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In Australia, many investors fail to reap the benefits of geographical diversification. The international fixed income market is more than 10 times larger than the Australian market and offers a greater variety of sectors and industries. As foreign fixed income instruments are generally denominated in the base currency of country of origin, the primary deterrent of international fixed income is usually currency risk. If an investor were to invest in a foreign instrument, they would have exposure to the underlying security but would also have an implied position in the relevant exchange rate. This is because income received would need to be exchanged back into Australian dollars at some point in the future.
One solution investors could consider is iShares (owned by Blackrock) and Vanguard’s suite of international fixed income exchange-traded funds (ETFs).
These tradable products allow investors to gain access to international fixed income indices in the absence of currency risk which is hedged out using other financial instruments. As these are ETFs, investors are able to gain exposure to broad international fixed income benchmarks rather than individual securities resulting in significant diversification benefits both across sectors and geographical regions. These products include:
- iShares Core Global Corporate Bond (AUD Hedged) ETF (ASX: IHCB)
- iShares Global High Yield Bond (AUD Hedged) ETF (ASX: IHHY)
- iShares J.P. Morgan USD Emerging Markets Bond (AUD Hedged) ETF (ASX: IHEB)
- Vanguard International Fixed Interest Index Fund (Hedged) (ASX: VIF)
- Vanguard International Credit Securities Index Fund (Hedged) (ASX: VCF)
For investors wishing to access broad international fixed income markets, the iShares Core Global Corporate Bond ETF tracks the Barclays Global Corporate Aggregate Bond Index which is the primary benchmark used to measure global corporate bond performance (investment grade). On the other hand, the Vanguard International Fixed Interest Fund ETF tracks the Barclays Global Treasury Index and the Vanguard International Credit Securities Index ETF tracks the Barclays Global Aggregate Government-related and Corporate Index. As a result, these products allow investors to gain exposure to both corporate and sovereign overseas issuers which would otherwise be out of reach.
However, for more experienced investors or those with a greater risk appetite, the iShares Global High Yield Bond ETF tracks the Markit iBoxx Global Developed Markets Liquid High Yield Capped Index (high yield exposure) and the iShares J.P. Morgan USD Emerging Markets Bond ETF tracks the J.P. Morgan EMBI Global Core Index (emerging markets exposure).
Figure 1. Historical Indexed Performance of iShares International Fixed Income ETFs
Although these products have been recently hit hard by the outcome of the presidential election (which sparked a global sell-off in bond markets), year-to-date performance has been solid as at 31st October 2016. The iShares Emerging Markets ETF has been the standout performer, returning 13.45%. The iShares High Yield ETF has also had a strong year returning 12.19%. The Core Global Corporate Bond ETF which is the most conservative iShares ETF has returned 8.08%. The Vanguard International Fixed Interest ETF and International Credit Securities ETF have returned 6.31% and 7.48% respectively. This compares to the ASX200 which as returned 2.22% year-to-date.
Overall, these products are a step in the right direction for investors to diversify away from the Australian fixed income market. Foreign wholesale securities typically out of reach to retail investors are now readily available with significant diversification benefits. While we currently have no recommendations on these types of products, we believe they should be considered within the context of a balanced diversified fixed income portfolio.
Click here for an introduction to fixed income ETFs and list of available products on the ASX.