Vanguard's new international bond index funds

Vanguard recently announced plans to introduce its first international bond funds and makes a good case for global bond investing. I've been asked several times what I think of the new offerings, and here is my take on what I've learned so far. One important caveat is that Vanguard must by law be in a "quiet period" before the launch of the funds, so I wasn't able to get any specific information beyond the press release. The funds are expected to launch in early 2012.

The Vanguard Total International Bond Index Fund will seek to track the Barclays Global Aggregate ex-USD Float Adjusted Index (Hedged). This benchmark includes more than 7,000 global government, agency, and corporate investment grade securities in 57 countries. While I haven't yet confirmed, this seems like the international counterpart of the Total Bond Fund, which follows the Barclays aggregate bond index of US government and investment grade taxable bonds. The annual expense ratio of the ETF and the Admiral share class will be 0.30 percent.

The second fund, the Vanguard Emerging Markets Government Bond Index Fund, will seek to track the investment performance of the Barclays Emerging Markets Sovereign Index (USD). The annual expense ratio will be 0.35 percent for both the ETF and Admiral share classes.

In addition to the annual expense ratio, Vanguard noted it would assess an upfront purchase fee of 0.25 percent for the total international fund and 0.75 percent for the emerging market fund. This purchase fee could be avoided

Neither fund will have foreign currency risk.The total international will be hedged and the emerging markets fund will be denominated in US dollars.

My take

I've long been agnostic on international bonds and have never owned any myself. Since I'm a believer in diversification, I can't ignore the non-US bond market, which, like equities, is larger than that of the US bond market. On the other hand, bonds should be your portfolio's shock absorber, so I don't recommend taking on foreign currency risk. It's a big mistake to assume the US dollar will continue to decline, and I believe an international bond portfolio should be hedged. However, costs until now have been too high for me to buy even a little of this large asset class.

Vanguard total international - the new champ

So I like the fact that Vanguard will be hedging and eliminating the foreign currency risk. Though I can live with the expense ratios, I'm pretty sure the hedging costs are in addition to the stated expense ratios. To hedge, Vanguard would have to buy forward contracts in currencies like the Euro and Yen versus the US dollar, and must continually buy them to stay in a hedged position.

If they can do that for less than 0.20 percent annually, then the funds should come within 0.50 percent of the total international index.

I'm leaning against the emerging market bond fund because I suspect the credit quality will be too low to serve as a portfolio shock absorber. But I'm taking a "wait and see" approach on the total international bond index fund.

I'll be following the launch of these two funds and will write more when I can estimate the total costs and get more of a glimpse inside the composition of the indexes. It's quite possible, however, that I'll soon be adding the total international bond index fund to the simple three fund second grader portfolio. This would be a very big change for me, so stay tuned.

More on MoneyWatch

Vanguard small cap international

DFA vs Vanguard - which is better?

  • Allan Roth On Twitter»

    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.