The asset category no one talks about

Christine Kashkari: Most investors today wouldn't dream of ignoring international stocks. But why is their international bond portfolio lacking? In this episode, we'll discuss why international fixed income is not just a nice to have for diversification, but a strategic necessity.

Welcome to Season 2 of Better Vantage by Vanguard, a podcast series hosted by custom content from WSJ and Vanguard. I'm your host, Christine Kashkari, editorial director at WSJ Custom Programming. And with me today is our co-host, Vanguard's global chief economist, Joe Davis. And joining us today to discuss the role of international fixed income as a diversifier is Dan Shaykevich, lead portfolio manager for emerging market debt and head of multi-sector strategy at Vanguard. Dan, welcome.

Dan Shaykevich: Thank you for having me, and great to be on this podcast.

Joe Davis: Yeah, Dan, thanks for doing it. And again, for the listeners, why am I so excited? We're going to hear from just an exceptional active manager. Dan, he's too humble to admit, but he leads one of the largest emerging market bond funds in the world and just impressive track record.

Christine: Let's start there. So, most investors know and utilize international stocks as a diversifier for their portfolios, but not so international bonds. But before we go into why that is, could you talk about this broad universe that maybe we're not aware of?

Dan: Thanks, Christine. I think the most important distinction that investors need to make before they decide on their allocations to anything international bond-related is: Are they talking about bonds that are denominated in U.S. dollars or bonds that are denominated in the local currencies.

And that's very important because if you look at the international currency allocation, there you have developed market government bonds, you have emerging market local bonds.
It's really part of your strategy about how much exposure you want to have outside the U.S. dollar.

And when you're looking at your dollar bond allocation—emerging market dollar bonds are very attractive asset class. And you look at that asset class in conjunction with other dollar-based assets in the bond market, for example, along with U.S. investment-grade bonds, along with U.S. high-yield bonds. And, if you have those other bonds, but you don't have emerging markets, you're probably missing out.

When you look at any fixed income asset class, the first thing you want to do is understand the credit quality. The average credit quality of the emerging market bond space is very close to investment-grade. In fact, half the bonds in EM indices and in a lot of EM portfolios are in investment-grade.*

So, if you compare that to, for example, U.S. high yield, which by definition is 100% below investment-grade, it tells you that in terms of credit quality, this asset class is pretty much middle of the road. When you look at local markets, you actually have even a higher quality mix in terms of ratings because the higher-quality countries tend to issue more in local markets and don't issue as many in dollars.

Christine: Dan, you would remember more than anyone else that trauma from the defaults of some emerging marketing countries from decades ago. So, I guess what we're trying to figure out is, how much has that market changed.

Dan: So, I was just getting kind of started in the industry when Argentina default on its bonds. This is an asset class with a 30-plus year history. But 25 years ago, when this was going on, it was it was a different asset class. At that point, Argentina composed more than 25% of EM bond indices and EM bond portfolios. Today, we have a lot more countries represented, where the index most commonly used wouldn't have more than 5% in any given country. So, the asset class is not only generally higher quality, but it's also much more diversified.

Christine: One of the other things, too, that we often hear is, if you're investing in international bonds, then you're exposed to currency risks. And I think what you're saying there is that actually is the point.

Dan: I think there's a lot of misunderstanding where currency exposure is. Currency is not a risk.
It is the intended destination of a lot of international bond investing. The bonds are simply a vehicle to give you that currency exposure, and there are a lot of very good reasons why investors do want to take a more diversified currency exposure than they have in a single home country portfolio.

Joe: Unpack that a little bit more for me, Dan. So, if I'm a U.S. investor, I’ve got my U.S. paycheck, it's in dollars, I have all my expenditures in dollars. Why would I want to try to diversify the currency risk, as a devil's advocate? Why would I want to do that?

Dan: I think it goes back to what is the purpose of investing. Usually, people are investing for something. They're trying to save for retirement. They're trying to save for the kid’s college education. And then if you think about what that is, you can decompose that into what is the currency exposure of your consumption basket in retirement. And just because you're buying everything in dollars doesn't mean that it's not sensitive to the fluctuation of the U.S. dollar. The U.S. is an import-heavy economy. A lot of the prices of things you will consume now and in the future will go up if the U.S. dollar depreciates.

And even something like a college education, you don't think of that as having currency risk. But we know how many international students are coming to U.S. campuses. We know how that can potentially drive prices for what tuition looks like.

So even that is susceptible to what happens with the relative valuation of U.S. dollar. So it would frankly be reckless not to consider your currency exposure when you're building your retirement portfolio.

Joe: I'm going to go to a little lightning round. You pick the choice, A or B, next three, five, 10 years, I won't be that specific for you. So here are the choices. So three questions.

First one is emerging markets: stocks or bonds?

Dan: Over the long term, I would take the bonds.

Joe: Second, active or indexing as a strategy in this space?

