Vanguard To Introduce New Total International Bond Index Fund In Q2 2013
Vanguard announced, well over a year ago, a new Total International Bond Index fund (read my take on their suitability). Well, they finally go around to giving us a few concrete data points as well as a very interesting (and surprising, to me) related announcement.
About The New Total International Bond Index Fund
First, the facts. For starters, this fund will be significantly cheaper than originally advertised. Back in November of 2011 I wrote that the investor shares of this fund were likely going to cost around 0.40% per year (per an article on Vanguard.com which seems to have been removed). As it turns out, the fund will cost barely half that much, or just 0.23%. Happy news!
Vanguard Total International Bond Index Fund Fact Sheet:
Investor Shares: 0.23%
Admiral Shares: 0.20%
This fund really isn’t all that much more expensive than the domestic version of this fund, which is great news for investors.
Don’t Forget Hedging Costs…
Foreign bond funds are a bit different. Most foreign equity funds don’t hedge their currency exposure, which is part of their appeal. Holding unhedged assets denominated in foreign currencies gives you some amount of protection against a falling dollar. Most international bond funds hedge their currency exposure, though. They do this for a variety of good reasons, the most important being that since investors typically own bonds for safety and not to speculate on currency fluctuations, it doesn’t make sense to take currency risk on the bond side. I won’t get into it here, but it’s a generally good thing.
The downside of hedging currency exposure is that it raises costs. Worse, the costs of hedging aren’t included in the stated expense ratio. Just how much does it cost to hedge a foreign bond fund? Vanguard isn’t saying and I haven’t seen any concrete numbers despite much searching. I would guess it’s not much. Still, in a low-interest rate environment in which every penny counts, even a small hedging cost can be significant. I’m not going to avoid buying this fund for that reason but neither will I rush to buy it. I’m not entirely convinced the diversification benefits will be worth the additional costs over the long run. I plan to wait and see how things pan out over the next few years. Vanguard is obviously convinced, though, which leads me to a somewhat surprising (to me) development.
Vanguard Is Adding The New International Bond Fund To Its Lifestrategy And Target Retirement Funds
Maybe I shouldn’t be completely shocked by this. After all, Vanguard published a pro-international-bonds research paper recently (open as a pdf in a different window). Still, I was pretty damn surprised to read that Vanguard is going to allocate a full 20% of the bond allocation of each of the Lifestrategy and Target Retirement funds to this fund. Why? I have a few theories.
- To quickly gather assets – Several folks on the Bogleheads forum noted this is likely a naked attempt by Vanguard to quickly gather a low-risk, sticky asset base for this fund. After all, the Lifestrategy and Target Retirement funds collectively have billions of dollars invested in them, which means this new fund is going to immediately take in a large chunk of change. I think this is spot on. Perhaps Vanguard is playing things safe by ensuring there’s a market for these types of funds before spinning up a new international bond department.
- The research really does support this move – Barely. Read the above-linked Vanguard study for details. I figure this move will either have no to a very tiny positive impact on these funds.
- All else being equal, more diversification is better than less diversification – If you can gain access to an entirely different asset class without having to significantly raise your overall investment costs, why not do it? It may not make any difference in the long run, but if you can be reasonably sure it also won’t hurt, it’s probably worth including.
- They needed these assets to bring the costs to a reasonable level – It’s telling that when Vanguard initially announced this fund a little over a year ago it was supposedly going to cost almost twice what it will actually end up costing. In a sense, Vanguard is taxing its fund-of-funds customers to subsidize other investors in this fund. Luckily, the tax is very small and probably to their benefit over the long run. Some people fault Vanguard for this approach, but I don’t.