Looking Toward Non US Bonds

August 27, 2014

Is the time—and interest—coming or going for non-U.S. fixed-income ETFs?

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Clayton Fresk, CFA, portfolio management analyst at Georgia-based Stadion Money Management.

Heading into 2014, all the talk was of a higher interest-rate environment here in the U.S. The 10-year Treasury note climbed to 3 percent, everyone was proclaiming that the end of the bull market in bonds was near, and numerous market participants had shortened duration of their bond portfolios.

Fast-forward to nearly eight months later and higher rates look like a distant memory. The 10-year note has rather steadily declined all year and is now trading around the 2.4 percent level. The higher-rates camp has quieted—at least for now.

We’ve also seen a sharp divergence in the normal market-risk pattern. While rates have steadily declined, risk assets have also traded stronger for most of the period. The S&P 500 Index is up nearly 8 percent and is just shy of the 2000 level. After a bit of volatility in July, high-yield spreads have since retreated.

All this said, the argument now could be, “Who’s right—bonds or equities?” History has proven bonds usually lead, which could be a bad sign for risk assets as we head into the last four months of the year.

However, taking the opposite view, which would hold that the rise in risk assets is sensible and that bond yields may again trade higher, how could an investor look to protect against this move? The first answer—shorter-duration and higher-spread fixed income, is a position that has already been put on by investors after the last rate rise. Flows data suggest that many participants are still hewing to this defensive end-of-2013 positioning.

So if the positioning question from above has partially been answered, what other portfolio changes might make sense if rates are about to start trending higher?

Further protection—and diversification—may be in the form of non-U.S. fixed-income ETFs, and there are a number of factors to consider in determining which allocations might be best for your portfolio.

Underlying Risk

In the U.S. bond space, the allocation decision takes into account risk determinants such as duration and credit risk. Investors have similar, though not identical, considerations in non-U.S. bond markets.

In the U.S., it’s become very easy to fine-tune the duration exposure of a portfolio via the different ETFs available, from short-, intermediate- and long-dated ETFs, to even more fine-tuning via the target-maturity options available via the Guggenheim Bulletshares and iShares iBonds products.

But in the non-U.S. bond space, there are fewer options available for duration-tuning. While the underlying exposure of the ETFs may vary in duration based on the index or on active management, State Street Global Advisors and iShares both have broad- and short-duration (one- to three-year) international Treasury ETFs available. Emerging Global Advisors meanwhile has a suite of short-, intermediate- and long-dated emerging market debt funds.

The credit risk question can also be addressed in the non-U.S. space, but similar to the duration question, fewer ETF options exist.

There are a handful of non-U.S. corporate bond ETFs—both investment-grade and high-yield options available. Those include:

 

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