International Bonding

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....

Comments

[JohnB:]

From an investment theory viewpoint, I can see the argument for 50% of bond allocation to international. But I think now wouldn't be the best time to pile in, with the dollar having dropped quite a bit already. "Everyone knows" the dollar is in trouble, so I'm thinking contrarian.

Certainly some international allocation greater than 0% would be prudent. I'd love to see a chart of bond portfolio return vs. risk for various allocations of domestic/international... I've seen such studies for EQUITIES, and usually going from 0% to about 30% international, you are getting higher (historical) returns with less overall risk. That's a no-brainer! Beyond that, both return and risk increases, so the decision isn't so clear cut.

2007 Dec 21 06:02 PM