Making your bond-fund portfolio less risky requires doing something that can feel like living dangerously: investing abroad.
If you’re like most people, you may have put too much of your money in bond funds invested in your home market and so failed to spread your bets around.
“People are used to thinking about diversification in their stock portfolio, and they understand how that works to control the risk,” said Rob Waldner, chief strategist for fixed income at Invesco. “You need to do that with your fixed income, too.”
Bond diversification matters all the more when traditional income producers like U.S. Treasuries are paying measly rates, he said.
1.7 percent in early April, compared with less than 1 percent in January. But rates are likely to remain relatively low by long-term standards.
Bonds come in a variety as rich — and sometimes baffling — as the screw-and-fastener aisle at Home Depot.
A well-diversified portfolio might include mutual funds or exchange-traded funds that buy bonds issued by the United States and foreign governments, and large U.S. and foreign companies, as well as ones backed by mortgages, auto loans or credit-card receivables in the United States. (Pools of these financial assets are securitized, and rights to payments from the pools become mortgage-backed and asset-backed bonds.)
“Home bias” is the financial term for people’s tendency to over-invest in their home market and shy from other places. Investment experts say it’s pervasive.
“It’s something we observe in every country,” said Roger Aliaga-Diaz, global head of portfolio construction at Vanguard.
Vanguard’s research has found that international bonds reduce portfolios’ ups and downs without hurting the total return. Internationally diversifying can provide access to securities from more than 40 countries.
“This broad exposure is important, as the factors that drive international bond prices are relatively uncorrelated to those that drive prices in the U.S.,” the report said. Lately, for example, South Korea’s 10-year government bond is yielding 2 percent, while Mexico’s is yielding nearly 7 percent.
The international bond slice of Vanguard’s target-date funds is invested in the Vanguard Total International Bond Index Fund, which owns mainly developed-world bonds. Like many international bond funds, it uses hedging to protect its shareholders against the return volatility that currency fluctuations can cause.
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Jean Boivin, head of the BlackRock Investment Institute, said his outfit’s research suggests that investors may want to be bold in their foreign bond forays and look beyond developed markets.
“You need to think about emerging-market bonds and, in particular, Asia ex-Japan,” he said.
In the past, investors could view the U.S. bond market as a proxy for the world, partly because U.S. companies often had sprawling international operations, Mr. Boivin said. But there is enormous global diversity today. Foreign markets, especially China, have risen so much that this approach doesn’t work as well.