BNDX: International Interest Rate Cuts Can Carry A Good Capital Appreciation

Investment Thesis

Some central banks, like the European and Canadian, have recently started cutting their interest rates, leading to high capital appreciation in associated long-term bond ETFs. Vanguard Total International Bond Index Fund ETF Shares (NASDAQ:BNDX) invests in government and corporate bonds outside the USA, and it will appreciate under an international interest rate-cutting atmosphere.

Fund Structure

BNDX is an ETF issued by Vanguard Group, Inc., in 2013. It seeks to track the performance of the Bloomberg Global Aggregate ex-USD Float Adjusted RIC Capped Index (Hedged). The fund invests in a board of low-risk governmental and corporate taxable bonds outside the United States, mainly in Europe and Japan.

The fund holds just above 6,800 bonds, with a maturity yield of 5.1% and a bond’s average duration of 7.2 years. (You can visit Vanguard’s official website for more details). The fund’s AUM is approximately $92B, with a low expense ratio of 0.07%. Notably, the fund has experienced a significant positive flow of $3B in the past three months, indicating its growing trust and confidence in its potential.

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Moving to bonds that the fund holds, we notice it is heavily invested in Europe, The Pacific, and North America (excluding the USA). These top three hold approximately 87% of the fund’s total bonds, which makes the fund sensitive to the above countries’ interest rates. We are going to discuss this comprehensively in a while.

BNDX has a low-risk exposure. As mentioned, it is invested in a diversified bond portfolio characterized by low-risk governmental and corporate taxable bonds, reflecting a solid credit rating of BNDX holdings. However, the fund contains some non-investment-grade bonds, but they only have a small minority share and do not alter the fund’s low-risk characteristics.

Quite unexpectedly, despite this very low-risk exposure, BNDX is still riskier than other bond ETFs created to track and hold the United States bond market. By comparing BNDX to its peer, the Vanguard Total Bond Market Index Fund ETF (BND), which has the same fund characteristics but exclusively invests in the U.S. bond market, many indicators demonstrate BND’s superiority as a lower-risk asset, as U.S. treasuries are generally considered the safest or risk-free assets in the financial markets.

Comparing BNDX to its peers from the same category, the international bonds holding ETFs, we can notice strong preferences that BNDX has. BNDX is associated with a far lower expense ratio of 0.07%; the ETF returns the highest total return amongst others in the past ten years. Furthermore, BNDX is a comprehensive ETF. It scores almost A for different Seeking Alpha ETF grade sectors: expense, Dividends, Risk, and liquidity, and scored D in momentum, which can be related to its impeded characteristics by holding international treasury bonds, whose prices are directly related to global interest rates, keeping in mind that most central banks have held interest rates unchanged since September 2023.

BNDX Is Safe, So Is It Profitable?

BNDX experienced a serious price plunge starting at the end of 2022. The price of the ETF has dropped almost 16%, and it has been at this low level since then. As a result, those who invest in this ETF suffer from huge book losses and actual losses if they decide to sell. This price drop can be explained by the high inflation in the USA, Europe, and the rest of the world economy after the pandemic, along with the reports frequently published about the interest rate hike in the USA, followed by the European Central Bank and other major central banks. Eventually, the European Central Bank (Where the Majority of BNDX bonds concentrated) started a series of interest rate hikes in July 2022 from 0% to reach the terminal interest rate of 4.5% in September 2023. These forceful hikes instantly caused a capital depreciation of the bonds held by BNDX, which is reflected directly in this sharp decrement.

However, the BNDX has continually yielded on-cost dividends between 4% and 5%, which is considered reasonable compensation for the ETF price drop. Yet, compared with its peer BND, we can notice that BNDX’s 30-day SEC yield is only about 3.3% lower than BND’s 4.6% SEC yield and the 4.8% yield of the 10-year U.S. Treasury. Despite this, it is always a good practice to diversify in investment allocation since the U.S. economy is still under inflation pressure, and it could be even worse than it looks (investors can find some details here).

Capital Appreciation Ahead

As mentioned above, BNDX has an average duration of 7.2 years for bonds, which is (the average duration) a measure of the sensitivity of bond-and bond mutual fund prices to interest rate tendencies as per the official Vanguard website. As a result, if a bond ETF has an average duration of 7.2 years, its price will increase by about 7.2% when interest rates decrease by one percentage point. The converse is true: the bond’s price would decrease by about 7.2% when interest rates increase by one percentage point.

Therefore, we can directly relate the BNDX price to the interest rates of its primary bond-holding issuer; if these issuers lower their interest rates, the share price of BNDX will increase. The European and Canadian Central Bank recently officially reduced their interest rates by 25 basis points (bps), with robust predictions and analyses to keep doing so. I summarized the interest rate expectation for the major bond-issuing countries as follows:

According to the facts mentioned above, I do believe it is a perfect entry point into BNDX; some of the two leading bond issuers, weighing 60% of the fund holding, have already started lowering their interest rates, which will lead to capital appreciation of the fund AUM and will push ETF price to increase. Yet, the fund holdings characteristics are nested, which makes it very hard to create a direct mathematical model that characterizes interest rate to capital appreciation relation. However, let us keep it simple: Lowering bond issuer interest rates will lead to a price increment of BNDX. This situation can continue until the ETF share price returns to its 2022 price level of $56 (approximately 15% share price appreciation from $48.7 today’s value).

Fund Drawbacks And Associated Risks

BNDX is a low-risk investment that pays decent monthly dividends and has a strong potential for capital appreciation. Still, all of this comes with many adverse consequences and conceivable risks, summarized as follows:

• There is no clear strategy for BNDX. It is a collection of diversified governmental and corporate bonds; the entire fund allocation is outside the U.S., where investors and even governments worldwide regard U.S. treasuries as the lowest risk among others.

• The yield of BNDX is low compared to that of other peers. Still, you can have a very low-risk, relatively high yield of 5% using T-Bills ETFs. Or you can have a potential price appreciation with an acceptable yield of 3.7% using Long-Term Treasury ETFs.

• Indeed, the European Central Bank and other central banks worldwide have started cutting their interest rates, but the U.S. has not, and it will not soon. The Fed Watch Tool still shows that there would be a probability of one or a maximum of two rate cuts at the end of this year. At the same time, economics reporters still indicate hotter-than-expected inflation rates in the U.S. As a result, if the United States does not lower its interest rate, the other major central banks cannot keep lowering their interest rates because this places enormous pressure on local currencies.

Investor Takeaway

BNDX is an ETF that invests in low-risk bonds (governmental and cooperates) outside the United States. It is well-diversified and has a portfolio of enormous holdings in vast financial markets. Therefore, you can expose yourself to the international bond market and lower your investment concentration.

However, exposure to bond markets other than the U.S. can be irrational, especially if the U.S. interest rate is equal to or higher than other markets’ rates. Many investors and governments classify Treasury Debt as risk-free, and the market has many ETFs oriented toward U.S. Treasury Bonds, which can offer a much more precise strategy and safer investment in many ways.

On the other hand, BNDX is considered a good solution for short and intermediate investments. Investors can use it to simultaneously expose themselves to investment-grade international bond markets, including Europe, Japan, Canada, the U.K., and other financial markets. Investors can usefully grow their portfolios from the potential capital gain every time one of these countries lowers its interest rates.

Finally, as demonstrated above, BNDX has robust investment characteristics, including diversification, potential capital appreciation, steady monthly income, a lower expense ratio, and investment-grade holdings. Therefore, I initiate a strong buy recommendation for BNDX because now is an excellent time to invest in an ETF that will enormously benefit from lowering interest rates worldwide.