Perspectives : Investment | May 15, 2023

(Re)validating the case for international bonds

Read time: 9 minutes

When speaking with everyday investors about their retirement portfolios, we find a high degree of familiarity with the equity securities that make up the S&P 500 Index and even commonly used U.S. fixed income instruments, such as U.S. Treasury bills and the bonds of prominent corporations. This familiarity leads many investors to portfolios with a large home bias. A portfolio's home bias is the weight allocated to securities, either equities or fixed income, issued by government entities or corporations of their home country.
By building a retirement portfolio that holds only familiar investments, investors may neglect one of the largest asset classes in the world: international bonds. Many people are unaware that international bonds make up about 24% of the liquid, investable market and 52% of the global bond market, as Figure 1 shows. When it comes to target-date funds (TDFs), we have long held the conviction that broad diversification is one of the key tenets of achieving long-term retirement goals.
Figure 1: Percentage of global capital market and of global fixed income market made up of international bonds
U.S. equities are represented by the MSCI U.S. Broad Market Index. International equities are represented by the MSCI AC World Ex USA IMI. U.S. bonds are represented by the Bloomberg Barclays U.S. Aggregate Bond Index. International bonds are represented by the Bloomberg Barclays Global Aggregate ex-USD Index. Calculations for global market allocations excludes U.S. TIPS and U.S. commodities.  
Source: FactSet data, as of March 31, 2023.

We are constantly evaluating our TDFs to ensure we have the right design and asset allocation to help our investors achieve a successful retirement. Recently, our Investment Strategy Group took a deeper look into our current fixed income exposure with a key question in mind: Should we change the fixed income home bias?

Our updated research reaffirms how and why this asset class continues to add value for investors. It also upholds our belief that maintaining a meaningful allocation to international bonds (30% of the total fixed income exposure) is a sufficient way for investors to improve risk-adjusted returns within their portfolios.

Vanguard’s approach is different

Because of Vanguard’s belief in the benefits of diversification, we were the first TDF provider to include meaningful exposure to international bonds within our glide-path sub-asset allocation in 2013 (further increasing our exposure in 2015).

In practice, this results in 30% of the bond allocation throughout Vanguard’s glide path allotted to international bonds. We achieve this using Vanguard Total International Bond II Index Fund, which provides broad exposure to non-U.S. investment-grade bonds, including international government, agency, and corporate securities from developed countries and emerging markets countries.

Compared with a U.S.-only bond portfolio, an investor with an allocation to international bonds benefits from diversified exposure to more securities (7,000 plus), yield curves, countries (40 plus), and macroeconomic regimes. This approach allows investors in Vanguard TDFs to capitalize on the benefits that fixed income securities, broadly, have provided investors for decades while not being overly concentrated in one country’s economic environment.

With that said, we do not believe in diversification for the sake of diversification. We are selective in what sub-asset classes we include. For example, high-yield bonds—and domestic high-yield bonds for that matter—are excluded. This decision is a result of Vanguard’s research showing high-yield bonds’ high correlation with equity markets, lessening their diversification benefits.

To hedge or not to hedge?

A clear demonstration of Vanguard’s thoughtfulness around asset allocation is our use of hedged international bonds within our TDFs. Currency hedging the allocation back to the U.S. dollar can provide the investor with the desired return stream without it being subject to excess volatility from movements in currency markets.

Figure 2 shows the impact that currency hedging has on international bond volatility. Currency hedging international bonds reduced the volatility of the asset class by 64%.

Figure 2: The impact of currency hedging international bonds
Sources: Vanguard calculations, using data from Bloomberg for the period January 1, 2003, through December 31, 2022. U.S. bonds represented by Bloomberg U.S. Aggregate Bond Index. Unhedged international bonds were represented by Bloomberg Global Aggregate ex-USD Index and Bloomberg Global Aggregate ex-USD Index Hedged for hedged international bonds.
Fortunately for TDF investors, Vanguard has decades of experience in currency markets. Thus, all the currency hedging is done in-house by traders within Vanguard Fixed Income Group (FIG). FIG’s expertise and experience helps to ensure effectively hedged portfolios using a consistent, scaled process.

New research, same conviction

Despite our clear conviction in the benefits of international bonds, we strive to revalidate our approach to every aspect of the glide path.. That led to a deep dive in late 2022 into the international bond allocation.

When evaluating the use of international bonds in a TDF, it is important to do so within the confines of a life-cycle model. We accomplish this with the Vanguard Life-Cycle Investing Model (VLCM), which incorporates investor characteristics such as risk tolerance profile, retirement funding needs, saving rates, and expected retirement age and evaluates Vanguard TDFs based on the utility an investor will derive over their lifetime. Vanguard combines its V-models, namely the VLCM with the Vanguard Asset Allocation Model (VAAM), to create and evaluate Vanguard TDFs with different fixed income home bias compared with the optimal glide path. 

Utility is the level of satisfaction or dissatisfaction associated with all possible outcomes that can take place when investing.

