Currency risk plays a large role in overseas fixed-income positions. Nevertheless, investors can consider an international bond exchange traded fund that hedges against changes in the Forex market to limit potential losses due to a weakening foreign currency.
“Currency risk can make international bonds significantly more volatile than U.S. bonds,” according to Morningstar analyst Thomas Boccellari. “For example, over the past decade, the Barclays Global Aggregate Ex USD Index was more than twice as volatile as the Barclays U.S. Aggregate Bond Index.”
A weakening foreign currency or stronger U.S. dollar translates to lower U.S.-dollar denominated returns in any foreign currency-denominated bond security.
A hedged international bond strategy can help diminish volatility in an investor’s overseas exposure.
For instance, between Jan 28, 2002 and March 18, 2008, the dollar fell 40% against a basket of currencies, which allowed unhedged-currency indices to more than double their hedged-currency counterparts but the unhedged indices experienced greater volatility, or less-attractive risk-adjusted returns.
“The dramatic reduction in volatility that currency hedging offers may allow conservative investors to invest abroad more comfortably and better diversify their interest-rate and credit risk,” Boccellari added.