International Bonds

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doodle
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International Bonds

Post by doodle » Thu May 12, 2011 7:21 pm

I have made international bonds (mostly emerging markets) a portion of my international exposure through the Templeton GIM and Wisdom tree ELD funds. I am trying to add about 20 percent Intl exposure to the traditional 4 way PP in an effort to avoid the potential for either 1) a Japanese style deflationary low growth / low yield environment that created very low returns for Japanese PP investors during the 90's 2) the potential that the US dollar recedes from its position as the world reserve currency and thus weakens vs. other world currencies.

Does anyone see any advantages / disadvantages to using Intl. bonds to achieve part of this Intl. exposure vs. getting the entire 20% of Intl. exposure through stocks?

It seems that a great deal of the returns from the Intl. bonds depend on currency fluctuations which I can see as a double edged sword.
Nevertheless many of the emerging market countries (Chile, Malaysia, South Korea) in many cases seem to have sounder balance sheets and more fiscal discipline than we do in the west, so I don't know why we should consider US treasury bonds to be any more secure than Chilean treasury bonds....
Last edited by doodle on Thu May 12, 2011 7:23 pm, edited 1 time in total.
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Re: International Bonds

Post by MediumTex » Thu May 12, 2011 8:59 pm

doodle wrote: I don't know why we should consider US treasury bonds to be any more secure than Chilean treasury bonds....
Military and Reserve Currency go a long way toward explaining it.

The relationship between sovereign debt and military strength is subtle but ever-present.  The reserve currency factor is also an obvious boon.
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Re: International Bonds

Post by AdamA » Fri May 13, 2011 12:59 am

doodle wrote: I am trying to add about 20 percent Intl exposure to the traditional 4 way PP.
20% of your PP in foreign bonds?  You might avoid the Japanese scenario this way, but you are also taking on a lot of extra credit risk. 

One thing to keep in mind, the Yen got a lot stronger during Japan's lost decade, so even if a Japanese PP didn't return a lot in nominal terms, it would have done it's job of preserving wealth under deflationary conditions, and you might have been able to buy a lot more stuff with the money you managed to hang on to. 

If the US continues to experience deflationary pressure, there's a pretty good chance that the rest of the world will too.  Do you want to be holding bonds denominated in Euros, Yuans or Pesos if this happens?  I don't.  The default risk is simply too high. 
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Re: International Bonds

Post by mkchiu » Fri May 13, 2011 9:08 pm

I tried to hedge against that with some international stocks, and zero coupon treasuries. I think 20-50% each from the stocks and bonds in the PP.
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Re: International Bonds

Post by BearBones » Sat May 14, 2011 6:48 am

doodle wrote: I am trying to add about 20 percent Intl exposure to the traditional 4 way PP...
mkchiu wrote: I tried to hedge against that with some international stocks, and zero coupon treasuries. I think 20-50% each from the stocks and bonds in the PP.
By including international stocks and bonds in the PP, aren't you degrading the inverse correlation between the traditional assets? The intention of the PP is that one or more assets classes zig while the others zag. By diluting the the bond portion with international holdings to any significant degree, the portfolio may not respond in the way intended during deflationary times, and it becomes "money that you can afford to lose" (i.e., VP) rather than "money you can't afford to lose" (i.e., PP). Ditto for international stocks, real estate, currencies, etc.

I have similar international exposure, but it is done exclusively in a VP.
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Re: International Bonds

Post by doodle » Sat May 14, 2011 8:44 am

I actually hold only about 5 percent of the intl allocation in bonds...the other is in equity.

In terms of the zigging and zagging I view international exposure as another class that zigs and zags independently of the other traditional 4 assets. I would imagine that it should smooth out the line more and potentially increase returns....especially if we were to get into the issue of economic stagnation (ala Japan) or currency devaluation.

I also don't like the idea of a variable portfolio. I guess I just can't get my head around separating my assets like that....it's a mental hangup for me more than anything else. I guess if one is able to truly view the assets as distinct pots than it would work for them.

The only problem with the intl exposure is the "gut check" test which is actually underestimated. That is....would I have the guts to buy more intl equity if there was a sudden crash in emg mkts or Europe? If not, then the idea of using it as a 5th asset class is useless. This is the question I am still asking myself.
Last edited by doodle on Sat May 14, 2011 8:46 am, edited 1 time in total.
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Re: International Bonds

Post by BearBones » Sat May 14, 2011 3:47 pm

doodle wrote: In terms of the zigging and zagging I view international exposure as another class that zigs and zags independently of the other traditional 4 assets. I would imagine that it should smooth out the line more and potentially increase returns....especially if we were to get into the issue of economic stagnation (ala Japan) or currency devaluation.
I do not believe that this is nearly as much a separate class as the others, and this could just as easily degrade returns in the PP rather than increase them. International equities are very correlated with US. And when they do not correlate, it might not be at the time you need them or in the direction you want them. I suspect that this is even more true for bonds than stocks.

