A dozen developed market nations have issued about $17 trillion in negative-yielding bonds — meaning that those who hold them to maturity are guaranteeing themselves a loss, asserts John Bonnanzio, editor of Fidelity Monitor & Insight.
So the obvious question is this: Why own them — especially when U.S. Treasurys offer more safety and higher yields? Just as our own Fed has done, central banks are cutting borrowing costs to institutions to spur growth.
At the same time, investors are nervous about the future, with high prices for stocks and other assets among their concerns. As such, pensions and other institutions are simply paying a premium to have a safe, liquid “place” to stash their cash.
In deflation-prone Japan, where inflation is only 0.6%, around $6 trillion in sovereign debt has been gobbled up. For its part, the European Central Bank has cut its overnight bank lending rate to -0.5% versus 1.50% to 1.75% for the Federal Reserve.
Enter Fidelity’s new International Bond Index Fund (FBIIX). Using statistical sampling to reduce the index’s 6,100 holdings, its goal is to merely mimic the attributes (and ultimately the performance) of a benchmark whose name hardly rolls off the tongue: the Bloomberg Barclays Global Aggregate ex-U.S. Dollar Float-Adjusted RIC Diversified Index (Hedged).
Because the fund was just launched, no holdings data are available, but the index should be a good gauge for metrics. On that basis, the fund is almost entirely invested in foreign developed-market, investment-grade bonds. (Only about 4% is in emerging market debt.) Japan is the biggest country slice (20%), although 57% is in Eurobonds.
And remember all those negative-yielding sovereign bonds? You won’t find them here. Instead, the index (and fund) will be 80% weighted in higher-yielding investment- grade corporates. (Three-fourths of its assets are in bonds rated A and higher.)
So how does International Bond generate an estimated yield of 2%? Its duration of 8.4 years is even longer than Corporate Bond’s 7.4 years, though the latter has a bigger stake in lower-quality bonds.
Partly because of hedging costs, International Bond’s expense ratio is 0.06% versus a slender 0.025% for U.S. Bond Index. But that’s not our primary interest. As with most bond funds, this one will perform best in a falling rate environment.
That explains the index’s year-to-date return of 8.6% — about the same as its U.S. counterpart. And, from a portfolio management standpoint, even with foreign currency hedging, it further diversifies the typical investor’s U.S.-centric portfolio.
Research suggests that over the long-term, a hedged foreign bond fund lowers price volatility while also enhancing risk-adjusted returns. For now, we rate this new offering Hold but may consider it for an upgrade at a later date.
