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How Risky Is Risky in World-Bond Funds?

Our FIEA tool allows you to dissect funds in multiple ways, offering an eye-opening look under the hood.

Global-bond fund managers routinely disclose fund-level credit-quality, sector, region, and country exposure breakdowns on their websites, but it can be extremely difficult to deduce where a strategy is taking its credit risk. It can also be hard to discern how far afield it is from the commonly used Bloomberg Barclays Global Aggregate Bond Index. Earlier this summer we rolled out a new Fixed Income Exposure Analysis, or FIEA, component for Morningstar Direct and Morningstar Office users to help investors make sense of their individual portfolios and thereby make better comparisons across funds. Elements of this will be available in fund reports on and other products later this summer.

We will take a look at the index-tracking Vanguard Total World Bond ETF BNDW as our baseline with the FIEA tool. It tracks a float-adjusted version of the investment-grade-focused Global Aggregate Index, with roughly 60% in government bonds, 20% in corporates, and various securitized sectors making up the rest. Emerging-markets bonds, which can add a lot of volatility, represent just 3% of this benchmark. Though this ETF’s non-U.S. holdings are all hedged back to the U.S. dollar (it resides in the world bond U.S.-dollar hedged Morningstar Category) it still provides a helpful picture of the larger sector and country components that managers use as guideposts and the level of credit risk that more-conservative world-bond funds take. (In a future iteration, the FIEA tool will incorporate the ability to dig into a portfolio’s currency exposures as well.)

The following FIEA view shows BNDW’s credit-quality exposure by sector as of June 30, 2020, which is already a helpful step up compared with what is available on the company’s website. From here, you can see that the bulk of its BBB exposure (17%) comes from corporates. (Small differences can occur owing to the various ways fund companies classify and report data, and the FIEA view is based on a fund’s bond portfolio rather than its total assets.)

Now let’s look at a couple of world-bond strategies that Morningstar analysts rate highly. BrandywineGLOBAL Global Opportunities Bond GOBSX, which has a Morningstar Analyst Rating of Silver, looks somewhat close to the bogy in its sector exposures, but a deeper look shows a much more aggressive credit profile. The FIEA view below highlights its much heavier BBB exposure (43%) compared with the Global Aggregate Index tracker, for example, as well as an 11.6% stake in BB rated debt as of mid-2020.

Dissecting the strategy's exposure further by country, as shown below, reveals where the strategy was invested in below-investment-grade corporates (U.S. and Brazil) and sovereigns (Brazil, Russia, and South Africa).

Another of our high-conviction picks in this category, Gold-rated Dodge & Cox Global Bond DODLX, also takes plenty of credit risk compared with the Global Aggregate Index. Its 55% corporate stake was more than twice the benchmark’s as of June 30, 2020. It also had about one fifth of assets stashed in below-investment-grade debt. The FIEA tool shows that the managers are willing to invest down the capital structure in asset-backed securities rated A and BBB, which come with heightened liquidity risk.

Another trick for teasing out how much credit risk is attributable to emerging markets is by checking the regional breakdown, as shown below.

The strategy has long featured emerging-markets bonds, to the tune of 26% across regions as of midyear when summing Latin America, Europe-Emerging, Africa, and Asia-Emerging, including about 7% in below-investment-grade issues.

Be Your Own Sleuth For riskier strategies in particular, it's good to be able to do some of your own detective work. Morningstar's new FIEA component can help you slice and dice a portfolio in ways you couldn't before, which should help you understand more about its risks.

Not surprisingly, these two strategies have been on a wild ride in 2020. Both funds went into the late-February coronavirus-driven sell-off with higher levels of corporate credit and emerging-markets risk than many in the world-bond category, and they plunged by roughly 15%-16% between Feb. 20 and March 23. The Global Aggregate Index (unhedged), meanwhile, suffered a milder 3% slide. The Brandywine fund’s tilt toward Mexican, Brazilian, and Colombian debt (and the countries’ currencies) was particularly painful. Dodge & Cox Global Bond was stung by the combination of overweightings in energy-related issuers, as well as positions in Mexico and Brazil. Many of the positions that detracted in the first quarter helped the strategies rocket back thereafter. BrandywineGLOBAL Global Opportunities Bond was up by 27% from March 23 through July 29, while Dodge & Cox Global Bond climbed by 23% (the index gained 9%).

Both strategies rely on a combination of valuation- and contrarian-driven calls by skilled and well-resourced teams, all of which has served patient investors well--which is why our analysts give them high marks. Their volatile performance profiles have been par for the course too, though, and understanding the roots of that volatility is a critical element in getting comfortable owning them.

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