Vanguard Blesses Foreign Debt

November 01, 2011

Vanguard is gearing up to enter the international bond space, a clear sign that non-U.S. fixed income has come of age.

Indeed, the move signals a new direction for Vanguard, and a lot more. The bastion of John Bogle has been cautious to wade into the international bond ETF market. But its competitors— including iShares and State Street Global Advisors, among others—have been marketing international bond ETFs for a year or more.

With Vanguard now in the game, retail investors and financial advisors are likely to embrace foreign bonds. That’s because Vanguard, more than any other issuer, represents the interests of retail investors with 401(k)s.

Historically, foreign bonds have been largely passed over as an investment for retirement funds. That was more due to neglect and liquidity concerns, than about real risks.

But the global bond market has matured and, more to the point, the ETF market has made it easy and practical for investors in the developed world to access foreign debt.

The new international bond ETFs bring broadly diversified exposure—always a Vanguard emphasis—home to U.S. investors.

That easy access to international bonds will bring more mom-and-pop investors to this part of the fixed-income universe. As materials published by Vanguard point out, foreign bonds are the largest single investable asset in the global economy.

If Vanguard is trumpeting what has been clear for quite some time, it seems quite likely that international bonds will become core holdings in most if not all portfolios, just as we have seen happen with international equities.

Vanguard also made the smart move and hedged the currency exposure in its funds.  I’ve written about currency-hedged equity products before, and the same logic applies to bonds. No matter what you’re investing in, currency risk always lingers as a factor that can derail returns.

Only time will tell if international bond funds will catch on the same way foreign equities have.

But if investment flows into current funds are any indicator, things are looking up.

The SPDR Barclays Capital International Corporate Bond ETF (NYSE Arca: IBND), just one example, has already attracted more than $500 million, and Vanguard’s push into the space will likely bring a big boost to assets. Also, the nearly five-year-old iShares JPMorgan USD Emerging Markets Bond Fund (NYSEArca: EMB) is the single-biggest ETF focused on non-U.S. bonds.

Vanguard, like iShares, plans to market a dollar-denominated emerging markets debt fund, again a sign that the company is staying conservative with currency exposure as it expands into a new realm.

I wouldn’t be the least bit surprised if a couple years down the line, with a little help from Vanguard’s push into the space, foreign bonds have found a home in core portfolios everywhere.


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