December 19, 2007
What's true for stocks also applies for bonds: Most of the planet's debt is issued outside of America. As of this past spring, roughly 53% of the outstanding value of the world's bonds with maturities of one or more years was issued in a currency other than the dollar, according to the Bank for International Settlements.
The implication: diversified portfolios for U.S. investors should have bond allocations that are more or less evenly split between domestic and foreign debt. In practice, it's very few U.S. investors take such a global approach to strategic bond allocations. But shunning foreign bonds is a bet, and a pretty big one, relative to Mr. Market's recommendation.
Yes, putting 50% of your bond allocation into foreign debt may seem extreme, although doing so would merely match the market's mix. Then again, a zero percent allocation to foreign bonds looks severe as well. Diversification, after all, is the only antidote to living in a world where the future's forever uncertain.
Whatever seems reasonable as a bond allocation, there's a strong case for having some exposure to non-dollar debt. That, in essence, is the theme in an article your editor penned for the December issue of Wealth Manager. As a preview, we argue that holding foreign bonds (and their ETF and mutual fund equivalents) denominated in local currencies improves the expected risk-adjusted performance for the long run. For the reasons, read on....
Posted by jp at December 19, 2007 9:54 AM
I don't think Jeff understands that in modern and/or classic finance, it is impossible to find an asset class that will out-perform other asset classes.
It is similar to say that passing in football is better than running. When in reality, much of the preference has to do with how the referee's call the game.
Posted by: dan at December 20, 2007 8:37 PM
It all depends on how you define "good asset allocation." I certainly agree that over time there's a cost to owning bonds. It's reasonable to expect that equities generally will outperform debt. As such, a portfolio of comprised of only equities should beat a portfolio that mixes stocks and bonds. But that's a long-term proposition.
Over any 3 to 5 year stretch, it's debatable if stocks will beat bonds. As a result, for many (most?) investors, the short term volatility of stocks may be too much to endure. A stock/bond mix helps to smooth out the ride--at a cost. Irrational? Perhaps. But this is finance, not physics and so emotions can't be dismissed entirely. If holding a mix of stocks and bonds increases the odds that an investor will stay the course for the long term, perhaps the diversification price tag relative to pure equities is worth the price.
Posted by: JP at December 20, 2007 9:54 AM
Good asset allocation should include no bond investments (domestic or international). Stocks outperform bonds virtually 100% of any 15-year investing period going back for at least the last century. And trying to time the market as to the relatively few individual years when bonds will outperform stocks is futile. Please don't waste your time (and especially your money) investing in bonds.
Posted by: Jeff at December 20, 2007 9:07 AM
I'm not sure how much of this isn't just a transaction-costs issue; a friend of mine, who reads law reports while waiting for code to compile, and plays games whose turn-cards look more terrifying than tax-return forms - not a man averse to either paperwork or complicated structures - spent a week of evenings attempting to buy Polish government bonds from the UK, and failed.
Posted by: Tom Womack at December 19, 2007 6:31 PM