International Bonding

Includes: AGG, BWX, DJP, EFA, PCY, SPY
by: James Picerno

What's true for stocks also applies for bonds: Most of the planet's debt is issued outside of America. As of this past spring, roughly 53% of the outstanding value of the world's bonds with maturities of one or more years was issued in a currency other than the dollar, according to the Bank for International Settlements.

The implication: diversified portfolios for U.S. investors should have bond allocations that are more or less evenly split between domestic and foreign debt. In practice, it's very few U.S. investors take such a global approach to strategic bond allocations. But shunning foreign bonds is a bet, and a pretty big one, relative to Mr. Market's recommendation.

Yes, putting 50% of your bond allocation into foreign debt may seem extreme, although doing so would merely match the market's mix. Then again, a zero percent allocation to foreign bonds looks severe as well. Diversification, after all, is the only antidote to living in a world where the future's forever uncertain.

Whatever seems reasonable as a bond allocation, there's a strong case for having some exposure to non-dollar debt. That, in essence, is the theme in an article your editor penned for the December issue of Wealth Manager. As a preview, we argue that holding foreign bonds (and their ETF and mutual fund equivalents) denominated in local currencies improves the expected risk-adjusted performance for the long run. For the reasons, read on....