A new year brings new opportunities and an opportunity to revisit fixed income allocations. From high yield bonds to corporate debt and securitized credit, investors have a wide variety of fixed income sectors to consider. It’s one thing to craft the right bond allocation with those sectors, but what about balancing domestic, overseas and emerging market bonds? Understanding bond domiciles and the markets they inhabit can help investors diversify their fixed income allocations more effectively.
As with equities, each market has its own economic conditions and narrative that inform the value and yield of available bonds. Interest rates and the outlooks for them (rising or falling) are, for instance, key factors in determining bond prices and they can vary from country to country.
Canadian interest rates are currently at 3.25% as of January 15, 2025 versus U.S. interest rates at 4.25% while the U.K.’s are at 5.25% and the eurozone, 3%. Investing in a mix of bonds from different markets can, as a result, help diversify your overall fixed income allocations. But there’s more to it than just different bonds from different markets, however. Investors using their domestic currency to buy foreign bonds can expose themselves to “currency risk.”
Per Investopedia, currency risk refers to the possibility of losing money due to unfavourable moves in exchange rates. Taking that risk into account, and the potential cost to hedge currency risk is an important consideration when investing in global and foreign bonds.
Investors should be aware of ETFs and mutual funds that explicitly address different domiciles’ currencies. These “currency-hedged” bond strategies help remove the currency risk while also providing diversification, potential yield enhancement and greater potential upside.