The recent panic over the dreaded Federal Reserve “Taper” sent bonds the world over tumbling.
While both U.S. Treasury and corporate bonds dropped the real carnage was in global bonds and especially emerging market bonds. Emerging market bonds dropped nearly 15 percent. So why would someone in their right mind want to take a look at investing in this asset? After all, bonds are generally considered to be “safe” investments, and a 15% drop doesn’t sound all that safe. Throw into the mix that there is an added risk when investing in global bonds and that’s currency risk.
All is well when the U.S. dollar is weak, but as it begins to strengthen the value of these bonds can drop as well.
This is what happened in the recent market turmoil.
Currencies that had been considered safe and strong suddenly got crushed to the tune of 15%-20% in a very short time period. So again I ask why would someone want to invest in this? Well, because of the old investing rule; buy low and sell high.
Does this recent rout portend a bigger trend, or is the move destined to be short-lived? There is no real way to answer that question.
My mother used to be fond of saying that “prophecy was given to fools.” Trying to predict currency behavior over the short term is near impossible.
What should we do?
For investors who need some more income to meet their retirement goals, or who are looking to diversify the fixed-income part of their portfolios, it may be time to start thinking global.
For fixed-income investors, the 1%-2.5% that bonds are yielding doesn’t cut it. To generate much-needed income, investors have turned to high-yielding, dividend- paying stocks that, despite their current popularity, are ultimately stocks and can get crushed like any other stock (turn the clock back 15 years to Citigroup and General Electric).
As such, investors may want to take advantage of cheap currencies and higher yields. If a 2% return is not enough to meet your needs, take a look at bonds that trade in foreign currency. While it used to be difficult to buy these bonds, nowadays most brokerage firms have the ability to purchase bonds in various currencies.
For example, a highly rated [AAA] bond in Brazilian reals can yield over 6%. A similar bond in Australian dollars will be over 4%. What makes these bonds even more attractive is that the currencies have been creamed of late against the U.S. dollar; not only do you get the high interest rate, you also have the potential to profit from the appreciation in the currency if some normalcy returns to the market.
If you can get a 4%-6% interest rate and a stable or appreciating currency, you are way ahead of the game and will be able to meet your retirement goals with even less than $1 million in the bank.
For investors who want this exposure but are gun-shy about actually buying foreign-currency bonds, there are plenty of exchange-traded funds out there that can do the job. The iShares S&P/Citigroup International Treasury Bond Fund (NASDAQ:IGOV) or the iShares JPMorgan USD Emerging Markets Bond Fund (BATS:CEMB) are both worth looking at.
Global bond funds
For investors who would rather not speculate in specific currencies, but would prefer professional management as opposed to the more-passive ETFs, one can invest in a global or an emerging market bond fund. This is a managed portfolio of bonds that are denominated in multiple currencies.
The advantage of this route is that there is a paid manager who is an expert in currencies who manages the portfolio for you. In addition, since it’s a bond portfolio, you also get monthly interest payments. However, be aware that a fund like this can also lose money and is not guaranteed.
It is important to note that past performance is no indication of future results, and with both of these options, if the U.S. dollar gets stronger against the world’s major currencies, you can end up losing money. I am not saying to put all of your net worth in these types of currencies, but some exposure can potentially make a big difference in your retirement.
Speak to your financial adviser to see if you can enhance retirement income by incorporating foreign bonds into your portfolio.
Disclaimer: The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates.