SET Monthly Issue October 2017
THE BEAUTIFUL BOND
It’s the question that smart investors have asked for generations. And even when they don’t get a good answer, investors continue to ask…
“How much of my total portfolio should I put in stocks and how much in bonds?”
If there was an easy answer, we wouldn’t keep asking. But in the absence of an easy answer, here are a few things to keep in mind.
In the United States, bonds have outperformed stocks for a meaningful stretch of time only once (back before the Civil War).
Stocks historically create more wealth than bonds. But there’s always a place in a portfolio for bonds, even right now, with income so tough to pull in… and with so many unanswerable questions about the timing and the degree of interest rate hikes.
Most investors are sticking to short-term bonds. This is clearly a good move.
But it also limits returns, which is why we believe now is a good time to diversify your bond portfolio and add more international bonds.
It’s why this month’s recommendation is The Vanguard Total International Bond ETF (BNDX).
THE CASE FOR INTERNATIONAL BONDS
This isn’t a small or exotic market. International bonds are the single largest slice of the global capital market’s pie. The market is large, liquid, and full of opportunity.
International bonds march to their own valuation drummer. Every country has its own growth rates, currency strength, inflation, yield curves, and interest rate policies.
For example…
What’s happening in Venezuela these days is a lot different from what’s happening in Japan. Japan is a current poster child for solid bonds despite a growing drumbeat of possible political disruption.
The pricing and performance of government bonds have little to do with U.S. bonds, and typically even less to do with U.S. stocks. This disconnect sets the stage for diversification that can benefit just about any portfolio.
And here’s the crux of it.
When you invest in international bonds, you can turn down the volume of risk by lowering volatility and turn up incremental return.
INSIDE BDNX
The Vanguard Total International Bond ETF (BNDX) was launched in 2013. It tracks an investment-grade, bond index.
This index, called the Bloomberg Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index (USD Hedged), is not priced in U.S. dollars. (Quite a mouthful for the name of an index, isn’t it?)
This index is hedged against currency fluctuations to try and maximize returns for investors here in the U.S.
Most of the fund’s investments are in government bonds. Most have an AA rating or better. Vanguard’s management fees are .12%.
The current yield is 1.77% and the YTD return is 1.66%.
THE TOP 5 HOLDINGS
The fund is highly diversified. Typically, less than 3% of its assets represent the top 5 holdings.
| Country | % Bonds | Category Avg. | |||
| Japan | 20.66 | 6.52% | |||
| France | 12.37 | 3.11% | |||
| Germany | 9.25 | 2.03% | |||
| Italy | 8.36 | 2.66% | |||
| United Kingdom | 7.79 | 5.75% | |||
| 07/31/17 | |||||
Maturities are slightly concentrated in short-term bonds…
| Maturity | % Of Bonds | ||
| 1-3 Years | 20.67 | ||
| 3-5 Years | 19.99 | ||
| 5-7 Years | 13.07 | ||
| 7-10 Years | 16.84 | ||
| 10-15 Years | 8.89 | ||
| 07/31/17 | |||
67% of the holdings are government bonds, 15% corporate bonds, with the balance in supernational, agency, and covered bonds.
More than 80% of the bonds are rated AAA, AA, or A. None of the holdings are below B, or not rated.
KEEPING EXCHANGE RATES IN FOCUS
Whenever you make an international investment, you need to keep an eye on the strength of the U.S. dollar.
Right now, the dollar is weaker than it was earlier this year. We’re not going to try and figure out where it goes from here, but we are going to keep in mind that we’re buying foreign bonds priced in foreign currencies.
Are we playing with a weak hand? Is it too late? Would this have been a better investment six months ago when the U.S. dollar was stronger?
Yes and no. Yes, because we would have started off with more bang for our buck. But no, because the performance of any country’s currency is driven by fundamental factors over the long haul.
Ups and downs will hit any country’s currency. Since we’re investing in an ETF that reflects the performance of dozens of countries bonds, their strengths will differ.
FIVE WAYS INTERNATIONAL BONDS COULD GO SIDEWAYS
There’s a reason why international bonds pay a higher yield. It’s the risk.
The risk comes in five flavors:
- Interest Rates… when interest rates go up, the market-price, or the resale value of a bond can tank.
- Inflation… let’s say you invest in a bond that pays 6%. Think of the 6% as a gross. The net, what you actually earn is your 6% minus whatever the inflation rates is. If inflation is 4%, your net payout comes in at 2%. Inflation can flare up quickly and dramatically in foreign countries. The 14% yield on the bond doesn’t look so hot when inflation is 12%.
