Currency Hedging Makes International Bonds Easier to Own
International-bond funds are a great way to diversify a fixed-income portfolio, but currency movements can create unnecessary volatility.
It isn't uncommon for investors to diversify their stock holdings abroad. Sure, currency fluctuations can make international equities a bit riskier than their domestic counterparts, but they do not significantly alter the risk profile. In contrast, currency risk can make international bonds significantly more volatile than U.S. bonds. For example, over the past decade, the Barclays Global Aggregate Ex USD Index was more than twice as volatile as the Barclays U.S. Aggregate Bond Index. Currency movements can dominate international-bond funds' performance in the short term. This often makes them more suitable as a bet against the U.S. dollar than as a way to share in the bond returns foreign investors enjoy. Hedging currency risk can solve this problem.
Without currency movements, international bonds have historically exhibited volatility comparable to their domestic counterparts. The hedged version of the Barclays Global Aggregate Ex USD Index only exhibited about a third of the volatility of its unhedged counterpart over the past decade. The dramatic reduction in volatility that currency hedging offers may allow conservative investors to invest abroad more comfortably and better diversify their interest-rate and credit risk.
Thomas Boccellari does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.