Most investors understand the value of foreign stocks in equity portfolios—diversifying can provide higher returns and fewer ups and downs because worldwide markets don’t always move in unison. That can also work with foreign bonds, which make up more than half of the global bond market. In 2022, the US bond market had its worst year ever, and returns through the first nine months of 2023 were negative. These fluctuations don’t matter if you are holding individual bonds to maturity, but if you invest through a broad bond exchange-traded fund (ETF), foreign bonds not only outperformed their US counterparts in both years but have averaged nearly one percentage point more annually over the past decade and with less volatility.
But there are caveats to owning foreign bond ETFs…
Choose a low-cost ETF that hedges currency risk. Most foreign bonds trade in their native currency. (Note: All the ones below hedge.)
Decide how much volatility you can accept. If you want a broad-based fund with less ups and downs: Vanguard International Bond Index ETF (BNDX) owns more than 7,000 bonds, mostly government debt from major European nations.
If you are willing to accept slightly more volatility for higher returns: iShares Core International Aggregate Bond ETF (IAGG) holds more than 4,800 bonds with a 20% exposure to emerging markets, mostly Chinese government debt.
Determine how much international versus US exposure you want. If you’d rather not make that choice: Vanguard Total World Bond ETF (BNDW) offers one-stop shopping with 50% of assets in foreign bonds and 50% in US bonds. But studies show that to get adequate diversification, US investors should start out with a 30% allocation to foreign bonds.
