BWX: International Government Bonds And A Nice Dollar Play

 

Thesis

With yields up across the board in bonds internationally, we find it to be a sensible idea to explore the benefits of purchasing international government bonds as a portfolio diversifier. We have conveyed our strong view on buying U.S. government bonds via several articles and instruments:

• we assigned a Buy rating to the Invesco 1-30 Laddered Treasury ETF (PLW) which we covered here
• we assigned a Buy rating to the BlackRock Income Trust (BKT), a CEF purchasing Agency MBS bonds here
• we assigned a Buy rating to the Vanguard Extended Duration Treasury Index Fund ETF (EDV) which covers the long end of the Treasury curve

To that end we are going to have a look at the SPDR Bloomberg International Treasury Bond ETF (NYSEARCA:BWX), which as per its literature:

[…] seeks to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the Bloomberg Global Treasury ex-US Capped Index (the “Index”)

A retail investor needs to be very careful in selecting international bond ETFs. Many of them are hedged, meaning they have currency swaps in place that take out the impact of the dollar on other currencies. We do not necessarily like that at this stage. We have seen a massive rally in the dollar in the past years, and many are calling for peak USD. With that information in mind, we find local currency international bond funds as more appealing, since they represent a nice play on a weaker dollar, hence a diversification effect. BWX is a local currency fund:

Seeks to provide exposure to fixed-rate local currency sovereign debt of investment grade countries outside the United States

Also please note that most of the risk here is rate risk since the fund purchases largely investment grade bonds. How have rates performed in the various global jurisdictions in the past year? Higher across the board:

 

 

Policy Rates (Charlie B.)

 

In the above table, courtesy of Charlie Bilello, we can see a sea of red ‘Hikes' by international central banks. As banks increase their central target rates, bond values fall. The story has been similar across the globe, with central banks moving rates higher to fight inflation. It is interesting to note the ‘Real Central Bank Rate' column above. Real rates are obtained by subtracting inflation from the central policy rate. Sound monetary policy usually advices for the real rate to be positive before pausing hikes. By that token, only half of the surveyed jurisdictions are done hiking. Please note that both the Eurozone and the UK do not seem to be done yet hiking rates, while Australia surprised markets yesterday via a rate hike.

The hikes will end at some point in 2023 though, and we see rate cuts starting with 2024. BWX was down almost -20% in 2022, which gives it a nice curve for capital gains down the road, in addition to its current 2.6% yield.

We like what we see here, although we would have preferred a larger UK bonds bucket and a smaller Japan one. We do not think BWX is there yet in terms of bottoming, but quite close. We like BWX starting $21/share, so we are on Hold for now until the fund gets there as the market prices in the continuing hiking cycle.

Holdings

The fund, as per its mandate, holds investment grade local currency government bonds from the following countries:

 

 

Countries (Fund Fact Sheet)

 

The table is slightly misleading since we would also like to see a grouping of the Euro countries here as a segregated EUR exposure bucket.

All bonds are investment grade:

 

 

Ratings (Fund)

 

This vehicle is not going to purchase EM government bonds, so most of the risk here will sit with local rates.

Performance

The fund has been hit hard by higher rates:

 

 

Data by YCharts

We like the comparison above where we look at the Vanguard Total International Bond ETF (BNDX) because BNDX is dollar hedged. So the difference between BWX and BNDX is in a large part constituted by dollar strength. Nothing lasts forever, so when the dollar will finally weaken do expect BWX to outperform BNDX significantly.

Conclusion

 

BWX is an international government bonds fund. The vehicle is not hedged, purchasing local currency bonds without any foreign exchange swaps or forwards. This makes it a nice dollar play and diversifier, with many institutions calling for peak dollar. BWX only purchases investment grade bonds, thus represents a rates play. As per the presented data, we do not think many central banks are done hiking. This should translate into further weakness for the fund. We like BWX at $21/share, with a 7% annualized total return for each of 2024 and 2025 in mind. We are on Hold until then.