Investment strategy: (No) Foreign currency bonds

According to the last Flash on currency hedging, it is advisable to hedge the currency risk of foreign currency bonds (FC). If this is not done, the FC bond asset class should primarily be seen as a currency bet, which can also be implemented more easily and cheaply with a money market fund in the desired foreign currency.

Consequently, the question arises whether the FC bond asset class, currency-hedged, represents a meaningful complement to the CHF bond asset class. The historical yield comparison illustrated in the table above tends to suggest no, as CHF bonds have outperformed both issuer segments, FC government bonds and FC corporate bonds, across all time horizons. The diversification argument can also be questioned in the case of high-grade CHF bonds (Swiss Confederation bonds, mortgage bonds, etc.).

Looking forward, comparing the yield potential based on yield to maturity shows that FC segments in local currency offer significantly higher yields due to higher interest rates. However, once the interest rate differential resulting from currency hedging is deducted, the hedge-adjusted yield to maturity of FC government bonds falls below that of CHF bonds, while the yield of FC corporate bonds remains above the level of CHF bonds even after hedging.

Credit risk deductions due to expected credit defaults have not yet been taken into account, but they are low for the high-ranking investment-grade segments under review (AAA–BBB).

Private investors who are subject to income tax must also bear in mind that coupon yields (which are significantly higher in foreign currency segments) are treated as interest income and are therefore subject to income tax and withholding tax. For us, this is the decisive argument for not including the asset class FC bonds, currency-hedged, in the composition of the Economico standard portfolios.