Dan: For a long-term investor, definitely active.

Joe: And then third, U.S. dollar, you just mentioned currency, general direction next five years, up or down?

Dan: It's come a long way. I think you have to trade both sides.

Joe: Christine, where do you want to go?

Christine: So, we can take the last part first of your outlook for the U.S. dollar and implications for emerging markets investing.

Dan: I think you have to separate the overall dollar trajectory from the attractiveness or lack of attractiveness of EM currencies.

The dollar has depreciated almost 10% in 2025.** The U.S. still has the highest rates in the developed world, and growth, now in 2026, looks like it's actually picking up. I would not be betting against the U.S. dollar, but you don't have to bet against the U.S. dollar to like EM currencies.

Unlike their developed market counterparts, you actually get paid to own EM currencies. You have positive interest rates well above the levels of inflation, sometimes 200, 400 basis points above the levels of inflation, and you still have vibrant economies that it's quite plausible you can see those currencies appreciate. So you don't have to be a dollar bear to like EM FX, but certainly the dollar weakness, it supports the trade.

Joe: So I hear you, Dan, if I have you right, you get some of that currency, you're getting that higher real or inflation-adjusted income. It comes with the territory, but you want that exposure.

Let me go back to what I thought was pretty controversial: stocks or bonds. You're saying, on emerging markets, you favor fixed income over stocks.

Dan: Well, I'm a bond guy, so I'm a pretty conservative investor.

Joe: Yeah, but you're also an asset allocator. You see both markets.

Dan: But, when you’re investing in EM stocks, what are you actually buying? Think about the companies that dominate these indices. Some of them are state-owned enterprises, and those enterprises might be more interested in building the soccer stadium than in delivering shareholder returns.

Other times, these are mature companies that have only gone public after the growth is over. And other times, you're really being exposed to the export of commodity sectors when that doesn't fully represent what those countries potential is.

But the bigger question is: Why should you have to invest in particular companies just to diversify your currency risk? It doesn't mean that EM stocks cannot be a good trade, when the valuations are there.
It just means you shouldn't have to go there just to do the conservative thing and have a diversified exposure.

Christine: Speaking of diversification and tying that back to our dollar conversation earlier, a lot of people that are trying to diversify away from the U.S. dollar are turning to crypto. But you're saying that there might be a better way.

Dan: I think a lot of people have thought about what happens if the dollar weakens and how to protect their portfolios. And it's not just crypto. You've seen a huge amount of demand for commodities. But we have to remember, commodities don't pay you interest. Crypto generally doesn't pay you interest, and there are obviously a lot of long-term questions about the value of that asset class. Meanwhile, you can have diversification away from the dollar and get paid for it in emerging market local currency.

So, I think if that's your goal, if you think you need to have more investments that are less susceptible to potential fluctuations in dollars, you should absolutely consider EM local.

Christine: Are there specific emerging markets? Emerging markets is a big pie. Are there any piece of it that excites you most?  Can we talk about specific countries, for example, or regions?

Dan: I think what makes the asset class really interesting from the active investor perspective is that it is so broad. My colleagues investing in U.S. investment-grade, they can pick companies, they can pick sectors, but overall the asset class tends to be very uniform.

When you're dealing with U.S. high yield, surely you have a lot of different companies out there, but they're all generally kind of wider trading companies. The bonds that offer tend to be shorter duration. You're really playing much more for carry than appreciation.

But, we can choose across the whole universe, across the whole globe, different regions, different sensitivities to commodities, importers, exporters. We can go from AA rated countries to countries where a small part of the index is still in default.

Joe: You leaned active in my lightning round versus the index, right? But what's part of your process? A day in the life—are you just looking at geopolitics as a risk factor? Are you looking at the economic?
How do you keep me out of the future Argentina sort of experiences but give me that yield that has been attractive historically.

Dan: The idea that active management works in fixed income is real, and it goes back to the idea that fixed income investing is less of a zero-sum game. In equities you have universal investors, universal investments, and they largely overlap. Everybody's picking from the same pool of companies, and everybody is trying to outperform the index out of the active manager space.

In fixed income, you have a lot of non-economic players that play in the bond markets. Everything from central banks conducting monetary policy to insurers using different accounting to banks managing the reserves.

The analogy I like to use is, if you're playing cards at a poker table on a casino late in the evening and a couple of people walk in, they've had a couple of drinks clearly, and they're playing very aggressively, throwing a lot of money around. If you're sitting at that table, your job is to get some of that money, and that's what active investing and fixed income is like. You have non-economic players spreading money around, and a good manager should be able to responsibly take a share of that alpha for their clients.

Now, for EM specifically, we do have a lot of opportunities. It's not all macro. Macro is important not only from making money but also from risk management. But, we go very deep into these countries’ balance sheets, their trajectories. There's a lot of fundamental research, and there are a lot of technical opportunities for relative value.

