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I already know, and so ask not, about the benefits and need of bond diversification across different kinds, maturities, and ratings (eg Short- vs Long-term, AAA to corporate).

Global diversification is definitively recommended for stocks, because its benefits have been proven.
But what of global diversification for bonds (eg buying a ETF comprising bonds of many foreign countries?)? Does global diversification for bonds improve a portfolio, compared to buying a ETF of bonds of just one First World country (eg Canada, US, UK)?

  • Global diversification is definitively recommended for stocks, because its benefits have been proven Where did you read that ? Diversifying is recommended but distributing it worldwide, only if you are a big player and have the money and time to expend. – DumbCoder Jun 24 '15 at 13:23
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    @DumbCoder- A lot of Nobel prize winning economists (Eugene Fama, Robert Shiller) and famous investors (Barry Ritholtz, Jeremy Siegel) argue for international diversification. The Vanguard Total International Stock Index and the Emerging Market Stock Index have minimum investments of $3,000, so they're definitely not only for big investors. – Powers Jun 24 '15 at 18:33
  • @Powers Do they say for bonds, which is the question ? And the index you mentioned is for equities I believe and not for bonds. – DumbCoder Jun 25 '15 at 8:50
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Adding international bonds to an individual investor's portfolio is a controversial subject. On top of the standard risks of bonds you are adding country specific risk, currency risk and diversifying your individual company risk. In theory many of these risks should be rewarded but the data are noisy at best and adding risk like developed currency risk may not be rewarded at all.

Also, most of the risk and diversification mentioned above are already added by international stocks. Depending on your home country adding international or emerging market stock etfs only add a few extra bps of fees while international bond etfs can add 30-100bps of fees over their domestic versions. This is a fairly high bar for adding this type of diversification. US bonds for foreign investors are a possible exception to the high fees though the government's bonds yield little.

If your home currency (or currency union) does not have a deep bond market and/or bonds make up most of your portfolio it is probably worth diversifying a chunk of your bond exposure internationally. Otherwise, you can get most of the diversification much more cheaply by just using international stocks.

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The Vanguard Emerging Market Bond Index has a SEC yield of 4.62%, an expense ratio of 0.34%, a purchase fee of 0.75%, and an average duration of 6.7 years. The Vanguard Emerging Market Bond Index only invests in US Dollar denominated securities, so it is not exposed to currency risk. The US Intermediate Term Bond Index Fund has a SEC yield of 2.59%, an expense ratio of 0.1% and an average duration of 6.5 years. So after expenses, the emerging market bond fund gives you 1.04% of extra yield (more in subsequent years as the purchase fee is only paid once).

Here are the results of a study by Vanguard:

Based on our findings, we believe that most investors should consider adding [currency risked] hedged foreign bonds to their existing diversified portfolios.

I think a globally diversified bond portfolio results in a portfolio that's more diversified.

  • Really interesting article though I will add this quote from the conclusion "We’ve shown that on average, the volatility of currencies can overwhelm any diversification benefit that international bonds may bring to a diversified portfolio." There are some currency hedged bond portfolios but those can be prohibitively expensive. – rhaskett Jun 24 '15 at 20:26
  • If I remember SEC yields don't include currency moves though I could be wrong. Based on forward rates EM currencies have expected depreciation rates between 1% to 10% next year that could eat up that yield difference. – rhaskett Jun 24 '15 at 20:32
  • Don't cherry pick statements, they give a wrong conclusion. If you go down to the conclusion in the document they mention the dangers of investing in foreign bonds. – DumbCoder Jun 25 '15 at 8:54
  • @DumbCoder - I agree and I changed the quote, thanks. – Powers Jun 25 '15 at 10:56
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    @rhaskett - The Vanguard Emerging Market Bond Index only invests in dollar denominated securities, so it doesn't have currency risk. It has an expense ratio of 0.34% and a purchase fee of 0.75%, so it's quite expensive, but not prohibitive, especially if the purchase fee is spread over a 10 or 20 year investment. – Powers Jun 25 '15 at 10:59

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