Anyone else with more background in economics want to weigh in on this?
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Re: International Bonds

Post by AdamA » Sat May 14, 2011 5:43 pm

BearBones wrote: I do not believe that this is nearly as much a separate class as the others, and this could just as easily degrade returns in the PP rather than increase them. International equities are very correlated with US. And when they do not correlate, it might not be at the time you need them or in the direction you want them. I suspect that this is even more true for bonds than stocks.

Anyone else with more background in economics want to weigh in on this?
Agree completely.  And the tendency towards noncorrelation  tends to disappear in a bear stock market, especially during a crash.
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Re: International Bonds

Post by doodle » Sat May 14, 2011 5:57 pm

That might have been the case in the past, but there is increasingly an argument that international emerging markets are decoupling from western markets. I am not 100 percent committed to my international exposure as I said earlier because i still don't know if I would have the guts to double down on emg market stocks if they suddenly imploded...
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Re: International Bonds

Post by BearBones » Sun May 15, 2011 6:41 am

doodle wrote: That might have been the case in the past, but there is increasingly an argument that international emerging markets are decoupling from western markets. I am not 100 percent committed to my international exposure as I said earlier because i still don't know if I would have the guts to double down on emg market stocks if they suddenly imploded...
Might be true, but there is no way to differentiate "argument" from "fact" in advance. Why not set up a distinct international PP? Then, if your emerging markets stocks implode another component of the portfolio might explode.

As has been stated many times before by others, the PP should be viewed as a whole, not by its individual components. At any given time, at least one component in a diversified, non-correlated portfolio will be doing poorly. The PP construct will force you to use those times to buy low and sell high.
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Re: International Bonds

Post by AdamA » Sun May 15, 2011 6:52 am

doodle wrote: That might have been the case in the past, but there is increasingly an argument that international emerging markets are decoupling from western markets.
I just don't see it.  Look at what happened in 2008.  International and emerging markets plunged just as much (if not more) as the S&P.
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Re: International Bonds

Post by AdamA » Sun May 15, 2011 6:53 am

BearBones wrote: Why not set up a distinct international PP?
Interesting idea.  What country would you use?
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Re: International Bonds

Post by BearBones » Sun May 15, 2011 11:24 am

Adam1226 wrote: Interesting idea.  What country would you use?
Like Clive, I would use index. But, in doing so, I bet that it would be impossible to construct something as safe and non-correlated at the single-country HB PP. For example, couldn't emerging market equities, bonds and currency tank at the same time? And I bet that most of the international bond ETFs have a relatively short duration and/or high default risk.

I have not tried doing this. Instead I just have a separate VP consisting mainly of international stock (biased toward Asia), energy, gold/silver, and my more "risky" (non-treasury) cash vehicles (banks, MM funds). No bond component, since I am betting more toward inflation rather than deflation. Obviously, this is "money that I can afford to lose."
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Re: International Bonds

Post by Pkg Man » Sun May 15, 2011 8:24 pm

BearBones wrote:
Adam1226 wrote: Interesting idea.  What country would you use?
Like Clive, I would use index. But, in doing so, I bet that it would be impossible to construct something as safe and non-correlated at the single-country HB PP. For example, couldn't emerging market equities, bonds and currency tank at the same time? And I bet that most of the international bond ETFs have a relatively short duration and/or high default risk.

I have not tried doing this. Instead I just have a separate VP consisting mainly of international stock (biased toward Asia), energy, gold/silver, and my more "risky" (non-treasury) cash vehicles (banks, MM funds). No bond component, since I am betting more toward inflation rather than deflation. Obviously, this is "money that I can afford to lose."
I tried to construct such a portfolio, and was not very happy with the results.  My investigation was limited, but from what I saw it behaved as you suspected -- the assets seemed to be too correlated.  But I would be interested in hearing from anyone who found something different.
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Re: International Bonds

Post by smurff » Sun May 15, 2011 9:14 pm

"Emerging Markets" covers an extremely wide territory.

All that economic diversity would make it hard to incorporate them into the HB PP--where do you stop?  Do you include both bonds and stocks?  What about currency?  Unless there is a "whole world" index for stocks, another for bonds, and another for currency, it would be hard to incorporate EMs into the PP.  Otherwise you'd become dependent on mutual fund advisers to become bond- and stock-pickers, with all the risk that entails.
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