Must-know variants in developed market international bond funds

International bond funds can have different stated investment objectives

International bond funds like the Vanguard Total International Bond Index ETF (BNDX) can have various investment styles determined by their stated choice of bond investments. The fund prospectus will state the index tracked by the ETF and the type of bonds covered in the index, characterized by the management style (active versus passive), type of issuer (sovereign or corporate), credit ratings, interest rate (fixed or floating), and currencies in which the bonds are denominated. To learn more about managing bond portfolios, please read the Market Realist series Investing in fixed income: What motivates bond investors?

Types of international bond funds

Major international bond fund types are usually categorized among the following.

• Developed and emerging markets bond funds
• Sovereign and corporate bond funds
• Investment-grade and high-yield bond funds

Developed market bond funds

Developed market international bond funds, as the name suggests, invest in bonds whose issuers are based in the advanced economies of the world—like Japan, Germany, and Australia. These funds exclude bonds issued by the U.S. Treasury and by American companies included in ETFs like the iShare Core Total Bond Market Fund (AGG). Developed market bond funds can be of two types: sovereign bond funds and corporate bond funds.

Sovereign bond funds

Developed market sovereign bond funds invest in bonds issued by foreign governments of developed economies. As these funds invest in highly rated issues, the yield is often low. However, these bonds often provide safe havens for investors during times of market stress, which can result in significant capital appreciation for the underlying bond portfolio in a short space of time. These are arguably the least risky of all international bond funds, because the underlying bonds are investment-grade and usually backed by the full faith and credit of the issuing foreign governments. However, although these funds have low credit risk, they’re still subject to interest rate risk, inflation risk, country risk, and currency risk.

Popular ETFs providing exposure to sovereign bonds issued by governments of developed economies include the iShare International Treasury Bond ETF (IGOV). IGOV tracks the S&P/Citigroup International Treasury Bond Index ex-U.S., which is composed of investment-grade developed-market government bonds. IGOV component bonds are denominated in local currencies—like the euro, Canadian dollar, et cetera. With an expense ratio of 0.35%, IGOV has net assets of ~$621 million (as of April 30).

Corporate bond funds

Developed market corporate bond funds, as the name suggests, invest in corporate bonds whose issuers are companies headquartered in developed countries outside the U.S. Examples of such ETFs include the Invesco PowerShares International Corporate Bond Portfolio (PICB). PICB tracks the S&P International Corporate Bond Index. The index measures the performance of investment-grade corporate bonds issued by non-U.S. issuers in the Australian dollar, British pound, Canadian dollar, EU euro, Japanese yen, Swiss franc, Danish krone, New Zealand dollar, Norwegian krone, and Swedish lrona. With an expense ratio of 0.5%, PICB has net assets of ~$230 million (as of April 30).

Some ETFs like the SPDR Barclays International Treasury Bond ETF (BWX) provide exposure to bonds issued by foreign governments that are rated investment-grade, irrespective of whether they’re from developed or emerging markets. BWX tracks the Barclays Global Treasury ex-U.S. Capped Index. The index is composed of fixed-rate, local currency, sovereign debt of investment-grade countries outside the United States. BWX invests “at least 80% of its total assets in the securities comprising the index or in securities that the Adviser determines have economic characteristics that are substantially identical to the economic characteristics of the securities that comprise the index.” With an expense ratio of 0.5%, BWX has net assets of ~$2.36 billion (as of April 30).

In the next part of this series, we’ll discuss the more popular variants of emerging market bond funds. Please read on.