An investor’s key guide to international bond funds (Part 1 of 7)

An investor’s must-know guide to international bond funds

Why invest in international bond funds?

International bond funds are funds that invest in debt issued overseas, either by foreign governments or corporates or both. These funds invest either in local currencies or U.S. dollar–denominated debt securities. International bond funds can provide viable alternatives for portfolio diversification by spreading interest rate and market risks over a wider geography.

Advantages of international bond funds

• Low and negative correlations with U.S. stocks (SPY ) and bonds (TLT ) help smooth portfolio returns. When the returns on one asset are below par, this would be compensated for by higher returns on those assets that have a low correlation with the assets, all else being equal. For a detailed overview of the correlations between international bond funds and ETFs investing in US stocks and bonds, please refer to Part 5 of this series.
• International bond portfolios have relatively low volatility compared to international stock portfolios, primarily due to the fixed income component that helps smooth returns. Besides, sovereign bond funds invest in debt issued by foreign countries, which is more often than not backed by the full faith and credit of the issuing country.
• Investors with a higher risk appetite can invest in international bond ETFs with exposure to emerging markets like the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB ), which offer higher returns.

In this series, we’ll compare the historical performance of international bond funds like the PowerShares Emerging Markets Sovereign Debt Portfolio (PCY ) with that of domestic funds investing in U.S. Treasuries. We’ll also compare the performance of domestic corporate bond funds with international corporate bond funds like the Invesco PowerShares International Corporate Bond Portfolio (PICB ).

We’ll compare ETF performance using metrics that are important to investors: total returns earned, the risks taken to earn them, and the Sharpe Ratio, which is a measure of risk-adjusted returns that tells us whether the returns earned by an ETF are commensurate to the risks taken to earn them.

To read about the impact of the Fed’s monetary policy and the outlook for the domestic fixed income market, please continue to Part 2 of this series.