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Our Favorite World-Bond Funds

Investors need to carefully consider various currency, interest-rate, credit/default, and geopolitical risks before jumping into this steadily growing category.

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The U.S. world-bond category has been growing at a steady clip in recent years, and this trend continued through 2015, albeit at a slower pace. The category more than doubled in size to $200 billion between 2010 and 2015, notching some of the biggest relative inflows within the taxable-bond space. (Only nontraditional bonds and emerging-markets bonds saw a faster rate of growth during that stretch.) While world-bond funds make sense for their diversification potential, it is also important to consider their various currency, interest-rate, credit/default, and geopolitical risks. Here we outline the key risks and return drivers of funds in this Morningstar Category and highlight a few of our favorites.

Key Risks
Currency: World-bond funds tend to follow one of three currency management approaches: unhedged, tactically hedged, and U.S.-dollar-hedged. Non-U.S. currency exposure is the most significant risk to consider as currency movements have the most significant impact on risk/return profiles. This risk affects unhedged funds the most acutely, followed by funds that use tactical currency approaches. When the U.S. dollar strengthens, losses from overseas currencies can result in weak or negative returns for unhedged bond funds. That’s been clear with the dollar’s recent surge: From January 2013 through December 2015, the U.S.-dollar-hedged Barclays Global Aggregate and its ex-U.S. counterpart posted gains on the order of 3%-4% annualized, whereas the unhedged versions of the benchmarks registered annualized losses between 2% and 4%.

Karin Anderson has a position in the following securities mentioned above: TPINX. Find out about Morningstar’s editorial policies.