Guide to International and European Bond ETFs
KEY TAKEAWAYS
Best International and European Bond ETF
Based on the Coronavirus Performance and full review I would suggest picking either of:
- For best protection: iShares Global Government Bond ETF
- For best protection/yield trade-off: (i) iShares Core Global Aggregate Bond ETF, (ii) SPDR Bloomberg Barclays Global Aggregate Bond ETF or (iii) Vanguard Global Aggregate ETF
This guide is designed for Investors looking to hedge the Equity portion of their International Portfolio
Here are the key criteria to think about when choosing European Bond ETFs (includes UK) for your Investment Portfolio:
- Availability – Not all of these options will be available with your Broker hence I have provided a good variety to choose from
- Geographical Diversification – You can choose an ETF with Bonds from the country/area you live in (Europe / UK) or diversify your risk further (Developed Countries)
- Bond Type – Government Bonds only or Government Bonds & Other High Credit Rated Bonds. You want minimal volatility as Bonds are there to protect your Portfolio. You have the choice of Government Bond ETFs or Aggregate Bond ETFs (which are c.60% Government with some other highly rated securities). A small protection vs income trade off comes with it
- Income Treatment – Choose whether you want income to be distributed or reinvested based on your needs and tax efficiency
- Currency – while this is not mandatory for Equities hedging cash flows to your currency (EUR,GBP) for Bonds is important to ensure stability of your portfolio and capital protection
- Size – Xtrackers and iShares are the largest players in Europe
- Coronavirus Stress Test – European and International Bond ETFs have generally performed well during the Coronavirus Market sell-off with some nuances discussed below
4 TYPES OF BOND ETFs FOR INTERNATIONAL PORTFOLIO
GEOGRAPHICAL FOCUS: INTERNATIONAL vs. EUROPE
Decide if you want to have exposure to your country, the region or the entire International Bond ETF Market
Outside the US, Bond ETFs can have 3 types of exposures:
- International Bond ETFs
- International Bond ETFs but concentrated in G7 Countries
- Single Area/Country Bond ETF – UK Bond ETF or European Bond ETF
International Bond ETFs
Typical Allocation of Global (Developed Countries) Government ETF
International Bond ETFs with focus on Developed Countries track either of two Benchmarks:
- FTSE World Government Bond Index
- FTSE Global Group of Seven Index (G7)
The map above represents the FTSE World Government Bond Index countries
UK or European Bond ETFs
Typical Allocation of European Government Bond ETF
Single Country / Area Bond ETFs are focused on either high quality EUR bonds or UK
What’s the difference?
Since you will be hedging currency, in the long term return from International Government Bonds and your local Government Bonds tend to be similar as far as the theory goes (look at Figure 7 from this Vanguard research piece)
In a nutshell, International Bond ETFs provide better diversification without reducing returns
ETF BOND TYPE: GOVERNMENT VS. AGGREGATE
You can choose between:
- 100% Government Bond ETFs
- Aggregate Bond ETFs (c. 60% Government Bonds)
What are Aggregate Bond ETFs?
They are the broadest fixed income ETFs. These bond ETFs use a total bond market approach, which means about two-thirds government bonds and one-third corporate / or highest quality mortgage products (e.g. implicitly guaranteed by the Government)
Typical Breakdown of Bonds found in a European and an International Aggregate Bond ETF
- The yellow breakdown is the sector allocation of the iShares Euro Aggregate ETF while the orange one is the iShares Global Aggregate ETF
- While the composition may similar the geographical coverage means that the International Aggregate Bond ETF will have exposure to the highest quality American Mortgage Securities while the European one won’t
- Non-Government Bonds provide you with enhanced yield compared to Government
European Aggregate ETF
International Aggregate ETF
What’s the difference?
- Pure Government Bond ETFs give you the best protection and will react faster in a downturn
- Aggregate Bond ETFs are still very good quality but provide a bit more income (Government Bond yields in EUR area can be negative nowadays so Aggregate Bonds give you a better income)
- As of August 2020, the Bloomberg Barclays Global Aggregate Index Hedged to EUR yields 0.9%. The Equivalent Yield to Maturity (8 yr duration) for most Developed Countries can be between 0.5% to negative but when averaged out and swapped to EUR Government Bond Index Yields will likely be negative
DIVIDEND TREATMENT: ACCUMULATION vs. DISTRIBUTION
Increase Returns by reducing Tax Impact
The Bonds that pay interest can be distributed via dividends.
Choosing between accumulating or distributing funds is among the first choices investors in Europe make. The appropriate option may reduce your taxes.
