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.
For years now, investors have prepped for higher interest rates here in the U.S. There were various tactics used to diversify away some of this risk, including introducing non-U.S. bond ETFs into a portfolio.
This has been a fruitful trade over the past few years, as the continued phenomenon of central bank intervention abroad has pushed rates in other countries into negative territory. While the ride down to this negative interest- rate policy (NIRP) has produced some nice positive price action, it would seem NIRP is not sustainable, and that eventually there will be a ride back up (and hence a reversal in the price positivity).
So if the rise back to positive interest rates in these countries is forthcoming, is the non-U.S. bond trade still worth keeping on in the meantime? If not, what are some alternatives?
As stated above, non-U.S. fixed income has been a strong trade recently. The chart below shows the differential between the underlying index for the iShares Core International Aggregate Bond (IAGG) and the iShares Core U.S. Aggregate Bond ETF (AGG | A-98).
After trailing decently during the six-year period from 2005-2011, the international index has performed strongly since, outperforming the U.S. index by 237 basis points per year (5.13% versus 2.76%) since the end of 2011 through April.
The question that may arise now is: Is that outperformance sustainable? The market has already seen some stabilization over the past year or so, which is evidenced by a flattening out in the differential in the chart above. Taking a step back, we can look at the underlying interest-rate action during this period.
This first chart shows the change in the U.S. curve versus the benchmark European and Japanese sovereign curves from the end of 2005 to the end of 2011.
During this period, there was a dramatic shift lower in U.S. rates. This compares to a moderate move lower in European rates and a rather unchanged Japanese curve. It should not be a surprise that the U.S. index outperformed during this period given the price appreciation it experienced from the rate move.