International debt funds: Is investing worthwhile?

The international debt market has seen quite a shake-up in the past year, largely driven by global interest rate hikes since 2022. This has resulted in a surge in US Treasury bond yields, reaching levels not seen since 2007, marking a 16-year high.

Launch of three FoFs
In response to these developments, three fund of funds (FoFs) have been launched in the last eight months in this space. These include Bandhan US Treasury Bond 0-1 Year FoF, Aditya Birla Sun Life US Treasury 1-3 Year Bond ETFs FoF, and Aditya Birla Sun Life US Treasury 3-10 Year Bond ETFs FoF. They have amassed a total of around Rs 341 crore to date.

The inaugural fund, Bandhan's FoF, launched in March 2023, focuses on investing in US Treasury bonds maturing within one year. The subsequent offerings from Aditya Birla invest in ETFs with underlying securities as US Treasury bonds, covering maturities of one to three years and three to 10 years, respectively.

Given the decade-high levels in US Treasury yields, the question arises: is there a compelling rationale for considering investment in these funds? Let's delve deeper into this matter.

The case for the US Treasury bonds

• Diversification: Renowned for being one of the safest investment vehicles, the US Treasury bonds present an attractive option for investors aiming to broaden the geographical diversification of their fixed-income portfolio.
  

• Closing yield gap: Traditionally, the Indian government securities offered higher yields than the US Treasury bonds, and they still do. However, the yield gap has narrowed with the recent robust rate hikes in the US. So, while Indian securities maintain their edge, the US Treasury bonds have become more attractive for Indian investors than ever before.

Despite the reduced gap, assessing the currency risks associated with these investments is crucial.

Currency risk
If you invest in these funds, your returns will be influenced by the fluctuation of the Indian rupee against the US dollar. Historically, the rupee has tended to depreciate over the long term, happening nine out of 10 times in the last decade.

Rupee depreciation has, historically, enhanced returns, generally yielding 3-4 per cent over a 10-year period. However, rupee appreciation can slash returns, which happened in 2017 when the rupee appreciated by 6.4 per cent. If you had invested in a one-year US Treasury bond in 2017, it would have resulted in an approximately -5.2 per cent return, considering the one-year US Treasury yield of 0.83 per cent at that time.

Our word
These funds suit those who seek geographic diversification in their core fixed-income portfolio. Consider a modest investment while exercising caution due to the complex interplay of factors, including US interest rates and currency risks.

Also read: Investing internationally: Does it truly diversify?