Consider Hedging Your Global Bond Currency Risk
Long-term investors haven't historically been rewarded for taking on currency risk.
On the heels of rate hikes in 2015 and 2016, the Federal Reserve has signaled that additional increases are likely. Rising rates could put a dent in U.S. bond returns, at least in the short term. But investors could reduce their U.S. interest-rate exposure by diversifying into international-bond funds. True, yields in most developed markets are low, but it is not prudent to ignore the diversification benefits international bonds can offer, especially if the actions of central banks around the world diverge. Investors who decide to take the plunge must determine whether to hedge their foreign-currency exposure. While the answer will not be the same for everyone, bond investors have historically not been compensated for taking currency risk in the long run, and this risk dramatically increases volatility. However, an investment in an unhedged bond fund allows investors to express a bullish view on the U.S. dollar.
Hedged Versus Unhedged
Whether hedged or unhedged, investors would have earned similar returns from portfolios of international bonds in the long run. In other words, currency movements have not added substantial returns to international bond portfolios over long investment horizons. Any outperformance from appreciating currencies was inevitably followed by underperformance stemming from currency depreciation, erasing prior outperformance in the long haul.
Phillip Yoo does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.