International Bond ETFs' Correlation to Equities

There was a recently a Good article from Tom Lydon at ETF Trends detailing some of the International Bond ETFs on the market. I normally like international bond exposure as a source of diversification, so to show the diversification effects I went to Assetcorrelation.com, which is a free website. I compared the 4 international bond ETFs/closed end funds Lydon mentions in his article (BWX, BWZ, JGT, and WIP) to SPY (the S&P 500 ETF), EFA (the EAFE, or international equity ETF) and IEF (7-10 US Treasury ETF).

IEF, the US Treasury ETF, still showed signficantly lower correlation to SPY and EFA then the international bond ETFs. During the 'panic' of 2008, investors fled to treasuries while everything else dropped like a rock. Thus, investors diversified in US Treasuries helped cushion any blow to the rest of their portfolio. In addition, a moving average system like the one's tracked at Scott's Investments would have helped cushion additional drawdowns to one's equity portfolio.

The problem with the backtest is that data for one of the ETFs, BWZ, only goes back to 1/30/09. Thus, it is a relatively short period to test correlation. I ran a second correlation matrix eliminating BWZ from the list. That matrix goes back to 3/19/08, when WIP started trading. This second test shows less correlation between SPY/EFA and the international bond ETFs. JGT, a closed-end fund, appears to be the most correlated to SPY and EFA among the three. However, IEF still has the lowest correlation to SPY/EFA and is significantly less correlated to the pair then the international bond ETFs.

The results back to 1/30/09:

BWZ only has a stock history since 2009-01-30. Shortening period accordingly.

Custom Correlation Matrix

The following table shows return correlations between the assets you entered for the past 224 days.

			SPY	EFA	IEF	BWX	BWZ	JGT	Return	StdDev
	S&P Dep Receipts	SPY							49.8%	1.8%
	Ishares Msci Eafe	EFA	0.93						81.5%	2.1%
	Ishares Barclays	IEF	-0.31	-0.27					-1.9%	0.7%
	Spdr Barclay Intl	BWX	0.33	0.47	0.24				24.5%	0.7%
	Spdr Barclay Tsy	BWZ	0.36	0.51	0.12	0.72			24.2%	0.7%
	Nuveen Mul Cur St	JGT	0.51	0.54	-0.13	0.18	0.35		63.0%	1.1%
	Spdr Db Int Gov B	WIP	0.45	0.58	0.11	0.70	0.70	0.33	39.0%	0.8%
	Portfolio								39.1%	0.8%

WIP only has a stock history since 2008-03-19. Shortening period accordingly.

Custom Correlation Matrix

The following table shows return correlations between the assets you entered for the past 541 days.

			SPY	EFA	IEF	BWX	JGT	Return	StdDev
	S&P Dep Receipts	SPY						-11.5%	2.4%
	Ishares Msci Eafe	EFA	0.94					-12.1%	2.8%
	Ishares Barclays	IEF	-0.39	-0.34				2.6%	0.6%
	Spdr Barclay Intl	BWX	0.13	0.26	0.25			2.0%	0.9%
	Nuveen Mul Cur St	JGT	0.62	0.60	-0.24	0.25		8.5%	1.9%
	Spdr Db Int Gov B	WIP	0.28	0.38	0.04	0.64	0.38	-4.0%	1.1%
	Portfolio							-2.3%	1.2%

Disclosure: No Disclosures

Comments

[Indexor:]

Here's a thought:

Take each of the four foreign bond ETFs you mentioned - BWZ, BWX, JGT and WIP - and compare each one to UUP (PowerShares US Dollar Bullish) on a charting service, such as stockcharts.com. You will find each of the foreign bond ETFs have a strong negative correlation to UUP.

While we are always looking for issues that provide additional diversification through negative correlation, do you find that foreign bonds are simply a good diversifier because of their currency "effect?" In other words, as long as the dollar continues to weaken, foreign bonds should provide both diversification and alpha. But if the US dollar begins to strengthen, won't foreign bonds prove to be much less of a diversifier and produce negative alpha just when global stocks are also entering a downward trend?

Sep 13 06:11 PM

[Scott's Inv...:]

Hi, Good suggestion, I published an article similiar to the one you suggested: "Dollar Correlation to Global Bonds"

Sep 21 05:54 PM