Why Invest in Global Bonds ETFs?
Global bonds provide a diverse source of alpha and reduce the overall volatility of a purely domestic bond portfolio.
In the wake of the 2008 global economic crisis, investors realized just how synchronized and risky the U.S. and G3 markets were together. Diversifying a U.S. portfolio with European bonds is no longer sufficient to reduce risk.
Non-G3 and developing markets provide alternative opportunities that are more appealing from a risk/rewards prospective. Since they are not as correlated to U.S. bonds, they are more effective as a diversification tool in portfolios. Many developing countries also offer superior growth rates and favorable capitalistic policies in recent times.
Interestingly, 74% of the world's sovereign debt is issued outside of the U.S., compared to just 50% of the world's publicly traded equity value, according to Brandywine Global Investment Management LLC. Despite these dynamics, it's far more common for investors to diversify an equity portfolio outside of the U.S. than it is to seek global fixed income exposure.
Global bond ETFs provide investors with an easy way to achieve this diversification with a single security that's traded on U.S.
stock exchanges.
Most Popular Global Bond ETFs
There are many different global bond ETFs available for investors to choose from, ranging from developed market indexes to more obscure emerging markets. Given the growing correlation between developed market bonds, investors seeking diversification may want to focus on either all-world bonds or emerging market bonds, as part of a diversified portfolio.
With nearly $2 billion in assets under management, the SPDR International Treasury Bond ETF (NYSE: BWX) is the most popular option in the market. The ETF holds over 400 different bonds from non-U.S. countries, with a yield to maturity and dividend yield of around 2.1% in both cases and a gross expense ratio of 0.5%, according to SPDRs.com.
Other options include emerging market bond ETFs like the iShares JPMorgan USD Emerging Market Bond Fund (NYSE: EMB) and the PowerShares Emerging Market Sovereign Debt ETF (NYSE: PCY). Both of these funds offer exposure to emerging markets with about $4.5 billion and $2 billion in total assets under management, respectively.
Finally, there are many individual country-specific bond ETFs that provide investors with a way to gain exposure to particular markets and build a more hands-on bond portfolio.
Expenses, Risks & Other Considerations
Investing in global bond ETFs involves many of the same risks as investing in equity or other ETFs, as well as some added risks that investors should consider. For instance, it's unlikely that the United States would ever default on a bond, but other countries have already done so in the past, making global bonds inherently more risky than domestic bonds.
Here are some important things to keep in mind:
- Expense Ratios. Expense ratios can cut into returns for any ETFs, which means investors should seek funds with lower expenses. Often times, index funds operate at lower costs than actively managed funds that do not follow an underlying index.
- Portfolio Holdings. Global bond ETFs can hold any number of bonds outside of the U.S., which makes it important to see where they are weighted. For instance, a heavily European weighted bond portfolio may not provide as much diversification.
- Sovereign Risks. Global bonds involve the risk of default, which is important to consider in many emerging markets. Meanwhile, non-U.S. dollar denominated bonds can involve added currency risk in countries experiencing excessive inflation.
Key Takeaway Points
- Global bond ETFs provide valuable diversification of the fixed income portion of an investment portfolio, although investors often neglect them.
- There are many popular global ETFs to choose from, ranging from broad all-world ETFs to specific country ETFs for do-it-yourself investors.
- Investors should consider the many risks of investing in global bond ETFs before committing any capital and speak to an investment professional.