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Should You Invest in Foreign “Dim Sum” Bonds?

There’s a good chance that you’ve never heard of a Dim Sum Bond [3]. This is a bond that is denominated in the Chinese Yuan (their currency) but issued in Hong Kong. Now, CNN [4] is reporting that Emirates NBD, the largest bank in the United Arab Emirates, is issuing $119 million in these bonds to interested investors.

The retail investor will likely not commit money to dim sum bonds any time soon but with such an exotic product finding its way to the mainstream financial media, it’s likely to spark curiosity and retail investors will ask the question, “should I look to such products to diversify my portfolio?” Investing in foreign markets, whether it’s in stocks or bonds, carries its own set of risks.

Foreign Bonds

Just like stocks, currency and commodities, American investors can invest in products outside of the United States. Financial professionals recommend diversifying portfolios with products outside of their home country in order to protect against events like the 2008 and 2009 financial crisis.

Sophisticated investors have found profits in European government bonds often cashing in on short term gains on Italian and German bonds playing on the volatility that surrounds the recent Eurozone crisis but are these products right for the retail investor?

Just Say No to Foreign Bonds

For the retail investor, less is often more. The first rule of investing is not to invest in anything you don’t understand. If you don’t know how a company makes its money, don’t buy the stock. If you can’t have an intelligent discussion about a master limited partnership, don’t purchase shares even though the dividend is attractive.

Part time investors have a tough enough time understanding the domestic bond market. Understanding the inverse relationship between price and yield, as well as interest rate risk, call risk and the many other risk facets of bonds is tough enough without adding the complicated variable of currency risk.

Once an investor holds a position in an investment product, constant research is key to knowing when to sell. Popular TV personality Jim Cramer suggests one hour of homework per week for each investment product. Foreign products are even more difficult to research because of the complicated nature of international politics and monetary policy.

Finally, for most, investment directly in to foreign bonds is impractical because of the high minimum requirement.

Alternatives to Foreign Bonds

The best way to gain international exposure is through international bond ETFs or low fee mutual funds. Not only do these funds have a lower minimum entry cost, they are more widely diversified making country specific events less important to the performance of the overall fund.

Sometimes paying higher fees is money well spent. These mutual funds and ETFs employ teams of researchers often living in the countries where the fund has positions. These analysts are in a better position to provide the manager information they can use to make important decisions about the fund but many low cost international products are available.

Bottom Line

There are a lot of investment products on the market and although the thrill of learning and reading about exotic products makes investors feel more knowledgeable and sophisticated, in reality the simplest products, which may include international diversified funds, are the best performers for most portfolios.