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3 Foreign Bond Funds for Conservative Investors

Picks for globalizing a portfolio without adding a lot of volatility.

Perhaps more than any other fund category, the world-bond group is a disparate grab bag. All of the funds in the group invest in debt issued by foreign entities, but the similarities end there. Some funds buy debt denominated in foreign currencies; others hedge their exposures to negate the foreign-currency fluctuations. Some offerings buy emerging-markets bonds as well as developed; others stick largely with Japan and developed Europe. Some funds have global mandates, while others only buy non-U.S. bonds.

Those strategic differences make a huge difference in the funds' risk/reward profiles. That's why understanding a fund's approach, as I discussed in this article, is crucial when deciding what role, if any, such a fund should play in your portfolio. 

Funds with unhedged currency exposures and heavy emerging-markets stakes have lower correlations with high-quality U.S. bond funds, but higher correlations with equities, as senior analyst Karin Anderson noted in this article. Because they'll tend to provide less of a portfolio benefit in weak equity markets, they're best used in addition to--rather than in lieu of--traditional high-quality bonds. I highlighted some of the best of this ilk in an article last week

This week, let's take a look at some of the group's best staid entrants--funds that hedge their currency exposures back into the dollar. Although they don't provide the same foreign-currency diversification as their unhedged counterparts, their returns are more bondlike--fairly low but steady, and in line with their yields. That's because foreign-currency fluctuations don't drown out the other determinants of their returns, including their interest-rate sensitivity and credit quality. Though investors in such funds shouldn't expect a major enhancement in their returns relative to a portfolio consisting of U.S. bonds, their benefit is a bit of extra diversification and potentially some risk reduction to go along with it, as analyst Thomas Boccellari discussed in this article. As Vanguard noted in this research paper on the topic, U.S. bonds represent less than half of the global-bond market, so it's reasonable for bond portfolios to include at least some foreign-bond exposure to give the portfolio exposure to non-U.S. interest-rate environments. 

 DFA Five-Year Global Fixed Income (DFGBX)
Category: World Bond | Analyst Rating: Bronze
This is one of the mildest world-bond funds around, owing to its strict parameters on duration and credit quality. Management focuses on bonds with maturities of five years or less and credit qualities of AA or higher, hedges its foreign-currency exposure back into the dollar, and maintains substantial exposure to U.S. bonds. That limited risk profile has meant limited upside, particularly over the past five years as benefits have accrued to longer-duration and/or lower-quality peers. The trade-off, though, is that the fund has delivered in volatile equity markets. It gained 4% in 2008, for example, even as the average world-bond fund lost almost 2%, and it also held its ground in 2011's global credit crunch, returning 2% in the third quarter of that year even as its average peer lost money. Its standard deviation is lower than the Barclays Aggregate Bond Index. Key to making the low-risk strategy pay is the fund's 0.28% expense ratio on the institutional share class. One caveat is that, like all DFA funds, this offering won't be readily available to do-it-yourself individual investors; while it might be available through some 401(k) plans, its main distribution channel is through financial advisors who use DFA funds. 

 PIMCO Foreign Bond (USD-Hedged) (PFORX)(
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Category: World Bond | Analyst Rating: Silver
While this fund also hedges its foreign-currency exposure and sticks with developed-markets bonds, it steps out a bit on the risk spectrum relative to the DFA offering. The fund's benchmark consists strictly of bonds issued by foreign governments, but manager Scott Mather has a good degree of latitude to incorporate PIMCO's global view into the portfolio. Amid 2008's credit crisis, for example, he shifted more than half of the portfolio into badly beaten-down corporate bonds. That move didn't pay off as the crisis was unfolding but set it up for exceptionally strong returns when the economy, and such credits, showed signs of recovering. Owing to that sort of flexibility, the fund is a bet on the strength of Mather and PIMCO's calls. Like all PIMCO funds, the institutional share classes can be a good deal for those who have access them, but the "lettered" share classes have expense ratios that could be tough to overcome. Mather also runs a global version of this fund,  PIMCO Global Bond (USD-Hedged) (PGBIX).

 Vanguard Total International Bond Market Index (BNDX)(
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Category: World Bond | Analyst Rating: N/A
This exchange-traded fund (also a traditional mutual fund), which launched last year, is a reflection of Vanguard's research on the role of foreign bonds in investors' portfolios. Unhedged foreign-bond portfolios' returns are determined largely by the fluctuations in foreign currencies relative to the dollar, whereas hedged bond portfolios deliver more bondlike returns and better diversification benefits relative to equity. Thus, the firm's first and only foreign-bond fund is hedged, and Vanguard has incorporated it into each of the funds in its target-date lineup. It tracks an index that is capitalization-weighted, meaning that the most heavily indebted issuers--in this case the governments of Japan and several European countries--top the portfolio. That positioning carries risks, as analyst Tom Boccellari discusses in  his recent analysis, and the fund's meager yield and nearly 7-year duration make it vulnerable to an interest-rate shock. But its costs are ultra low and its indexed approach provides straightforward foreign-bond exposure.

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