World bond funds were up 4.25 percent for the year-to-date, through August, way ahead of a 2.7 percent loss for long-term U.S. government bond funds, according to Morningstar, Inc. Should you add such a fund to your portfolio?
That depends on your outlook for the U.S. dollar. A fund that hedges currency exposure neutralizes currency risk while an unhedged fund can capture additional gains (or get hit with losses) from currency fluctuation.
Recent bond-fund returns mostly reflect the boost that a weakened dollar has given to unhedged funds. Thus, the argument for diversifying into non-U.S. bonds right now is that the dollar will remain weak, any U.S. economic recovery will be slow, and that there is more room for interest-rate cuts in places such as Europe.
A fund’s prospectus will tell you whether a particular fund hedges, doesn’t hedge, or just partially hedges. Highly regarded foreign bond funds include BlackRock International Bond Fund, which recently has switched to an unhedged strategy, and American Century International Bond Investors, a perennially unhedged fund that can have “astounding” returns when the dollar weakens, as Morningstar puts it.
