Bonds are supposed to provide both income and stability in your portfolio. International bonds, especially Emerging Markets bonds, are becoming more popular. But do you need them in your portfolio? Respected author/money manager William Bernstein doesn’t think so. From an ETF.com interview:
ETF.com: One thing that puzzled me is that among your recommendations, I don’t see an international bond fund as part of the allocation—even one that’s currency-hedged. Why?
Bernstein: Well, first, there is absolutely no way any rational investor would want an unhedged international bond fund in their portfolio for a very simple reason: Your bonds are your “safe” assets. They are what you are defeasing your retirement with; they are what enables you to sleep at night; they are your liquidity for when you lose your job or for when you want to buy cheap equities or the corner lot from your neighbor who got caught in a liquidity squeeze.
And the unhedged currency exposure with unhedged international bonds is very risky. All you have to do is look to what happened to the euro and the yen in the last crisis—they cratered. That’s a risk you simply don’t want to take.
Now, when you have hedged currency risk as opposed to unhedged currency risk in a bond fund, you’ve got a smaller problem, but it’s still a problem. And that’s when you take foreign sovereign bonds and hedge them back to the dollar—you’ve basically got U.S. bonds.
Maybe you get a tiny bit of extra diversification, but it’s a trivial amount—plus you’re paying higher expenses and higher transactional costs to deal with foreign bonds.
On the other hand, the Vanguard Group apparently does believe that holding international bonds is a worthwhile way to add diversification to your portfolio, as in 2013 they added international bonds to their Target Date Retirement and LifeStrategy all-in-one mutual funds (currently 20% of the total bond allocation). The Vanguard Total International Bond ETF (BNDX) has an expense ratio of 0.20%, while the domestic Vanguard Total Bond Market ETF (BND) has an expense ratio of 0.08%.
As Bernstein puts it, “owning a currency-hedged bond international fund is just basically getting into slightly more expensive U.S. bond exposure.”
Personally, I’m also not convinced that international bonds offers something necessary. Maybe someday that will change. Whenever I’m not convinced, I choose simplicity. Thus, I have never and currently do not own any foreign bonds.