Diversify portfolios with U.S. and international bonds

Diversify portfolios with U.S. and international bonds

Investing broadly across asset classes such as stocks, bonds and cash can help reduce volatility and risk within a portfolio. Canadian investors have added international stocks to their portfolios for diversification, but they ve had limited access to broad foreign bond markets. Our new international and U.S. bond ETFs provide that access at low cost. Contents 1 More accessible markets 2 Diversification benefits 3 The role of currency hedging 4 Vanguard U.S. Aggregate Bond Index ETF (CAD-hedged) 5 Vanguard Global ex-u.s. Aggregate Bond Index ETF (CAD-hedged)

More accessible markets Globalization has accelerated in the last decade, making world markets more accessible and contributing to an increase in governmentissued debt. The larger, more accessible market is attracting investors. Figure 1 shows that at 35% of global investable assets (up from 19% in May 2000), the bond market outside the United States now represents an asset class larger than U.S. stocks, U.S. bonds or international stocks. Non-U.S. bonds account for 60% of the USD 42 trillion global fixed income market, while U.S. bonds account for 40%. 1 A diversified bond portfolio should reflect these proportions. Figure 1: Growth of international bonds 21% 23% May 2013 International bonds are the largest asset class 35% 22% U.S. stocks U.S. bonds International stocks International bonds 19% May 2000 International bonds were the second-smallest asset class 17% 30% 34% U.S. stocks are represented by the MSCI US Broad Market Index. International stocks are represented by the MSCI All Country World ex USA Investable Market Index. U.S. bonds are represented by the Barclays U.S. Aggregate Bond Index. International bonds are represented by the Barclays Global Aggregate ex-usd Bond Index plus the Barclays Global Emerging Markets Index. Data as of May 31, 2013. Percentages may not add up to 100 due to rounding. Sources: MSCI, Barclays, and Vanguard. 1 Percentages and market size are based on the Barclays Global Aggregate Bond Index, which measures the global investable bond market, as of January 16, 2014. 1

Diversification benefits Diversification is the strategy of investing in different asset classes and among the securities of many issuers in an attempt to lower investment risk. Diversifying a portfolio can help smooth out returns over time. Outperformance in one investment can help offset underperformance in another. These benefits can apply to an entire portfolio or to an asset class within a portfolio. For example, you can diversify a fixed income portfolio that holds only Canadian bonds by adding international and/or U.S. bonds. Global bonds provide exposure to interest rates, inflation, economic cycles and political climates in a wide range of markets outside of Canada. Figure 2 illustrates how different the interest-rate profiles of Canada and other countries can be. The difference is measured by correlations, the degree to which two variables such as asset classes behave similarly (or not). A perfect correlation of 1.0 means two variables move in lockstep. While perfect correlation is rare, stocks of companies in the same industry, for example, would come close. A correlation of zero means movement in one variable is unrelated to movement in the other. The imperfect correlations shown in Figure 2 are evidence of the potential diversification benefits of adding both U.S. and international bonds to a portfolio of Canadian bonds. Figure 2: Difference in interest rates Correlation of monthly changes in each country s 10-year government bond yield to the change in the 10-year Canadian government bond yield, January 1998 through November 2013. 1.0 0.8 0.6 0.4 0.2 0.0 Australia Belgium France Germany Italy Japan Netherlands South Korea Spain Sweden U.K. U.S. Source: Vanguard illustration based on data from Thomson Reuters Datastream. 2

The role of currency hedging Because investing in international bonds can expose investors to the constant movements of global currencies, it s important to hedge international bonds currency exposure to the Canadian dollar. Currency fluctuations can cause higher volatility for investors in international fixed income securities, while their effect on returns can be either positive or negative. As Figure 3 illustrates, hedging fixed income investments to the Canadian dollar has historically reduced volatility within balanced portfolios of global stocks and global bonds. This reduction in volatility allows the underlying bonds to play the traditional fixed income role of risk reduction. Figure 3: Volatility and the effects of currency hedging Annualized volatility of balanced global stock/global bond portfolios, with either hedged or unhedged global bonds, January 1985 through November 2013. The illustration displays the annualized volatility of monthly returns with various stock/bond allocations. The global bond allocations are either hedged to Canadian dollars or are unhedged that is, they include the effect of currency movements. 16% 14 Annualized volatility 12 10 8 6 4 2 0 0/100 20/80 40/60 60/40 80/20 100/0 Portfolio stock/bond allocation Unhedged global bonds Hedged global bonds Source: Vanguard illustration based on returns expressed in Canadian dollars on a monthly basis, with income and dividends reinvested. Data covers January 1985 through November 2013. Canadian stocks are defined as the S&P/TSX Composite Index. Global stocks are defined as the MSCI World Index in Canadian dollars from January 1985 through December 1987; the MSCI All-Country World Index in Canadian dollars from January 1988 through January 1999; and the MSCI All-Country World Investable Market Index in Canadian dollars thereafter. Canadian bonds are defined as the Citigroup World Government Bond Index Canada All Maturities Index from January 1985 through September 2002 and the Barclays Canadian Issues 300MM thereafter. Global bonds are defined as hedged and unhedged versions of the Citigroup World Government Bond Index from January 1985 through January 1999 and the Barclays Global Aggregate thereafter. 3