- In most Continental Europe accumulating funds generally have lower taxes because they fully reinvest dividends without triggering dividend taxes
- In the UK’s deemed tax on dividends taxes all accumulating fund dividends at the same tax rate as normal dividends except when part of an ISA account (where you don’t pay taxes). Other similar countries where distributing and accumulating makes no difference include Switzerland and Austria (again, except if in tax protected schemes)
- Verify ETF tax treatment for your country before choosing an accumulating or distributing ETF
Hedge the currency risk
Below are three lists with currency hedged funds
- International Government Bond ETFs
- European Government Bond ETFs and UK Bond ETFs
- Global and European Aggregate Bond ETFs
All are good options but not all of them may be available with your Broker
Which ETF should I pick?
- Pick the ETF in your currency to reduce FX Risk
- Choose between accumulating and distributing based on your personal tax situation
LISTS OF INTERNATIONAL AND EUROPEAN BOND ETFS
A. Most liquid International Bond ETFs (Only Government Bonds)
As mentioned above you have the choice between ETFs tracking two benchmarks FTSE World Government Bond Index or FTSE Global Group of Seven Index (G7)
If you choose an International Government Bond ETF choose based on the Type of Income Treatment you want and Currency Hedging available
B. Most liquid UK and European Bond ETFs (Only Government Bonds)
European Bond ETFs are mainly distributing Income and UK has little flexbility in this respect as well.
If you choose a local Government Bond ETF Income Treatment is the most important aspect
C. Most liquid International and European Bond ETFs (Aggregate Funds)
Aggregate Bond ETFs are great to generate a bit more income while still preserving the protection benefits
CORONAVIRUS STRESS TESTING
Reviewed Index Funds have generally performed well in the COVID-19 Stress test in March 2020:
- International Government Bond from G-7 Countries (as tracked by iShares IGLE Fund) have performed best – it’s perhaps no surprise since US Treasuries are the safest assets and these represent 44% of the Index – while iShares outperformed Xtrackers International Governments this could be due to liquidity of EUR classes since USD classes had very similar drawdown at -5%
- International Aggregate ETFs have benefited from exposure to the US
- European Government Bond ETFs have performed similarly (-8/-9%) for similar duration as International Government Bond ETFs
- European Aggregate Bond ETFs have had the worst performance (as expected) since they provide incremental yield vs. Government Bond ETFs (trade-off explained above)
EUR denominated International and European Bond ETFs performance during March 2020 Sell-Off
Conclusion
- All ETFs performed quite well in the context of the crisis
- Pure Government Bond ETFs with US exposure provided marginally better protection
CONCLUSION
Key ETF Market Players
- The key players are somewhat different from the US Markets – while BlackRock’s iShares, State Street SPDR and Vanguard are all present, local players have also a strong footprint – Deutsche Bank’s Xtrackers, Societe Generale’s LYXOR, Amundi ETFs or UBS ETFs
- The choice is somewhat narrow compare to the US Market and one should choose among the most liquid Funds
- If you have the choice Deutsche Bank Xtrackers have the largest funds and it makes sense to invest in them if you want increased liquidity (Vanguard is still relatively small in Europe) while overall BlackRock’s iShares remains the leader in Europe
- Either one of these two would be a great choice but an International Aggregate Fund can provide you with a nice yield pick up
Appendix - READ MORE
European Bond ETFs - Read More
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- How to build a Long Term Portfolio for Financial Independence - Guide to creating a Smart & Simple Long Term Portfolio with ETFs
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- How do I benefit from a market crash? - In the long run no crash (including Japanese style) can derail you if you do it right
My fundamental reviews include:
- Spectacular Market Crashes - how much can you lose? How long will it take to recover? How to take advantage of the next recession
- What about currency risk? Should I hedge my Portfolio? - Hedge or not to hedge? Guide to hedging currency risk in your Equity and Bond ETFs
- Should you buy Gold? - Is it necessary to have an asset that generates no yield? What really drives Gold price?
- International and European Bond ETFS - For Long Term International Investors Bonds are key to protect their Equity Portfolios
- US Bond ETF Guide - Comprehensive Review of Blend Bond Funds, Treasuries, Corporates, High Yield, Inflation Linked, Muni ETFs
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The information provided in Bankeronwheels.com is general in nature only and does not constitute personal financial advice.The information has been prepared without taking into account a reader’s personal objectives, financial situation or needs.
Before acting on any information contained in Bankeronwheels.com you should consider the appropriateness of the information having regard to your objectives, financial situation and needs, and seek professional advice where appropriate.
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Raph
Very useful summary
Hi Raph, I wanted to thank you for producing this. It’s the most useful guide I’ve found on Bond ETFs. As someone who understands stocks well enough but pretty clueless about bonds, it was just what I was looking for. It hits the sweet spot between simplicity/ease of understanding and the important details that we need to know and the decision points we need to worry about most. Great job.
Thanks, Simon
Glad it helped!