WASHINGTON — It would be nice — and so, so easy — to ignore what bond markets are doing in Germany, Japan and Zambia. But you shouldn’t.
If you own a bond mutual fund or have a 401(k) account, there’s a good chance that you have foreign-bond investments, even if you don’t know it. That’s because many bond funds have been buying foreign bonds, including some that could serve as the only bond fund in your portfolio. Also, most target-date mutual funds, which have become the default way for many investors to save for retirement, keep small portions of their portfolios in foreign bonds.
Some fund managers are going abroad for diversification, while others are hungry for higher yields than what’s available in the United States. These global bonds, though, come with risks. Bonds from emerging markets offer higher yields but also higher price swings. Changes in the dollar’s value against other currencies can quickly wipe out any returns. In many developed markets, yields are even lower than in the U.S.
“Do people have more foreign bond (investment) than they think? Yes, and it’s very possible that it’s been there a long time,” says Karin Anderson, a senior analyst at Morningstar.
To see how common foreign bonds have become, look at target-date mutual funds. They put investment decisions on autopilot, automatically morphing from a stock-heavy portfolio to a bond-heavy one as the target retirement date approaches. Their ease of use has made them popular, and they control more than $650 billion of total assets.
Nearly 60 percent of the target-date fund series tracked by Morningstar held foreign bonds at the end of 2013, says Janet Yang, director of multi-asset research at Morningstar. Perhaps more importantly, all three of the industry’s biggest players had them. Fidelity, Vanguard and T. Rowe Price control nearly three quarters of all target-date fund assets.
It’s not just target-date funds that are scouring the globe. Bond mutual funds commonly have the freedom to invest as much as 20 percent of their assets outside the United States, Anderson says. Managers have taken advantage, buying bonds from developing economies in particular.
That means you should look at your funds and make sure you’re comfortable with how much and what kind of foreign bonds they hold. Funds typically include a link describing their composition on their websites.
Pay close attention to whether the fund “hedges.” This refers to whether it tries to limit the impact that shifting currency values can have. When the euro, yen or peso fall against the dollar, it can quickly wipe out foreign bonds’ returns.
Some funds invest in currencies to hedge against such risk. Others prefer to remain unhedged, looking to benefit from the boost received when the dollar is falling.
