Americans Get Burned by Europe Bond Rally That’s Undone by Euro

You can’t blame U.S. credit investors for wanting to ride this wave of European central bank stimulus. As policy makers buy bonds from traders in the market -- the thinking goes -- they’ll bid up prices.

The problem is buying euro-denominated corporate bonds hasn’t necessarily been a good trade because the euro has been tanking relative to the dollar.

While euro-denominated corporate bonds have gained 1.4 percent this year according to a Bank of America Merrill Lynch index, a U.S. exchange-traded fund focused on the debt has lost 9 percent. State Street Corp.’s International Corporate Bond ETF is the second-worst performer among all U.S. debt ETFs this year, according to data compiled by Bloomberg.

The huge difference in returns all comes down to how Americans bring their European investments home. Most likely, when they’re ready to cash in, they’ll have to convert those euros back into dollars.

With yields at record lows, that means this trade is as much a bet on the euro as anything else. And that’s a huge problem given the euro’s 10 percent drop against the greenback this year. The average yield of less than 1 percent on European investment-grade corporate bonds isn’t enough to offset that currency move.

Fund Flows

“It’s not attractive at all for global investors,” said Dorian Garay, a New York-based money manager for an investment-grade debt fund at ING Investment Management Co. To the extent that money is still going into the debt, either it’s coming from euro-specific funds or “investors who are just trying to profit from any small window of opportunity.”

Money is still pouring into global bond funds, with such strategies attracting $5.7 billion last week, according to EPFR Global data. Investors also funneled about $3 billion into debt ETFs traded in Western Europe, Bloomberg data show.

That State Street international fund -- which is registered in the U.S. -- has accumulated $228.7 million of assets since its inception almost five years ago. While it outperformed comparably-rated U.S. debt in the two years through 2013, it’s struggled ever since, losing more than 13 percent.

This has a lot to do with the euro as about 88 percent of the fund’s holdings are in securities denominated in the currency, according to data compiled by Bloomberg. The euro was at $1.0854 at 10:51 a.m. in New York, lingering at an almost 11-year low Monday as the European Central Bank begins buying government bonds under its expanded quantitative-easing program.

Danny Casarella, a spokesman for State Street, didn’t immediately provide a comment.

With the dollar rallying on the Federal Reserve’s plans to raise interest rates this year and U.S. corporate bonds yielding close to the most they’ve ever offered relative to European debt, American credit investors may find the best strategy is to simply stay at home.

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