Investors in the hunt for higher yields have to search far and wide and consider avenues they may not have investigated before. One investment type that may be worth a look is foreign bonds and foreign bond funds.1
Investing in foreign bonds can have a number of advantages, including that the returns from foreign bonds are typically higher than returns offered via U.S. Treasury securities. However, Treasury securities are guaranteed as to the timely payment of principal and interest, which cannot be guaranteed for many foreign bonds. What’s more, the monetary and budget policies of many foreign nations are often unsynchronized with those of the United States, which can help your portfolio diversification.2
There are many types of foreign bonds, both from government entities as well as corporations.
- Eurobonds — A eurobond is a bond issued and traded in a country other than the one in which its currency is denominated — not always a European nation. Eurobonds give issuers the flexibility to choose the country in which to offer their bond according to that country’s regulatory constraints. They are usually issued in more than one country of issue and traded across international financial markets. But they are unsecured, leaving bondholders without the first claim to the issuer’s assets in case of default.
- Global Bonds — A global bond is a type of bond that is issued in multiple markets in different currencies. By issuing global bonds, a government or corporation is able to attract funds from a wider set of investors and potentially reduce its cost of borrowing.
- Sovereign Debt — Issued by national governments, sovereign bonds are generally among the safest investments in most countries. Even if countries are not particularly creditworthy, their sovereign bonds are usually safer than their other domestic alternatives.
- Yankee Bonds – Yankee bonds are U.S. dollar-denominated bonds issued by foreign governments and corporations and sold in the United States. American investors can purchase the securities of foreign issuers without being subject to price swings caused by variations in currency exchange rates. As a result, Yankee bond prices are influenced primarily by changes in U.S. interest rates and the financial condition of the issuer.
As with all types of investments, there are anumber of risks associated with foreign bonds.
- Currency risk — Any time you hold a foreign currency, you are subject to currency risk, which is the potential for loss due to fluctuations in exchange rates. Currency risk can literally turn a profit on a foreign investment into a loss.
- Sovereign risk — This is the risk of a government becoming unwilling or unable to meet its loan obligations, or reneging on loans it guarantees. This risk is especially present in emerging markets, where governments are more likely to be unstable.
- Inflation risk — As inflation rises, bonds that have already been issued lose value in the secondary market. In an inflationary environment, bonds issued more recently are usually more attractive because they’ll often have higher interest rates, as central banks such as the U.S. Federal Reserve and European Central Bank often raise rates in response to inflation fears.
- Interest rate risk –– As interest rates rise, bond prices fall as investors are able to realize greater yields by buying newly issued debt that reflects the higher interest rate.
- Liquidity risk — As with many U.S. corporate bonds, it can be difficult to find a buyer for an international government or corporate bond.
Which foreign bonds or bond funds best complement your portfolio will depend on a number of factors, including your existing holdings and appetite for risk.
1Investing in mutual funds involves risk, including loss of principle.
2Diversification does not ensure a profit or protect against a loss.