We're bond pickers. We look at shorter bonds, longer bonds, sovereign bonds, quasi-sovereign bonds.
And we're not afraid to change our minds or find a better opportunity if it comes up.

And as a result, we're picky. We're not just playing offense. We're also playing defense. We're not just looking for stories that we think will outperform. We're looking for stories that can define, protected by the carry, protected by the fundamentals, even in a more challenging environment.

Joe: You've helped us say, “OK, this asset class has evolved, you're getting compensated for bearing certain risks, and the universe has evolved and there's at least historically attractive risk-adjusted return.” But, let's say there's the listener saying, “OK, I hear you, Dan, but I still have some reservations.”

Dan: So you look at the risk of, say, an EM dollar bond index, you're looking at something that's maybe a quarter more volatile than the U.S. bond market. So it's riskier, but it's not double, it's not triple. And you're probably looking at drawdowns that are maybe half what you see in U.S. equities, if you look at the last 25 years.*** Meanwhile, you look at the returns, and they're actually very equity-like. So you're almost keeping up with equities in good years, you're generating income and yield in regular years. And you turn out to be quite defensive, not risk-free, but quite defensive in bad years. That's why people invest in EM.

Now, in terms of the allocation, the biggest risk investing in the EM used to be and is concentration. So if you have an index with 20% in a single country, you don't put all your money into that index, because you're introducing a lot of jump risk if something does go wrong and sometimes it does.

So you do have to make sure that when you look at your dollar bond bucket, and you look at your credit bucket, and you decide what percentage you want to put into emerging market debt, you want to say: How much can I take exposure to Mexico? How much exposure can I take to Brazil? How much exposure can I take to Hungary or Indonesia? But certainly with a much more diversified asset class today, a higher number makes a lot more sense.

Christine: For investors that are looking for this formula, a new formula that can guide them, basically saying that maybe it's 40 stocks and 20 U.S., 20 international, and the rest is in fixed income. Within that bucket, what percentage would you assign for international bonds or emerging markets bonds?

Dan: So this is where I'm going to be a little bit more kind of controversial.

Christine: OK, go ahead.

Joe: Boom, here we go.

Dan: I'll give you the easy answer, then I'll give you the hard answer. The easy answer is, within your dollar bond bucket, within the credit portion of the bucket, you can easily put 20% in emerging market bonds. Again, it should sit alongside with U.S. IG, alongside with U.S. high yield. Or, you should buy a fund or set of funds that frankly have enough flexibility to rotate between those asset classes. But that's the easy question. The hard question is: What do you do with the local side?

I would argue actually your decision on how much to invest in EM local happens before the 60/40 decision. Before that, you should decide how much you want to invest in dollar-based assets and how much you want to invest in non-dollar assets. And when you make that decision, a portion of that should go into your local markets.

Christine: What else are we missing in this conversation?

Dan: Well, I think we talked about active management, and obviously the biggest problem with active management is, finding the right active manager.

This is where, I think a lot of investors might want to seek some professional help, but ultimately, it's about identifying the manager's investment process, making sure that the results you see correspond to that investment process.

The easiest thing you should do is just look at the correlation between the manager and the market return to make sure that you're not paying active fees for what's essentially levered data.

And, of course, the fees do matter because if everything the manager generates in value goes back to the manager in the form of fees, then you're not any better off as an active investor.

Joe: So, if I got you right, then if I have 10 tickers, Dan, make sure I'm not overpaying for a very expensive index fund. And then B, you or your competitors, you've been able to add value at the security level, at the country level. That's the sort of thing that I should be thinking about, right, if I have you right?

Dan: Exactly right. I think you have to look at the example. So, for us for example, when we strive to deliver diversified sources of alpha, we do a lot of bond picking, we do a lot of country relative value. We're also a very active manager. We have high turnover because the moment we find a better trade than the one we have in the portfolio, we work hard to rotate into that trade.

Christine: Dan, you've absolutely crushed a lot of the myths that are around, floating around about international bonds and emerging market bonds. What's the key take away, if there's one thing that you want everybody to remember from this conversation, what is it?

Dan: Look at your portfolio, see if you can use a little bit of EM credit in there, and then look at your portfolio as a whole holistically and analyze your currency exposure.

Joe: We know you're talking about scale and cost. If Jack Bogle were here, founder of Vanguard, he would have 100% agreed with you, Dan.

Christine: Thank you so much for being here, Dan.

Dan: Thanks for having me.

Christine: That's it for today's episode. Join us again for the next episode of Better Vantage by Vanguard. If you enjoyed this episode and found it helpful, subscribe and share.

Notes:

*Source: J.P. Morgan, as of April 1, 2026.

** Source: Federal Reserve Bank of St. Louis (FRED), Nominal Broad U.S. Dollar Index, as of April 7, 2026.

***Source: Vanguard, Bloomberg, and J.P. Morgan, as of December 31, 2025.

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