While U.S. investors have achieved diversification in their domestically focused portfolios mainly through international equities, they are increasingly considering global bonds. In the past decade, there’s been substantial growth and maturation of world bond markets, combined with the ongoing globalization of businesses and capital flow, according to Vanguard.
International bonds now make up more than 35% of the world’s investable assets, and yet many domestic investors have little or no exposure to these securities, the fund family says in a recent research report, which examines the strategic case for an allocation to international bonds by addressing the possible diversification benefits, risks, and costs.
For the average investor seeking to further mitigate volatility in a diversified portfolio, the Vanguard analysts — led by Christopher Philips — find that foreign bonds can play such a role, assuming that the currency risk inherent to this asset class is hedged. Though there is currently not an optimal allocation for all investors, the research shows that having some exposure can be better than having none.
At the same time, however, a home bias in bond portfolios may be defensible on grounds other than the pure question of diversification; thus, the report concludes, investors considering international bonds should “balance the diversification benefits against both the costs involved and the benefits inherent to preserving a core allocation to the U.S. bond market.”