February 26, 2024

Why should investors consider Foreign Currency Bonds?

Foreign currency bonds have the potential to provide enhanced fixed income returns while adding additional diversification your investment portfolio

Consider foreign currency bonds

Foreign Currency Bonds provide an opportunity to participate in another country’s debt market. Interested investors may pursue multiple strategies, including portfolio diversification, enhanced yield, or as a hedge against inflation or currency movement.

Whether it be government or corporate bonds, investors seek to participate in the income and value growth of the foreign country’s debt markets.

The opportunities on offer are varied and extensive, and may include investment in expanding economies, emerging markets, and a wider range of borrowers and industry sectors that may not be as readily available domestically, in areas like information & technology, communication services and specific sub-sectors like cybersecurity, defense and semi-conductors.

This broader international exposure can provide investors with the potential for higher returns and increased diversification.

The case for Foreign Currency Bonds

Interest rates vary across different countries as they manage economic impacts domestically. Countries with higher interest rates to Australia can offer potentially higher fixed income returns for investors. Furthermore, Australian-specific risks can be reduced by investing in bonds with non-Australian dollar currencies, as investors can benefit from varying economic cycles, inflation, and interest rate policies in other countries due to increased geographical exposures. This diversification helps manage the risk profile of a portfolio, as potential gains in one market can offset losses in another. Additionally, foreign currency bonds can provide a hedge against Australian inflation or a devaluation in the Australian dollar, ensuring a more stable investment performance.

Foreign currency bonds can also serve as an effective currency hedging structure for investors with a substantial exposure to the Australian dollar. By investing in bonds denominated in different currencies, investors can hedge against potential losses caused by a depreciation in the Australian dollar. This hedging strategy helps protect the portfolio against currency risks, providing stability and mitigating losses in volatile market conditions and unexpected fluctuations in currency markets.

In addition to providing some balance to foreign exchange risks, foreign currency bonds can take advantage of the potential for currency appreciation. If an investor believes a foreign currency is undervalued compared to the Australian dollar and has the potential to appreciate, investing in bonds denominated in that currency can offer the potential for gains. As the foreign currency strengthens relative to the Australian dollar, investors can benefit from capital appreciation on top of regular coupon payments. This potential for currency appreciation further enhances the total return on investment. However, there is also a risk for returns if the currency moves in the opposite direction to the investor’s expectation, which may negatively impact portfolio returns.

Plan your investment

When considering foreign bonds, it is a good idea to start with your goals and determine your current portfolio exposure to foreign markets. Depending on the strategy and goals, the appropriate allocation towards foreign bonds can be examined. Should you currently have a large allocation to foreign assets, this may influence how much and which markets to further explore. Taking into account the development of foreign markets in respect to regulatory standards and what sectors are available for investment should also be considered to align with what you are trying to achieve.

It is essential for investors to conduct thorough research and assess country-specific risks to ensure informed decision-making and mitigate possible investment risks. Investors can consult with specialists to gain additional insights to aid their decision making.

Conclusion

Investors can take advantage of currency moves, however they also face exchange rate risks should the foreign currency depreciate against the Australia dollar. Investors should also be aware of political, economic and interest rate risks of the foreign country. With increasing interconnectivity of global markets, bonds in currencies other than Australian dollars offer a way to broaden investment possibilities, tap into offshore markets, and potentially outperform domestic investments. Investing in foreign currency bonds can be a rewarding strategy for investors who are seeking diversification, higher yields, currency appreciation opportunities, and protection against currency risks. When carried out wisely, investing in foreign currency bonds can prove to be a valuable addition to a diversified investment portfolio, contributing to financial growth and stability.

 

Important Information

This article has been prepared without taking into account any person’s objectives, financial situation or needs. NAB recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article. Past performance is not necessarily indicative of future results. No warranty is made as to its accuracy, reliability or completeness. To the extent permitted by law, neither NAB or any of its related entities accept liability to any person for loss or damage arising from the use of this information. ©2023 NAB Private Wealth is a division of National Australia Bank Limited ABN 12 004 044 937 AFSL and Australian Credit Licence 230686.

 

 

 

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