(PUB) Investing 2016

406 / 708

20
Managing world-bond funds has become much more
difficult. That’s because the overseas government
bond market is awash with roughly $13 trillion in
bonds sporting negative yields. Japanese government
bonds, or JGBs, represent the vast majority of this
debt, more than 4 times as much as France or Germany,
which have issued the next-largest amounts. Given
Japan’s prominence in global bond indexes (typically
20% –35% of overall exposure), yields on those
benchmarks have been feeling the crunch since the
two-year JGB dipped into negative territory in
December 2014. This year, 10- and 20-year JGB yields
slid below zero as well.
Given the trend, yields on world-bond funds are lower,
too. Japanese bonds may seem a necessary evil for
these fund managers, especially those that need to
align a fund’s risk/return profile with the benchmark.
But JGBs can still be a useful tool. Many managers
use them to some extent to balance a portfolio’s
higher credit risks, and the yen has historically pro-
vided ballast in times of market stress. Japan’s
currency climbed by 23% versus the U.S. dollar in
2008, for instance, and it also strengthened versus
the dollar in more-recent risk-off markets. From a
fundamental perspective, a negative-yielding JGB can
still “roll down” capital gains as the bond matures
and its yield falls, provided the yield curve maintains
its shape. JGBs can also realize gains if Japanese
interest rates slip deeper into negative territory.
PIMCO Foreign Bond (Unhedged) PFBDX, which also
comes in a U.S. dollar-hedged version, stands out
for its heftier exposure to Japan, 39% of assets as of
mid-2016. That’s 6 percentage points above its
Barclays Global Aggregate ex-USD Index benchmark’s.
The fund’s managers are comfortable with the over-
weighting because they don’t think the Bank of Japan
will push rates deeply negative, thereby destroying
the roll-down effect, because that would inflict too
much damage to regional banks’ profits. The fund’s
Japan stake is primarily in longer-dated government
and agency bonds, a part of the yield curve that the
team finds more attractively valued compared with
longer-dated European debt. Despite the large stake
in Japanese debt, the fund’s 1.9% SEC yield was
in line with its average peers thanks in part to its 12%
stake in higher-yielding emerging-markets bonds.
That said, most actively managed world-bond funds
have had underweightings to Japan and/or the
yen during the past two years. For example, Loomis
Sayles Global Bond ’s LSGLX 12% Japan stake
came in 7 percentage points below its Barclays Global
Aggregate Index benchmark, but its 1.4% SEC yield
is below the world-bond Morningstar Category norm.
A handful of managers with more flexibility have
avoided Japan completely. Templeton Global Bond
TPINX, which has the Citi World Government Bond
Index as its prospectus benchmark, has had no Japan
exposure for more than five years because its
managers haven’t liked the country’s long-term funda-
mentals and because of a general preference for
higher-yielding bonds. That focus has kept the fund’s
SEC yield on the high side for the category (3.8%
as of July 2016). While its benchmark has 24% expo-
sure to JGBs and the yen, the fund has a 40%
short on the currency as part of a hedge for its hefty
emerging-markets exposure (two thirds of bond
exposure and four fifths of currency exposure). If the
U.S. dollar strengthens versus the yen and other
currencies, this poses a risk to the fund’s emerging-
markets exposure, but under that scenario the short
yen position would pay off.
In the end, there is risk in choosing a world-bond
index fund or exchange-traded fund over an actively
managed option that has already dialed down Japan
exposure or can tactically manage it. Vanguard Total
International Bond Index VTIBX and similar passive
options have more than 20% in JGBs, not to mention
other negative-yielding European debt. K
Contact Karin Anderson at
Negative Yields Challenge
Portfolio Managers
Income Strategist | Karin Anderson