When measuring glide-path success, we use two goal-based metrics: certainty fee equivalent (CFE) and probability of success. The CFE is the variable that determines the amount an investor is willing to pay to invest in an improved glide path (e.g., the optimized one) relative to a reference glide path (e.g., the current one). Probability of success refers to the likelihood that a particular glide path will meet an investor’s spending goals through retirement across the full range of economic scenarios.

In reevaluating the case for fixed income in TDFs, our updated research supports our existing use of international bonds and Vanguard’s home bias. We assessed both age-varying fixed income home bias and static fixed income home bias and found that altering our existing approach did not have a materially positive impact on either model-based metric.

Age-varying fixed income home bias

Through our first approach, we sought to evaluate whether fixed income home bias could vary with age in a glide path. This will lead to different home bias across different vintages. We found that age-varying home bias does not offer any meaningful improvement to investor outcomes. Moreover, this negligible improvement comes with added complexity that could have adverse effects for the end investor.

Static fixed income home bias

Through our second approach, we sought to evaluate different fixed income allocations within TDFs when the fixed income home bias remains the same for all ages in a glide path. This will lead to the same home bias across different vintages. Currently, the fixed income allocation in our TDFs is composed of a 70% allocation to U.S. bonds and 30% allocation to international bonds.

We found that increasing the share of U.S. bonds in the portfolio does not improve investors’ retirement outcomes. In fact, as U.S. bond allocation increases, the portfolio loses the diversification benefits of international bonds, and the CFE decreases. In addition, decreasing the share of U.S. bonds does not improve investors’ retirement outcomes in any material way, leading to the recommendation to retain our current level of home bias.

The result of our research reflects that maintaining current fixed income home bias maximizes participant outcomes.
In practice, this means Vanguard’s TDFs will maintain a 70/30 home bias, with 70% of the bond exposure held in U.S. bonds and the residual 30% invested in international fixed income securities, throughout the entirety of the glide path. In addition, the underlying sub-asset allocation will remain the same, and we will continue to include both developing and emerging markets at their weights per the indexes. Investors using TDFs as the sole or primary retirement plan holding will find that our results reflect the most beneficial outcome.

A constant debate but not constant change

Vanguard prides itself on continuously looking for ways to improve retirement savings outcomes for investors. The goal of our TDFs and annual due diligence is to answer the question: How can we best serve a range of investors? This line of thinking guides the research we conduct in the TDF space. It also ensures that our TDFs reflect our best thinking on glide-path design and sub-asset allocation.

The case for international bonds is one that is constantly debated. However, unlike with competitor offerings, our debates do not result in constant change to our TDFs. The most recent review resulted in a simple yet meaningful decision to maintain our current allocations. Vanguard’s willingness to avoid change for the sake of change has driven outcomes for the past decade and, based on our research, should continue to drive outcomes in the future.


  • Important information:
    For more information about Vanguard funds, visit or call 800-662-2739 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

  • Investments in Target Retirement Funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in a Target Retirement Fund is not guaranteed at any time, including on or after the target date.

  • All investing is subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.

  • Investments in bonds are subject to interest rate, credit, and inflation risk.

  • Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk, which is the chance that political upheaval, financial troubles, or natural disasters will adversely affect the value of securities issued by companies in foreign countries or regions; and currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates. These risks can be especially high in emerging markets.
  • Vanguard Total International Bond II Index Fund is subject to currency hedging risk, which is the chance that currency hedging transactions may not perfectly offset the fund's foreign currency exposures and may eliminate any chance for a fund to benefit from favorable fluctuations in relevant currency exchange rates. The Fund will incur expenses to hedge its currency exposures.

  • The Vanguard Life-Cycle Investing Model (VLCM) is designed to identify the product design that represents the best investment solution for a theoretical, representative investor who uses the target-date funds to accumulate wealth for retirement. The VLCM generates an optimal custom glide path for a participant population by assessing the trade-offs between the expected (median) wealth accumulation and the uncertainty about that wealth outcome, for thousands of potential glide paths. The VLCM does this by combining two set of inputs: the asset class return projections from the Vanguard Capital Markets Model® (VCMM) and the average characteristics of the participant population. Along with the optimal custom glide path, the VLCM generates a wide range of portfolio metrics such as a distribution of potential wealth accumulation outcomes, risk and return distributions for the asset allocation, and probability of ruin, such as the odds of participants depleting their wealth by age 95.

  • The VLCM inherits the distributional forecasting framework of the VCMM and applies to it the calculation of wealth outcomes from any given portfolio.

  • The most impactful drivers of glide-path changes within the VLCM tend to be risk aversion, the presence of a defined benefit plan, retirement age, savings rate and starting compensation. The VLCM chooses among glide paths by scoring them according to the utility function described and choosing the one with the highest score. The VLCM does not optimize the levels of spending and contribution rates. Rather, the VLCM optimizes the glide path for a given customizable level of spending, growth rate of contributions and other plan sponsor characteristics.

  • A full dynamic stochastic life-cycle model, including optimization of a savings strategy and dynamic spending in retirement, is beyond the scope of this framework.