People invest in bonds for safety and regular income. Investors in the US who want the highest degree of safety buy US Treasury bonds. But these bonds offer low interest rates. So investors are attracted to international government bonds, especially government bonds of emerging economies which offer higher rates.
Investing in foreign bonds of other developed nations is definitely safer but the yield is very low. Higher interest rates on the other hand, come with higher risks. If one wants to cash in on the rapid development of emerging economies, investment in equity would be a better option than bond investments. After all one buys bonds for safeguarding one’s investments.
One more reason for investors to invest in international government bonds is their desire for currency diversification.
Risks of Investing in International Government Bonds
Investing in foreign government bonds poses a currency risk. When the US Dollar appreciates, the investment loses value in dollar terms. Conversely, when there is a fall in the US Dollar, the value of the investment rises.
Investing in international government bonds which offer high rates of interest is fine, but one should remember that the rate is high to compensate for the high risk. There have been cases where the governments of countries have defaulted on their debt. In such cases, the bond holder may lose his entire investment.
There are Primarily 2 Ways of Investing in International Government Bonds
- Purchasing the bonds
- Investing in mutual funds or ETFs of International Government Bonds
A. Purchasing The bonds
One can buy international government bonds through a broker or directly from the foreign government issuing them. The purchase has to be done in the domestic currency of the country issuing the bonds.
Buying Through a Broker
- All brokers may not deal in these kinds of securities.
- Those who do may charge very high commissions.
- The bond markets are not very liquid. So brokers accept only high value orders as there is a wide difference in the asking and bid prices for small orders.
Buying Directly From the Government Issuing Them
- One can save on the huge commissions which would otherwise have gone to the broker.
- It is a time consuming process.
- This kind of direct purchase can be done only when the bond issue is open.
B. Investing in Mutual Funds or ETFs of International Government Bonds
Buying units of Mutual Funds or ETFs which have invested in these bonds is the preferred way of foreign bond investments.
The Advantages of This Indirect Investment are many
- First of all, this investment can be done in one’s own currency. So there are no problems related to foreign exchange transactions like compulsorily opening a forex account.
- If we were to individually buy bonds, it would be very difficult to do the necessary research and find out which bond of which country would be an ideal investment and then keep track of that investment. A bond fund is run by professionals who have the expertise to make the correct decisions.
- Also, an investor buying bonds would find it very difficult to spread his risks across bonds and countries as making separate investments in each of these bonds would be a cumbersome procedure. A fund solves this problem as the investor can easily spread his risk by buying units of a single fund which would have invested in different kinds of international government bonds.
- Mutual Funds and ETFs are more liquid and can be bought and sold more easily than bonds.
Clearly, investment in international government bonds through dedicated funds would be better than directly investing in the bond.