Investor Guide To International Treasury Bond ETF Investing (ISHG, BWZ, IGOV, BWX)
Eric Dutram: Recent developments in the domestic as well as global markets have led to an increase in volatility across all asset classes. After getting off to a good start in 2012, the present scenario in the U.S equity markets is choppy, to say the least. The outlook for the same remains bleak in the near future, mainly thanks to the never-ending euro zone debt crisis and a slowdown in global economic growth (read The Five Best ETFs over the Past Five Years).
The recent ‘risk off’ environment has led the investors to flee from the risky asset classes and seek solace in the so-called safer bond segment. However, this trend has led to plummeting U.S. Treasury rates to near all time lows, forcing many investors to seek yield in other corners of the market.
Furthermore, recent steps and hints by the FOMC to either extend or expand Operation Twist or add another round of QE could keep rates depressed for the foreseeable future. If anything, investors could see rates slowly tick down, especially if emerging markets remain weak, uncertainty is the name of the game in Europe, and the U.S. struggles with low growth levels.
International Treasury ETFs
Thanks in part to the low yields in the U.S. market, some investors may want to consider obtaining some international bond exposure as a way to diversify fixed income exposure while still obtaining a high yield. These international bonds are also much less volatile than their stock peers, allowing many to obtain foreign assets with lower levels of risk than what many are seeing in the equity world.
Unfortunately, there are some risks in a few of the major European bond markets at this time, meaning that a broad basket approach across a variety of economies may be the best approach. In this way, investors can gain access to a number of different bond markets without worrying too much about individual inflation rates and credit ratings which vary from economy to economy.
Given this, the International Treasury ETFs could provide investors with an opportunity to look beyond the low yielding U.S sovereign bonds to earn higher yields. Moreover, these bonds can also go a long way in terms of diversification as these ETFs have a relatively low correlation with U.S Treasury securities while paying out solid yields as well (read Floating Rate Bond ETF Investing 101).
Risks of the International Treasury ETF Space
One of the main risks to be aware of is exchange rate risk as the ETFs hold securities issued in different currencies. Moreover, if the U.S. Dollar appreciates further against other major currencies, the value of the investments will go down even if the investment has generated positive sub-par returns. Therefore, investing in this foreign currency denominated assets necessarily involves having a bearish view of the U.S. Dollar.
Also, the ongoing socio-economic and political drama in the many parts of the world has resulted in a slowdown in many economies, including the U.S. Many developed as well as emerging markets are facing pressure in the form of a rising debt-to-GDP ratio, sovereign rating downgrades, recapitalization of the banking sector and rise in unemployment rates (read Beyond the PIIGS, Three Troubled European ETFs to Watch).
In particular, there has been some weakness in a variety of developed markets around the world. The recently reported high unemployment rate from Australia also indicates a slowdown in the economy and is a cause for concern. So is the double-dip recession which has been plaguing United Kingdom for quite some time now.
Speaking of European troubles, the PIIGS nations (Portugal, Ireland, Italy, Greece and Spain) are the front runners for the most troubled euro zone economies, and could alter the international treasury bond market going forward, depending of course on what the ECB does in the near future.
However, given the present circumstances of weak stock markets and low U.S. yields, International Treasury ETFs could make for a lucrative investment option with their relatively higher weighted average yields coupled with the cushion of investment grade sovereign rating and benefits of diversification.
Below, we highlight the four main choices that investors have in this space, breaking down the pros and cons of each, as well as some recent performance and yield figures of the funds in this group:
SPDR Barclays Capital International Treasury Bond ETF (NYSEARCA:BWX)
Launched in October of 2007, BWX follows the Barclays Capital Global Treasury Ex-US Capped Index. The index measures the performance of investment grade sovereign debt securities located outside the U.S. It has a fairly large asset base of around $1.85 billion and daily volume around 235,706 shares.
The ETF pays out an impressive yield of 3.93% but has slumped 58 basis points for the year as of the end of June. The ETF targets the longer end of the yield curve and has an average maturity of 9.28 years.
While this may go a long way in increasing yields, on the flip side this makes the ETF more sensitive to interest rate movements as indicated by an average duration of 7.19 years (see Three Muni Bond ETFs to Weather the Coming Storm).
