Rolling the Currency Dice: Investing in International Bond Funds

Posted on December 4, 2012 | Investing

The search for yield and the weak U.S. dollar have prompted individual investors to set their sights abroad, and to consider investing in foreign bond mutual funds. International bond mutual funds, however, have their own unique set of risks. And these risks are magnified by the often rapid ebb and flow of international currency markets.

Yields may be higher in other countries and the dollar may be swooning, but a careful look at international bond mutual funds is in order before you let your money travel overseas.

The two primary risks of investing in foreign fixed-income securities are:

Credit Risk: The riskiness of the issuers of the individual securities in the portfolio, and
Currency Risk: The risk that the currency in which the securities are denominated will change in value relative to the U.S. dollar.

There is also a more subtle risk for individual investors: understanding the sometimes arcane portfolio holdings of these funds, which may include futures, options, repurchase agreements, loan participations and asset-backed debt such as collateralized mortgage obligations.

And in terms of holdings, it can be surprising to what degree some of these international bond funds are actually invested in U.S. securities—contrary to the purpose driving most individual investors to international bond mutual funds in the first place.

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