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A New Vanguard Index Fund Could Lag Active Managers

In contrast, most actively managed global bond funds hold foreign currencies. When foreign currencies decline against the dollar, the value of overseas assets declines for U.S. investors. That has happened in recent months and presented headwinds for most foreign funds. The Vanguard fund has been unscathed because it holds currency forward contracts that do not fluctuate as the value of the dollar moves.

Whether or not the dollar strengthens, chances are good that active global bond funds will outdo passive choices in coming years. If the global economy continues growing, as many economists expect, then low-quality foreign bonds should rise as investors worry less about defaults.

For investors who can tolerate some risk, a solid active fund is Legg Mason BW Global Opportunities (GOBAX). During the past five years, the fund returned 11.2% annually, outdoing 91% of world bond funds. The Legg Mason fund buys bonds of varying credit qualities, seeking unloved securities with attractive yields.

To top the benchmarks, the portfolio managers sometimes take contrarian positions. In 2012, they bought out-of-favor bonds from Portugal, one of Europe's most troubled economies. The move proved on target as investors gained more confidence that the country wouldn't default. "The Portuguese were slowly pulling through the crisis and having some success with labor market reforms," said portfolio manager Richard Lawrence.

The Legg Mason fund has held few assets in Japan where yields have been tiny. Instead, the portfolio has had big stakes in Mexico. The bonds pay relatively rich yields and Mexican exports are strengthening as the U.S. economy grows.

Even if the active funds top the benchmarks, chances are that assets will continue flowing to the Vanguard global fund. Vanguard has been pounding the table for its new fund, saying that international bonds can help diversify portfolios.

To underline the point, Vanguard has added the international bond fund to the portfolios of the company's fast-growing target-date retirement funds, which are popular choices for 401(k) plans and hold more than $150 billion in assets. The international bonds will account for 20% of the fixed-income allocation of the target-date funds. As retirement plans grow, the international bond fund should attract a steady flow of assets.

At the time of publication the author had no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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