Vanguard U.S. Aggregate Bond Index ETF (CAD-hedged) VBU Our U.S. aggregate bond ETF seeks to track the performance of the Barclays U.S. Aggregate Float Adjusted Index (CAD Hedged). VBU provides a low-cost way to obtain diversified exposure to the broad U.S. fixed income market. VBU invests in units of the U.S.-domiciled Vanguard Total Bond Market ETF, which invests in more than 3,000 bonds representative of the broad U.S. investment-grade market. About the benchmark The Barclays U.S. Aggregate Float Adjusted Index measures the investment return of investmentgrade, taxable, fixed income securities in the United States including government, corporate and international U.S. dollar-denominated bonds, as well as mortgage-backed and asset-backed securities all with maturities longer than one year. The average maturity is between five and ten years. Lower costs With a management fee of 0.20% 2, VBU is among the lowest-cost options in the international bond fund marketplace. The fee compares with an average asset-weighted management fee of 1.52% for global fixed income mutual funds. 3 As of the date of publication, Vanguard U.S. Aggregate Bond Index ETF (CAD-hedged) is the most broadly diversified U.S. bond ETF in Canada. 2 The management fee is equal to the fee paid by the Vanguard ETF to Vanguard Investments Canada Inc. and does not include applicable taxes or other fees and expenses of the Vanguard ETF. Since this Vanguard ETF invests in another Vanguard fund, the management fee also includes any fees paid to Vanguard Investments Canada Inc. or its affiliates by such other Vanguard fund as well as certain expenses of the other Vanguard fund that are paid directly by the other Vanguard fund. At any time during which Vanguard Investments Canada Inc. is the trustee, it will receive no fee in respect of the provision of services as trustee. 3 Source: Series A data based on the Canadian Investment Funds Standards Committee (CIFSC) asset classification for global fixed income mutual funds from Investor Economics through December 31, 2013. CIFSC is a classification-standards organization that compares investment funds with similar investment objectives made up of mutual fund database and research firms. Vanguard and CIFSC are unaffiliated. 4

Vanguard Global ex-u.s. Aggregate Bond Index ETF (CAD-hedged) VBG Our ex-u.s. aggregate bond index ETF seeks to track the performance of the Barclays Global Aggregate ex-usd Float Adjusted RIC Capped Index (CAD Hedged). VBG provides a low-cost way to obtain diversified exposure to the world s largest asset class. VBG invests in units of the U.S.-domiciled Vanguard Total International Bond ETF, which invests in more than 2,000 bonds representative of the broad global bond market with the exception of U.S. dollardenominated bonds. About the benchmark Barclays Global Aggregate ex-usd Float Adjusted RIC Capped Index is a broad-based measure of the non-u.s. investment-grade, fixed-rate debt markets. It includes government, agency, corporate and securitized non-u.s. investment grade fixed income investments issued in currencies other than the U.S. dollar. It caps exposure to any particular bond issuer, including governments, at 20%. Lower costs With a management fee of 0.35% 4, VBG is among the lowest-cost options in the ex-u.s. bond fund marketplace. The fee compares with an average asset-weighted management fee of 1.52% for global fixed income mutual funds. 5 Vanguard Global ex-u.s. Aggregate Bond Index ETF (CAD-hedged) is the first ETF in Canada offering broad international bond exposure across government and corporate issuers. 4 The management fee is equal to the fee paid by the Vanguard ETF to Vanguard Investments Canada Inc. and does not include applicable taxes or other fees and expenses of the Vanguard ETF. Since this Vanguard ETF invests in another Vanguard fund, the management fee also includes any fees paid to Vanguard Investments Canada Inc. or its affiliates by such other Vanguard fund as well as certain expenses of the other Vanguard fund that are paid directly by the other Vanguard fund. At any time during which Vanguard Investments Canada Inc. is the trustee, it will receive no fee in respect of the provision of services as trustee. 5 Source: Series A data based on the Canadian Investment Funds Standards Committee (CIFSC) asset classification for global fixed income mutual funds from Investor Economics through December 31, 2013. CIFSC is a classification-standards organization that compares investment funds with similar investment objectives made up of mutual fund database and research firms. Vanguard and CIFSC are unaffiliated. 5

Vanguard Investments Canada Inc. 155 Wellington Street West Suite 3720 Toronto, ON M5V 3H1 Connect with Vanguard vanguardcanada.ca/advisorsalpha 888-293-6728 Commissions, management fees and expenses all may be associated with the Vanguard ETFs. Investment objectives, risks, fees, expenses, and other important information are contained in the prospectus; read it before investing. Copies of the prospectus are available at www.vanguardcanada.ca. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated. Date of first publication: July 2014. Vanguard ETFs are managed by Vanguard Investments Canada Inc., an indirect wholly-owned subsidiary of The Vanguard Group, Inc. This communication is solely for informational purposes, and is not a recommendation, offer or solicitation to buy or sell any ETFs or to adopt any investment or portfolio strategy. The information is not investment and/or tax advice, nor is it tailored to the needs or circumstances of any individual investor. The Vanguard ETFs are not sponsored, endorsed, sold or promoted by Barclays. Barclays does not make any representation regarding the advisability of investing in Vanguard ETFs or the advisability of investing in securities generally. Barclays only relationship with Vanguard is the licensing of the Index which is determined, composed and calculated by Barclays without regard to Vanguard or the Vanguard ETFs. Barclays has no obligation to take the needs of Vanguard or the owners of the Vanguard ETFs into consideration in determining, composing or calculating the Index. Barclays has no obligation or liability in connection with administration, marketing or trading of the Vanguard ETFs. Notes on Risk: All investments, including those that seek to track indexes, are subject to risk, including the possible loss of principal. Investing in ETFs involves risk, including the risk of error in tracking the underlying index. Diversification does not ensure a profit or protect against a loss in a declining market. Foreign investing involves additional risks, including currency fluctuations and political uncertainty. Investments in bond funds are subject to interest rate, credit, and inflation risk. While this information has been compiled from sources believed to be reliable, Vanguard Investments Canada Inc. does not guarantee the accuracy, completeness, timeliness or reliability of this information or any results from its use. 2014 Vanguard Investments Canada Inc. All rights reserved. CBCABC 072014