International income strategies

These days, income is getting harder and harder to find. In the U.S., stocks are yielding a 1.97% dividend while a Barclays Aggregate Bond is yielding about 1.56 percent. The current yield on a five year Treasury bond is 0.72%.
With such low rates in the U.S., investors may be wondering where to turn for more income. Well, it just so happens that more income can be found offshore. Foreign stocks as a whole are paying a much higher dividend. According to Morningstar, the iShares EAFE ETF yielded 2.84% in the last year. The Vanguard Total International Index Fund yielded 3.05%. That’s 55% more income than in the yield of U.S. stocks.
International bonds are getting red hot too. Even Vanguard is about to launch its first international bond fund, though its yield isn’t expected to be any higher than the U.S. equivalent. But that is not to say there isn’t higher yield to be found. For example, the iShares Local Currency Emerging Market’s bond ETF is yielding 3.22%, the Market Vectors EM Local Currency Bond ETF is yielding 4.22%, and the Franklin Templeton Emerging Market Debt fund is still yielding 5.32%.
Though it would be nice if these higher yields came without risk, we know better than that. In addition to market risk, international stocks have foreign currency risk. International stocks bested the total return of U.S. stocks last year, but are lagging so far this year. The standard deviation of international stocks is greater than that of the U.S., measured in U.S. dollars.
International bond investing is far more problematic. The funds with the highest yields are invested in local currency. This means that the majority of their price movement will be due to foreign currency fluctuations. Morningstar classifies most of the credit quality of the underlying bonds in the funds as low.
All of the international bond funds I mentioned that were around during the financial markets crash performed more similar to stocks than bonds. They zigged nearly as badly as stocks, just when our clients needed them to zag. A high quality Barclays bond fund gained five percent, giving our clients’ portfolios a shock absorber when they needed it the most. High income vehicles proved disastrous in 2008, and it appears the flight again to risky income proves investors have very short memories.