From a holdings perspective, BWX allocates 23.32% of its total assets in the low yielding Japanese Government bonds. Another drawback of investing in BWX is the fact that it allocates more than half of its assets in European nations. It holds all investment grade securities in its portfolio but 8.24% of its total assets are rated Baa.
However, it provides a fairly well diversified portfolio allocating only 9% in the top 10 holdings. This has caused the ETF to perform relatively better than its counterparts.
iShares S&P/Citigroup International Treasury Bond (NASDAQ:IGOV)
The ETF tracks the S&P/Citigroup International Treasury Bond Index Ex-US which measures the performance of foreign currency denominated treasury bonds issued by developed countries other than the U.S. Like BWX, IGOV also mostly places its bets on the Japanese government bonds as these account for almost 23% of its total assets.
The ETF pays out 3.78% as yields and has a weighted average maturity of 8.59 years. IGOV seems to be well placed as far as credit risk is concerned since a majority of its assets are rated investment grade. However, it is exposed to high levels of currency risk as it holds all securities denominated in foreign currency.
IGOV has an average duration of 6.66 years. This particular international Treasury bond ETF holds 220 securities in all and allocates 25.43% of its total assets in the top 10 holdings (readGuide to the 25 Most Liquid ETFs).
The ETF charges a low premium in the form of expense ratio of just 35 basis points. It also has a tight bid-ask spread of just 35 basis points. Both these factors give this fund a competitive edge over its peers as it reduces the total cost of investing and does not limit its profit potential. IGOV has total assets of $292.78 million and an average daily volume of 37,181 shares.
SPDR Barclays Capital Short Term International Treasury Bond ETF (NYSEARCA:BWZ)
The ETF debuted in January of 2009 and since then it has managed to amass $222.21 million in assets under management. The expense ratio stands at 35 basis points and it has an average daily volume of 32,260 shares.
This is done by tracking the Barclays Capital 1-3 Year Global Treasury ex-US Capped Index. This benchmark measures the performance of investment grade short term treasury bonds of developed countries excluding the U.S.
The ETF targets the shorter end of the yield curve by focusing on securities having a residual maturity between one and three years. This makes BWZ relatively more stable than its long term counterparts in terms of interest rate risk as indicated by an average duration of 1.86 years.
Despite targeting near-dated securities, the ETF pays out a solid yield of 3.51%, however, in terms of total returns the ETF has slumped 6.41% in the most recent one year period (see Real Return ETF Investing 101).
iShares S&P/Citigroup 1-3 Yr International Treasury Bond ETF (NASDAQ:ISHG)
Like BWZ, this product also targets securities having a residual maturity of one to three years. The ETF was also launched just after the debut of BWZ as a strategic move by iShares to steal assets in the short term international Treasury bond ETF space. It has total assets worth $177.35 million and an average daily volume of 10,824 shares.
In terms of strategy and expense structure, both ISHG and BWZ are very similar and charge the same expense ratio, but, ISHG limits exposure to countries with higher debt and replaces them with countries having lower debt levels. However, this did not help prevent it from slumping 8.40% for the one year period as of 30thJune 2012.
ISHG has a weighted average maturity of 1.86 years and an average duration of 1.80 years. It pays out an annual yield of 4.56% (see 11 Great Dividend ETFs). From a weightings perspective, the ETF holds 23.41% in Japanese short term bonds and around 65% in the European nations’ near-dated securities.
|ETF||Total Assets||Expense Ratio||Yield||% in Top 10 holdings||1-Year returns (as of 6/30/2012)||Avg. Daily Volume||Avg. Duration||Avg. Maturity|
|BWX||$1.85 billion||0.50%||3.93%||9.04%||-0.58%||235,706 shares||7.19 yrs||9.28 yrs|
|IGOV||$292.78 million||0.35%||3.78%||25.43%||-3.32%||37,181 shares||6.66 yrs||8.59 yrs|
|BWZ||$222.21 million||0.35%||3.51%||20.03%||-6.41%||32,260 shares||1.86 yrs||1.92 yrs|
|ISHG||$177.35 million||0.35%||4.56%||30.88%||-8.40%||10,824 shares||1.80 yrs||1.86 yrs|
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