Fixed-income investors can utilize exchange traded funds to diversify and access global debt markets, but when investing in overseas bonds, investors should consider the negative effects of foreign exchange fluctuations or currency risks.
“Currency has a zero return over the long run and doesn’t bring enough diversification to a portfolio to justify the additional risk,” Rob Bush, an ETF Strategist for Deutsche Asset Wealth, said in a research note.
Bush argued that the case for currency hedging international bonds may be even more compelling than that for stocks, given the low volatility aspect of fixed income securities. Consequently, the additional risk from fluctuating currencies has the potential to make up a greater proportion of overall risk.
“Historically, FX tends not to add return to a portfolio (again, over the long run) but has added risk,” Bush said. “In our view, the only way in which investors might justify the inclusion of currency in a portfolio is if it brings down the risk of the portfolio as a whole.”[related_stories]
However, currencies add risk to a portfolios with international bond exposure. Looking at the rolling volatilities of a hedged and unhedged Barclays Global Aggregate Corporate ex USD Total Return Index since 2002, currency exposure increased volatility in all time periods, notably during the financial crisis.