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How risky is risky in world bond funds?

Karin Anderson  |  03 Aug 2020Text size  Decrease  Increase  |  
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Global-bond fund managers routinely disclose fund-level credit-quality, sector, region, and country exposure breakdowns on their websites, but it can be extremely difficult to deduce where a strategy is taking its credit risk. It can also be hard to discern how far afield it is from the commonly used Bloomberg Barclays Global Aggregate Bond Index.

Earlier this summer we rolled out a new Fixed Income Exposure Analysis, or FIEA, component for Morningstar Direct and Morningstar Office users to help investors make sense of their individual portfolios and thereby make better comparisons across funds. Elements of this will be available in fund reports on Morningstar.com and other products later this summer.

We will take a look at the index-tracking Vanguard Total World Bond ETF BNDW as our baseline with the FIEA tool. It tracks a float-adjusted version of the investment-grade-focused Global Aggregate Index, with roughly 60 per cent in government bonds, 20 per cent in corporates, and various securitized sectors making up the rest. Emerging-markets bonds, which can add a lot of volatility, represent just 3 per cent of this benchmark. Though this ETF’s non-US holdings are all hedged back to the US dollar (it resides in the world bond US-dollar hedged Morningstar Category) it still provides a helpful picture of the larger sector and country components that managers use as guideposts and the level of credit risk that more-conservative world-bond funds take. (In a future iteration, the FIEA tool will incorporate the ability to dig into a portfolio’s currency exposures as well.)  

The following FIEA view shows BNDW’s credit-quality exposure by sector as of June 30, 2020, which is already a helpful step up compared with what is available on the company’s website. From here, you can see that the bulk of its BBB exposure (17 per cent) comes from corporates. (Small differences can occur owing to the various ways fund companies classify and report data, and the FIEA view is based on a fund’s bond portfolio rather than its total assets.)

Vanguard Total World

Now let’s look at a couple of world-bond strategies that Morningstar analysts rate highly. BrandywineGLOBAL Global Opportunities Bond GOBSX, which has a Morningstar Analyst Rating of Silver, looks somewhat close to the bogy in its sector exposures, but a deeper look shows a much more aggressive credit profile. The FIEA view below highlights its much heavier BBB exposure (43 per cent) compared with the Global Aggregate Index tracker, for example, as well as an 11.6 per cent stake in BB rated debt as of mid-2020.

BrandywineGLOBAL

Dissecting the strategy's exposure further by country, as shown below, reveals where the strategy was invested in below-investment-grade corporates (US and Brazil) and sovereigns (Brazil, Russia, and South Africa).

BrandywineGLOBAL Credit quality exposure

Another of our high-conviction picks in this category, Gold-rated Dodge & Cox Global Bond DODLX, also takes plenty of credit risk compared with the Global Aggregate Index. Its 55 per cent corporate stake was more than twice the benchmark’s as of 30 June 2020. It also had about one fifth of assets stashed in below-investment-grade debt. The FIEA tool shows that the managers are willing to invest down the capital structure in asset-backed securities rated A and BBB, which come with heightened liquidity risk.

Dodge and Cox Global Bond

Another trick for teasing out how much credit risk is attributable to emerging markets is by checking the regional breakdown, as shown below.

Dodge and Cox Global Bond

The strategy has long featured emerging-markets bonds, to the tune of 26 per cent across regions as of midyear when summing Latin America, Europe-Emerging, Africa, and Asia-Emerging, including about 7 per cent in below-investment-grade issues.

Be your own sleuth

For riskier strategies in particular, it’s good to be able to do some of your own detective work. Morningstar’s new FIEA component can help you slice and dice a portfolio in ways you couldn’t before, which should help you understand more about its risks.

Not surprisingly, these two strategies have been on a wild ride in 2020. Both funds went into the late-February coronavirus-driven sell-off with higher levels of corporate credit and emerging-markets risk than many in the world-bond category, and they plunged by roughly 15 per cent-16 per cent between 20 February and 23 March. The Global Aggregate Index (unhedged), meanwhile, suffered a milder 3 per cent slide. The Brandywine fund’s tilt toward Mexican, Brazilian, and Colombian debt (and the countries’ currencies) was particularly painful. Dodge & Cox Global Bond was stung by the combination of overweightings in energy-related issuers, as well as positions in Mexico and Brazil. Many of the positions that detracted in the first quarter helped the strategies rocket back thereafter. BrandywineGLOBAL Global Opportunities Bond was up by 27 per cent from 23 March through 29 July, while Dodge & Cox Global Bond climbed by 23 per cent (the index gained 9 per cent).

Both strategies rely on a combination of valuation- and contrarian-driven calls by skilled and well-resourced teams, all of which has served patient investors well—which is why our analysts give them high marks. Their volatile performance profiles have been par for the course too, though, and understanding the roots of that volatility is a critical element in getting comfortable owning them.

 

 

is director of North American fixed-income strategies for Morningstar.

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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