Financial Advisor or visit the fund company’s website. The prospectus contains this and other information about the mutual fund. Read the prospectus carefully before investing.
Zero Coupon Bonds are taxed each year on the amount of interest that has accrued from the last year even though the accrued interest is not actually paid to investors in that year.
The market value of convertible bonds and the underlying common stock(s) will fluctuate and after purchase may be worth more or less than original cost. If sold prior to maturity, investors may receive more or less than their original purchase price or maturity value, depending on market conditions.
High Yield Bonds are issued by companies without a long track record of sales or of questionable credit strength that are generally rated BB or lower. High yield bonds pay a higher yield than investment grade bonds to compensate for its higher risk.
Todd Hauer is a Wealth Advisor and Senior Investment Management Consultant with the Global Wealth Management Division of Morgan Stanley in Denver. He can be reached at Todd.Hauer@morganstanley.com or 720.488.2406.
The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. Investing involves risks and there is always the potential of losing money when you invest. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Wealth Management, Member SIPC, or its affiliates. Morgan Stanley Wealth Management LLC. Member SIPC.
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