The Federal Reserve’s ambitious plans to raise interest rates and contain inflation have sent bond markets reeling over the past few months. As of late March, the Bloomberg Global Aggregate Index slid by more than 10% from its January 2021 peak, leaving a lot of investors wondering whether they should own bonds in their portfolio at all.
This article will look at why actively-managed international bond funds may be an attractive option in today’s environment.
See our Active ETFs Channel to learn more about this investment vehicle and its suitability for your portfolio.
Why U.S. Bonds Are Reeling
Inflation soared to an 8.5% annual pace in March, according to the Department of Labor, representing its hottest level since 1981. The speed of inflation appears to have caught many experts off-guard. As a result, the Federal Reserve is under pressure to aggressively raise interest rates and bring inflation closer to its 2% target rate.
According to the CME Group, the futures market projects a 45.1% chance that interest rates will rise to a 275-300 basis point range by December 2022. A further 44% believe rates could reach a 300-325 basis point range, while 6.7% project a 325-350 basis point range. That’s much higher than the current 50-75 basis point range.
Of course, rising interest rates are bearish for fixed income investments like bonds. Bonds issued at lower interest rates typically drop in price until their yields reach market rates, resulting in potentially significant losses for bondholders. Given the plans to aggressively raise rates, investors may want to look elsewhere for fixed income allocations.
Active Funds Navigate Challenges
Most passive bond funds track a market capitalization-weighted index. While that makes some sense for stocks, bond indexes preferentially hold the most indebted companies. Not surprisingly, actively-managed funds have performed exceptionally well in the fixed income market since they can factor in credit quality and other criteria.
According to CNBC, 84% of active bond fund managers outperformed in the one year ended June 30, 2021. While the outperformance of active bond funds doesn’t hold up over the long term (just 27% outperform over ten years), fund managers are uniquely positioned to navigate the challenges of rising interest rates and growing geopolitical risk.
But interestingly, actively managed international bond funds also have a better track record than the broader market. According to Morningstar, actively-managed world bond funds have an average annualized return of 1.9% compared to just 1.1% for their indexed peers over the past ten years –a much more robust, long-term track record.
International Markets Offer Protection
The Federal Reserve’s move to increase interest rates leaves few safe-haven options for domestic active fund managers. Fortunately, the U.S. bond market represents just 43% of the global bond market, leaving many opportunities for active managers abroad. These countries may offer less interest rate risk, higher yields or better credit profiles.
For example, the actively-managed Hartford World Bond Fund holds securities from over 30 countries, including the United States. Rather than investing indiscriminately across all markets, the fund can pick and choose the best opportunities. For example, it counted Australia and New Zealand among its top holdings last year.
In addition to choosing the best countries, actively-managed international bond fund managers can place bets on currencies. While some hedge against currency risk, others effectively place currency bets by leveraging the fact that the bonds pay in local currency. And in many cases, these movements have a greater impact than interest rates or credit exposure.
Active International Bond Funds and ETFs To Consider
| Name | Type | Ticker | Market Cap | Expense Ratio |
|---|---|---|---|---|
| BlackRock Strategic Global Bond Fund | Mutual Fund | MHWIX | $830M | 1.57% |
| Dodge & Cox Global Bond Fund | Mutual Fund | DODLX | $1.9B | 0.45% |
| Hartford World Bond Fund | Mutual Fund | HWDIX | $3.5B | 0.70% |
| Fidelity Tactical Bond Fund | Mutual Fund | FBAGX | $25.5M | 0.75% |
| WisdomTree Emerging Markets Local Debt Fund | Active ETF | ELD | $110M | 0.55% |
| WisdomTree Emerging Markets Corporate Bond Fund | Active ETF | EMCB | $60M | 0.60% |
| JPMorgan International Bond Opportunities ETF | Active ETF | JPIB | $332M | 0.50% |
Data as of April 22, 2022.
The Bottom Line
The Federal Reserve’s move to increase interest rates to combat inflation has taken a toll on the domestic bond market. As a result, investors may want to consider international bond exposure since global markets may have less interest rate risk. Actively-managed funds have a strong track record in these markets, given their increased flexibility.
Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.