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I disagree with Ben Felix and Vanguard on this topic of foreign bonds. The PWL position is that the investor should hold a small amount of foreign bonds, currency hedged to eliminate the FX risk.

The reason I don't like this is that ETFs and mutual funds have a very poor track record in currency hedging. With vehicles like XSP and XIN (long histories) the "cost of hedging" using derivatives worked out to something like 0.5% to 1.0% annual performance loss. Tremendously inefficient!

If you hold domestic bonds using XBB/VAB/ZAG you have a portfolio of efficiently held securities at just 0.10% MER. Maybe something like 0.15% total fees once you add in trading costs.

But if you hold foreign, currency hedged bonds (as PWL suggests) then you're probably looking at 0.3% to 1.0% total fees, once you include the inefficiencies and spreads of the currency derivatives required. I just don't think it's worth it. The problem will flare up when bonds become more volatile, which they just did in 2020.

Anyway, I don't hold any foreign bonds, because I don't like ETFs which use complex derivatives.
 

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A quick look finds only currency hedged funds. I generally eschew currency hedging in equity funds. How cost effective is the hedging? I am used to it being expensive in MER, but relatively ineffective. Is there something about bonds that makes hedging cheaper and more accurate? Are there unhedged global bond funds worth owning?
You are correct, they are inefficient. It's not exactly a fee, but rather, various kinds of inefficiency and friction due to trying to match the FX derivatives (swap contracts) to the underlying positions. And then having to adjust the FX derivatives when there are fund inflows & outflows, plus index changes.

I think the people pitching these (like Vanguard) will argue that currency hedging will be more efficient with bonds since volatility is low, compared to equities.

My counter argument to that is that, yes maybe in normal circumstances, but bond volatility can happen. We just saw foreign bonds crash about 25% in March followed by a 25% rally. Are they really less volatile than equities?

And the fund manager had to keep tracking FX derivative positions through all those movements. That's while the bond market had seized up (illiquid) plus derivative volatility premiums went through the roof at the same time.

There's no way that FX hedging on foreign bonds was efficient this year, and bond volatility may continue. I think it's going to turn out to be just like XSP and XIN; the currency hedging is inefficient, too big a (hidden) cost.

I think Vanguard is just trying to innovate/create something new, based purely on theory. I think they will find out it's very different in reality.
 

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At one time, I had a look at buying individual foreign bonds. Interest rates across the world vary a lot, even those in reasonable stable countries. However, I didn't find much. Foreign bonds are not readily available for our on-line accounts.

Only bonds I found that could be traded here were the so called Maple or Yankee bonds. And not many were available through on-line brokerages. (Verizon issued Maple bonds recently. )These are bonds of foreign companies issued in Canada or USA. Other countries have similar bonds, but I don't think we can easily trade them. (e.g. eurobonds, Matador bonds, Kangaroo or Matilda bonds, Samurai bonds, Bulldog bonds, Sushi bonds , Shogun bonds , Dragon bonds, Dim Sum bonds, etc.

There are the issues of hedging and of liquidity. Hedged foreign funds seemed only way to go, but haven't gone there.
 

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Without currency hedging, foreign bonds could easily wipe out any return.
Sure, but the reverse could happen, wiping out your C$ earnings -- and that scenario is perhaps more likely. I hold a U$ GIC ladder, along with some cash, precisely because it IS a hedge on C$ performance overall, and because I hold and sometimes trade U$ domiciled equity (also not hedged). While holding U$ earning bupkas is a reasonable hedge for me, maybe holding a basket of CHF, EUR, AUD, JPY etc, via a responsibly managed bond fund would make sense too.
 

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Fair enough but I hold Fixed Income for preservation of capital, not return. Thus no high yield shite and no currency volatility. My portfolio is about 15% FI and I want that portion to be as good as cash.
 

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Two differences really.
One is that you have control and receive the cash from GICs annually (or more often if desired) to re-invest at best rate available.
Second is that GICs don't lose capital. In a ladder, you get your capital back at least once a year without loss. A bond fund may be more liquid, but in an increasing interest scenario, you would likely take a loss when selling.

Personally, I have a mix of 58 individual bonds and GICs in a ladder (spread over 6 accounts). Maturities spread throughout year. All held to maturity. GICs no risk, but lower yield than bonds. Liquidity not a problem.
If you need money at a specific date in the future, then a bond or GIC or declining GIC ladder work. But if you have a 5 year GIC ladder and you don't need the funds for 10 or 20 years then you have similar uncertainty around rates and future return that a bond ETF has. That's what I meant when I compared fixed income ladders with bond funds.

I don't care if my bond fund declines in value once in a while, since I don't need the money for a decade. One of the fundamental tenets in bond investing is keep your expected holding period equal or longer than the bond's duration to minimize the possibility of having to redeem without receiving all your capital back.

When one of your 58 bonds or GICs matures what do you do with the funds? Will you reinvest at some unknown future rate and return? If that is the case, then your future rate and return are unknown, similar to a bond fund.

Holding individual bonds or GICs gives somewhat more control, whereas a bond fund holder outsources the management of the ladder for a cost of 0.09%.

I hold a 5 year GIC ladder for medium term fixed income, and an aggregate bond fund for longer term.
 

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When one of your 58 bonds or GICs matures what do you do with the funds? Will you reinvest at some unknown future rate and return? If that is the case, then your future rate and return are unknown, similar to a bond fund.
Holding all the bonds and GICs individually also creates management challenges for the investor. It's not as simple as it looks, and I've seen these discussions constantly at CMF. The person will feel unsure about reinvesting back into a 5 year GIC, because of their attempts to time the bond market. Everyone loves timing the bond market.

Interest rates will feel 'too low' so they will have trouble sticking to their reinvestment methodology. They may even let the amounts sit in cash, suffering cash drag.

Bond ETFs have big advantages here. They are professionally managed, and all maturing bonds are immediately reinvested to maintain a constant average portfolio maturity. This is very difficult for DIY investors to do.

I hold a 5 year GIC ladder for medium term fixed income, and an aggregate bond fund for longer term.
Sounds smart, and also what Topo suggested in the neighbouring bond thread.
 
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