- Currency… at some point, you’ll want to cash in the ETF and get your money. If your bond is priced in a foreign currency that over time, loses value against the U.S. dollar, your gains will be offset. The exchange rate can work against you. It can also work for you, but that’s frosting on the cake. The Vanguard ETF comes with built in currency hedging to try and reduce these risks.
- Politics… revolutions, coups, and terrorist uprisings aren’t good for business. When you see a high yield on a government bond, behind that yield you usually see a government that’s not exactly stable.
- Repayment… Unfortunately, countries have a nasty habit of going broke. A bond could lose 50% of its value. (Look no farther than Greece.)
To steer clear of the worst of these risks, and to capture the highest yields with a reasonable amount of safety, the trick for investors is to diversify – to invest in different countries, different regions, and in bonds with different maturities.
THE ROLE OF BNDX IN YOUR PORTFOLIO
Bonds give investors two things… liquidity and less volatility. They soften the up and down swings we get with stocks. Bonds are usually not counted on to generate a high return, particularly when they are short term and issued by stable governments.
Junk bonds, where risk and returns are higher, play a different role. So do international bonds.
The well-diversified bond fund usually includes short-term U. S. Treasuries, highly rated corporate bonds, Junk Bonds, and International Bonds.
Trade Alert
Buy: The Vanguard Total International Bond ETF (BNDX) up to $54.60
Recent Price: $54.53
Price Target: $59.00
Stop Loss: $52.50
SECTOR SPOTLIGHT
52 WEEK SECTOR PERFORMANCE
| Consumer Discretionary | XLY | +12.32% | |||
| Consumer Staples | XLP | +3.77% | |||
| Energy | XLE | -9.44% | |||
| Financials | XLF | +12.90% | |||
| Health Care | XLV | +19.48% | |||
| Industrials | XLI | +15.30% | |||
| Materials | XLB | +16.48% | |||
| Real Estate | XLRE | +5.59% | |||
| Technology | XLK | +24.28% | |||
| Utilities | XLU | +10.15% |
PORTFOLIO UPDATE:
INVESTOR GUIDANCE FOR THE FINAL ISSUE
OF SECTOR ETF TRADER
. . . . iShares Latin America 40 ETF (ILF) – BUY
The ETF has been rattled by concerns over the costs of rebuilding in Mexico following devastating earthquakes. Costs could run as high as $4 billion (US). Another set of concerns… the ongoing political uncertainty in Brazil. The current yield is 1.69%.
. . . . Global X Robotics & Artificial Intelligence ETF (BOTZ) – HOLD
The thirst for this corner of the tech sector continues to surge. The ETF is up 12% since our recommendation in August.
. . . . Vanguard Financials ETF (VFH) – HOLD
What a month. On September 7th, the ETF closed at $60.15. Today, it closed at $66.53. What’s been happening? One big factor is a widespread belief that when all the details of tax reform are ironed out, banks will be among the big winners.
. . . . VanEck Vectors J.P. Morgan EM Local Currency Bond (EMLC) – BUY
The ETF has given up ground the past month. On September 8th, it closed at $19.62. Today’s close, $18.92. We invested in the ETF for income, and the current yield is now 5.07%.
. . . . Vanguard FTSE All-World ex-US Index Fund ETF (VEU) – HOLD
Global markets continue to perform well. Current yield is 2.6%. If the U.S. dollar continues its rebound, global stocks may become more attractive based on local pricing.
. . . . SPDR S&P Metals & Mining ETF (XME) – HOLD
It’s a pure play on supply and demand. XME has been moving in the right direction and coming off late Spring lows as global demand for metals rebounds.
. . . . iShares MSCI Switzerland Capped ETF (EWL) – HOLD
For the past month, trading in our “shelter from the storm” ETF has been in a fairly narrow range. Swiss stocks are digesting gains from earlier in the year, and prices are holding. EWL is now paying a 2.13% yield.
. . . . Vanguard REIT ETF (VNQ) – HOLD
We love the 4.75% yield. The price of the ETF has been in a non-stop whipsaw pattern since the beginning of the year.
. . . . First Trust ISE Global Engineering & Construction Index Fund (FLM) – HOLD
Who knows what will happen with infrastructure spending from the Federal Government. In the meantime, the ETF continues to gain ground based on an upswing in global construction activity.
. . . . Vanguard High Dividend Yield ETF (VYM) – HOLD
The yield is now 2.99%, edging back up into the range we expected. It’s the VYM share price which delights us, up by double digits since our recommendation a year ago.
. . . . Utilities Select Sector SPD (XLU) – HOLD
No changes. Continue to hold.
Category: SET Monthly Issues
