BNDX ETF: Still No Investment Case For International Bonds

The Vanguard Total International Bond ETF (NASDAQ: BNDX) suffered heavy losses in 2022, with a 12.5% ​​decline in total return. This is important for high quality, relatively short duration bond funds.These losses are a direct result of incredibly low yields BNDX yields have risen significantly over the past year, but are still too low to justify a long position in the context of the inflation outlook. Even if central banks are forced to keep borrowing costs low amid rising debt levels and yields fall in the coming years, upward pressure on inflation could further erode long-term real returns. there is.

BNDX ETF

BNDX seeks to track the performance of the Bloomberg Global Aggregate ex-USD Float Adjusted RIC Capped Index (USD Hedged) with an expense ratio of 0.07%. It currently yields 3.0%, but the costs associated with currency hedging can have a significant impact on returns. The fund has a maturity of 9.0 years and a duration of 7.6 years. The fund has significant exposure to Japan and Europe, with 16% Japanese bonds and 55% European bonds. Emerging market government bonds account for just 6.5% of total holdings. In terms of credit quality, about half of the bonds are rated AAA or AA.

Yields are now reasonable, but not attractive

BNDX yield of 3.0% is reasonable if not attractive. I don’t have exact data on yields a year ago, but I think they were around 1%. Long-term inflation expectations have also fallen slightly over the past year, so for a USD-denominated bond fund, the real return outlook has improved significantly over the past 12 months. Based on US 10-year breakeven inflation expectations of 2.3%, BNDX is expected to deliver an average real return of 0.7%. That compares to his 1.8% in the Vanguard Total Bond Market ETF (BND), which is entirely US-focused. market.

This 0.7% yield is also subpar when compared to international equities. The MSCI World (ex-U.S.) yields 3.4%, but the real yield of international bonds is clearly inferior, as stocks are real assets whose dividends rise with inflation.

New focus on monetary stimulus will be bittersweet for bondholders

For BNDX investors to achieve real returns in the next few years that exceed those likely to be seen in US Treasuries and international equities, they will need to see yields fall significantly from current levels. I have. For this to happen, either global disinflationary pressures will need to reignite or the focus shifts across European and Japanese monetary authorities to contain bond yields despite inflation still rising. I guess.

Disinflationary pressures in Europe seem unlikely again. Unlike the US, M2 money supply growth he remains at 4.7%. Moreover, many investors cling to the belief that weak real GDP growth is inherently disinflationary, but as I explained, this is not the case.Understanding the true drivers of inflation‘.

There is certainly a case for monetary authorities to abandon the fight against inflation in order to prevent rising bond yields from triggering a debt crisis. The Bank of Japan appears to be moving in the opposite direction with its recent move to allow bond yields to rise, but as the real economic impact of higher yields begins to set in, the bond market calms in the UK in September as inflation rises. It turns out that it takes precedence over rising. to feel.

That said, increased bond purchases across international markets could lead to higher long-term inflation. Lower bond yields will give BNDX holders very large returns in the short term, but these returns will only come at the cost of lower future returns, especially due to higher inflation. In such a scenario, BNDX is still expected to fall relative to US bonds and international equity indices.

overview

After the sharp rise in yields over the past year, international bonds are no longer the terrible investment they once were and are now expected to deliver positive real yields over the long term. likely to be inferior to A policy shift to support growth could generate positive returns in the short term, but the impact of higher inflation could lead to greater underperformance over the long term. there is.