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Vanguard's international bond ETF gets a due date

Feb 6, 2013 @ 11:21 am

By Jason Kephart

ETFs, bonds
+ Zoom
(Bloomberg)

It's been a long time coming, but The Vanguard Group Inc. is finally ready to bring its international bond exchange-traded fund to investors.

The firm announced today it will launch the Vanguard Total International Bond Index Fund during the second quarter. Vanguard had originally filed paperwork to launch the fund in October of 2011.

It will be the first ETF to offer investors a blend of investment-grade sovereign and corporate bonds in a single index. It also will be the first international bond ETF to hedge out the currency of its underlying bond holdings.

“We really think the primary purpose of our bond allocation is to act as a diversifier to equities,” said Fran Kinniry, a principal in the Vanguard Investment Strategy Group. “If you look at the difference between hedged and unhedged non-U.S. bonds, the currency fluctuation is so dominant, you primarily have a currency fund.”

By hedging out the currency, investors are treated to a purer exposure to the interest rate and inflation environment outside of the United States, Mr. Kinniry said.

“You end up with a much more broadly diversified portfolio with bond risks and return characteristics,” he said.

Currency can have a very meaningful impact on returns, as investors in Japanese stocks have found out recently. With the Bank of Japan making moves to devalue the yen, the falling currency has taken a big bite of out returns.

From Nov. 14, when the yen's more than 20% slide versus the U.S. dollar began, through Jan. 25, the $5 billion iShares MSCI Japan Index ETF (EWJ) has had a return of 13%. Its currency hedged counterpart, the $2.7 billion WisdomTree Japan Hedged Equity ETF (DXJ), has had a return of more than 30%.

Of course, if the yen was rising, the returns would likely reverse.

“Hedging the currency may sometimes be a good idea, and other times you'd wish you had it,” said Mariana Bush, an ETF analyst at Wells Fargo Advisers. “At least now investors have an option.”

More options on the fixed-income side couldn't come soon enough for advisers. The possibility of rising interest rates, and the losses they would cause U.S. bonds, has caused runs into more esoteric fixed-income classes like high-yield and emerging markets. Those might not provide the protection bonds are used for, Mr. Kinniry said.

“We think carefully about what our bond looks like,” he said. “We want it to complement our equity risk. A lot of investors have gravitated to high-yield, emerging markets, or unhedged international bonds. Those may not hold up as well when equities are in a bear market.”

Vanguard plans to add the international bond ETF to its asset allocation funds, which include the Vanguard Retirement Funds and LifeStrategy Funds. Each of the funds will place 20% of its fixed-income allocation in the ETF.

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