International Bond Mutual Funds

International bond mutual funds and emerging markets bond mutual funds currently are not as diverse in their offerings as are domestic bond funds. Generally, you have two options: diversified international and diversified emerging markets.

International bond mutual funds invest in the debt securities of companies and governments primarily in the developed markets of the world, excluding the United States. However, many of these funds invest a significant portion of their assets in emerging markets debt and a few are regional in composition. As with domestic bond funds, the average quality and duration vary from fund to fund.

International bond mutual funds show little correlation with U.S. equities and only moderate correlation with investment grade U.S. debt. Thus these funds qualify as yet another excellent opportunity to diversify your portfolio.

Emerging markets bond mutual funds invest in the debt securities of companies and governments in those countries whose markets are emergent. These funds tend to have low average quality ratings, as much of the emerging markets debt is rated below investment grade or not rated at all.

Emerging markets bond mutual funds provide good diversification but not as good as the international bond funds, as their correlation with U.S. equities is slightly greater than that of the international bond funds. If you buy these funds for their relatively high yield, you will be sacrificing some degree of diversification and accepting significantly more risk.

You can increase the diversification of your portfolio by selecting international bond mutual funds or emerging markets bond funds that do not restrict their investments to dollar-denominated issues and do not hedge their currency exposure.

World bond mutual funds, a.k.a. Global bond mutual funds, invest in the debt securities of companies and governments worldwide, i.e., including the U.S. The composition of these funds varies widely with respect to their concentrations in various countries and regions, their participation in the emerging markets and the proportion of their assets invested in government debt.

World bond mutual funds are a convenient way to invest in bonds worldwide but they leave a lot to be desired in terms of diversification, which is due primarily to their investing in U.S. debt. Intuitively, it would seem that the diversification is imbedded in these funds' portfolios and thus not apparent numerically, which is correct. The problem lies in determining how much is invested in each of the primary market segments (U.S., international, and emerging markets), and the average credit quality and duration of each segment. Then there's the question of whether their scope is so broad that the funds' staffs could do an adequate job of analyzing the debt securities of all the companies and governments within their universe. So, I would be inclined to say that you're better off making individual investments in each of the three major bond market segments.

Add an international bond mutual fund to your portfolio to add overall diversity and to complement your investments in domestic and emerging markets bond funds.

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