Ask the Spud: Should I Use Global Bonds?

Q: I was surprised to see a Vanguard infographic pointing out that international [non-US] bonds are the largest asset class in the world. Do you have any thoughts on why Canadians have not embraced international bonds in their portfolios? – A.M.

While stocks grab all the headlines and dominate the conversation among investors, the bond market is vastly larger. Yet while a diversified index portfolio can include 10,000 stocks from over 40 countries, chances are your bond holdings are entirely Canadian.

There are some good reasons for a strong home bias in bonds. The main one is currency risk. Exposure to foreign currencies benefits an equity portfolio by lowering volatility (at least for Canadian investors), but taking currency risk on the bond side is usually unwise. Because currencies are generally more volatile than bond prices, you’d be increasing your risk without raising your expected return. That’s a bad combination.

It also gets to the heart of why few Canadians have international bonds in their portfolios: there just aren’t many good products offering global bond exposure without currency risk. iShares and BMO have a number of ETFs covering US corporate and emerging markets bonds. But if you wanted to build a low-cost, diversified, currency-hedged portfolio with high-quality bonds from around the world, it was hard to do so until this summer. The wait ended in June with the launch of the Vanguard U.S. Aggregate Bond (VBU) and the Vanguard Global ex-U.S. Aggregate Bond (VBG), both of which are hedged to Canadian dollars.

(Another option is the global fixed income funds from Dimensional Fund Advisors, but these funds are not available to do-it-yourself investors.)

Now that international bonds are available to all Canadian investors, should you rush to build a globally diversified fixed income portfolio? For most people, the answer is probably no. The benefits of holding non-Canadian stocks is enormous, as equity returns vary widely from country to country. But the diversification benefit of international bonds is likely to be much more modest. Here’s how the broad Canadian bond market stacked up against a global index over various periods ending in July 2014:

Canadian Global
1 year 5.80 5.95
3 year 4.33 5.07
5 year 5.19 5.11
10 year 5.52 4.89
Since February 1999 5.73 5.18
Source: FTSE TMX Canada Universe Bond Index (formerly the DEX Universe Bond Index) and Barclay’s Global Aggregate Bond Index (Hedged to CAD). Data from Dimensional Returns 2.0.

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If you’ve got $100,000 and a 30% allocation to bonds, a global bond holding is probably not worth the added complexity and cost. But the argument for adding global bonds is much stronger for those with very large portfolios and a higher allocation to fixed income. Say you have $2 million and a target asset mix of 70% bonds and 30% equities. Now your fixed income allocation is a hefty $1.4 million, and a shock to the Canadian bond market would deal a swift kick to your net worth. In that situation it might make sense to divide that among Canadian, US and international bonds to reduce your risk.

 

 

57 Responses to Ask the Spud: Should I Use Global Bonds?

  1. Canadian Couch Potato November 8, 2015 at 3:32 pm #

    @JWW: HTB does not hedge currency, so I would not recommend it unless you specifically needed exposure to the USD dollar in your fixed income (for example, if you happen to have future obligations in USD). The problem is, if all of your holdings need to be in taxable accounts then your options are very limited, because the only global bond index ETF that hedges to CAD is VBG, and it is not tax-efficient. With that in mind I would say any diversification benefit from global bonds would be outweighed by the tax disadvantage.

  2. meera April 20, 2016 at 4:36 pm #

    Thanks for the site lots of usefulness imfo, just stumbled upon this post.

    What about for someone who is planning on either retiring or spending half time overseas. If you knew that you had a specific country in mind you could buy bond etf hedged to their currency? If you didnt have a specific location but knew it wasnt Canada, is this a case where unhedged global bond fund would make sense? Holding 50% of portfolio in Cdn bond etf if a significant portion of retirement expenditures will be non-cdn seems like a really big bet on Cdn dollar?

  3. Canadian Couch Potato April 20, 2016 at 4:41 pm #

    @meera: In theory, yes, it makes sense to hold a portion of your assets (maybe a large portion) in the currency where you expect to have your future liabilities. In practice, though, I am not sure how one would set this up unless the foreign country was the US. It is not possible to get any meaningful exposure to other foreign currencies using fixed income ETFs in Canada.

  4. meera April 20, 2016 at 10:03 pm #

    @ccp

    Thanks for your reply! What if one were to buy something like vanguards new etf VETY on LSE? As a canadian am i eligible to buy these etfs? I think TD DI lets me trade on LSE but have nevee tried

  5. Canadian Couch Potato April 21, 2016 at 10:14 am #

    @meera: I believe that TD and a few other brokerages (such as HSBC) do allow you to trade on foreign stock exchanges, but be aware that the fees and commissions are likely to be quite high.

  6. calyth September 15, 2017 at 4:28 pm #

    Similar to the question I’ve asked before (on a different) regarding USD income and choosing USD index-equity funds, what’s your take on buying bonds outside the Canadian market?

    If I have access to USD, and now isn’t a particularly great time (compared to a year ago) to convert to CAD, would it make sense to buy some BND and BNDX?

  7. Canadian Couch Potato September 16, 2017 at 8:58 am #

    @calyth: I do not recommend taking current risk in fixed income. If you have USD, it is generally preferable to use it to buy US and international equity ETFs and to keep your fixed income in CAD.

    http://canadiancouchpotato.com/2012/03/01/ask-the-spud-should-i-hold-us-bonds/

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