Negative yields find their way into U.S. investor portfolios

Some bond index funds have no choice but to maintain large weightings in bonds with negative yields

Sep 30, 2019 @ 3:13 pm

By Jeff Benjamin

A migration toward a globally diversified bond allocation could be exposing fixed-income investors to the world's unprecedented $15 trillion worth of negative-yielding government debt.

Last week, the $23 billion Vanguard Total International Bond ETF (BNDX) led all exchange-traded funds with $2.3 billion in net inflows, perhaps in response to the current geopolitical environment or just regular quarter-end rebalancing.

What investors and financial advisers might not fully appreciate is that the ETF tracks an international bond index that is heavily weighted in government bonds offering negative yields, which means investors are paying for the privilege of owning the security.

According to Vanguard, as of June 30, the fund's top three country allocations — Japan, France and Germany — combined to make up 40.7% of the fund. The yields on the government bonds issued by all three of those countries are negative.

BNDX, which has a year-to-date total return of 9.35%, has a 30-day SEC yield of just 37 basis points, reflecting the drag created by negative-yielding bonds.

"The income component that investors tend to look for with international bond strategies is not being offered in the current environment," said Todd Rosenbluth, director of mutual fund and ETF research at CFRA.

"It's counterintuitive that investors continue to add to this product given that the yield is minuscule, and these are primarily U.S. investors," Mr. Rosenbluth said.

BNDX isn't the only international bond index fund exposing investors to negative yields.

The $1.8 billion iShares Core International Aggregate Bond ETF (IAGG) tracks an index that is has an allocation of more than 28% to negative-yielding bonds.

IAGG, which has a 9.58% total return so far this year, has an SEC yield of 63 basis points.

The $167 million Vanguard Total World Bond ETF (BNDW) is more than 32% allocated to countries issuing negative debt, but because it is a global fund it is also anchored by a 43.2% allocation to U.S. Treasury bonds. BNDW, which has a 9% total return so far this year, has a more respectable SEC yield of 1.82%.

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Some institutional investors have mandates that require them to hold government bonds, which forces them to buy negative-yielding debt. But individual investors face no such requirement.

In an email response, Josh Barrickman, Vanguard's head of fixed-income indexing in the U.S., pointed out that Vanguard's international bond index fund invests on a U.S. dollar-hedged basis, "which in the current environment tends to add additional return to the fund."

"Though global bond yields are unusually low, investor may still allocate to high-quality bonds as a ballast against riskier assets within the portfolio, and not just for yield," Mr. Barrickman said. "Even at low or negative yields, bonds are expected to soften excessive volatility in equity markets."

Karen Schenone, fixed-income strategist at iShares, also defended allocations to funds loaded with negative-yielding bonds.

"The fund has positive performance because bond yields have fallen, and that drives positive price returns," she said. "While the income isn't stellar, we have seen a lot of positive price return."


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