Investors have historically embraced international diversification in their portfolios as a way to smooth out volatility and reduce overall risk. But the last two years have shown that the benefits of such diversification aren’t what they once were. A meltdown that began in the U.S. mortgage market quickly spread throughout the world, sparking countless complaints about how Wall Street’s greed and excessive risk taking set off a chain of events that sent stock markets plummeting and unemployment rates soaring around the globe.
In recent weeks, U.S. investors have found themselves on the other side of that relationship, as concerns over tightening monetary policy in China and a potential debt crisis in Europe have sent global equity markets sharply lower. Continuing a trend that has emerged over the past two years, it has been the world’s developed economies that have struggled the most in the current environment. The current crisis in Europe has focused primarily on Greece, which faces mounting deficits amidst declines in tax revenues and huge spikes in government spending to ward off a double dip recession. The country’s budget deficit has swelled to 13% of GDP–well above the 3% limit imposed for euro-zone countries.
Much of the rest of Europe is on relatively solid financial footing, but the potential for defaults in Greece has rippled throughout the region and even reached overseas markets. The cost to insure debt issued by Spain and Portugal has skyrocketed in recent weeks, as risk averse investors race to find protection against other European countries with large deficits.
More Bargain Buys?
The recent pullback has created a number of buying opportunities for bargain-hunting investors. As Europe’s bond markets have been crushed by an increase in the likelihood of a regional debt crisis, many investors now see an attractive entry point. Greece’s deficit problem is a serious issue, but a default is far from certain. Even if the country were to default, the relative size of outstanding debt would make a bailout by EU neighbors a manageable undertaking.
Options for U.S. investors to invest in European debt markets are fairly limited, but there are a handful of global funds that offer exposure to this region. Following a surge in the dollar and rise in yields on European debt, many of these funds look relatively attractive.
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- SPDR Barclays Capital International Treasury Bond ETF (BWX): This ETF is designed to track the performance of government bonds issued in local currencies by investment-grade countries outside the U.S. with at least one year remaining until maturity. BWX has lost about 3% so far this year, and has an average coupon of 4.21%. BWX maintains a weightings of about 4.1% to Greece and 4.6% to Spain.
- SPDR DB International Government Inflation-Protected Bond ETF (WIP): As concerns about an imminent uptick in inflation have materialized, investors around the world have flocked to inflation-protected bonds. WIP invests in inflation-protected government bonds in both developed and emerging markets outside the U.S., and maintains an average coupon of 3.2% and a 30-day SEC yield of 1.5%. By comparison, the iShares Barclays TIPS Bond Fund (TIP) offers a weighted-average coupon of 2.2% and 30-day SEC yield of just 0.7%. WIP has lagged its U.S. counterpart by about 400 basis points this year.
- iShares S&P/Citigroup International Treasury Bond Fund (IGOV): Japan accounts for about a quarter of IGOV’s total assets, followed by Germany (9.6%), Italy (8.2%), and France (7.3%). Spain and Greece account for about 9% of total assets. IGOV features an average coupon of 3.6%. By comparison, the iShares Barclays 7-10 Year Treasury Bond Fund (IEF) has an average coupon of 3.8% and an SEC yield of 3.3%.
Disclosure: No positions at time of writing.