Foreign Bond Funds Underperform, With 91% Posting Losses This Year
Translated & summarized from Calcalist by baba
Nearly all foreign bond mutual funds in Israel, 91%, have incurred losses this year, with some experiencing declines of up to 7.5%. These funds, typically considered safe investments for diversification, have been negatively impacted by rising U.S. interest rates, inflation concerns, and a strengthening shekel. The losses are widespread across various categories, including dollar-denominated and euro-denominated funds, and even currency-hedged funds have seen negative returns. This situation contrasts sharply with conservative domestic bond funds, which have shown positive returns.
The story in 5 lines · by baba
- 91% of foreign bond mutual funds in Israel have posted negative returns this year.
- These funds collectively manage approximately 9.9 billion shekels.
- Losses in some funds have reached as high as 7.5%.
- Rising U.S. interest rates and inflation concerns are key factors driving the downturn.
- Conservative domestic bond funds have shown positive returns, averaging 2.5%.
Investors seeking stable returns through foreign bond funds have experienced significant losses in 2026, contrary to expectations of diversification and capital preservation. A review of mutual funds as of October 25 reveals that 62 out of 68 foreign bond funds, approximately 91%, have recorded negative returns since the beginning of the year. These funds collectively manage about 9.9 billion shekels, with 8.3 billion shekels in funds that were intended to offer diversification and protection against stock market volatility but instead yielded negative returns, some as high as 7.5%.
The downturn in these typically conservative investments is attributed to rising U.S. interest rates, concerns about prolonged high interest rates, and a strengthening shekel. Even funds designated as foreign currency-exposed, managing 3.9 billion shekels, were impacted. For instance, the Meitav 10/90 Foreign Bond Portfolio up to 30% Foreign Currency, managed by Lior Kagan and the largest in its category with 1.3 billion shekels in assets, saw losses that are inconsistent with an investor's expectation of preserving capital. Real returns for these investors were even lower, with the consumer price index rising 1.6% year-to-date, meaning investors lost up to 9.1% in real terms.
In contrast, conservative parallel funds, such as 90/10 funds (90% bonds, 10% stocks), achieved an average return of 2.5% this year. Foreign bond funds are not designed for high returns but rather to complement conservative portfolios, offering diversification beyond Israeli government and corporate bonds. However, geographical diversification did not eliminate risks, as even stable government bonds experienced sharp price declines, and foreign currency exposure added another layer of risk.
The rise in U.S. Treasury yields, from 4.19% to 5% for 10-year bonds and from 4.86% to 5.33% for 30-year bonds, reflects falling bond prices. This increase in yields is driven by fears of sustained high interest rates and the U.S. government's deficit. The situation is exacerbated by maturing low-interest bonds requiring new issuance at higher rates, creating a negative cycle where higher rates increase the deficit, necessitating more borrowing and further rate hikes.
The losses are widespread across different categories of foreign bond funds. Dollar-denominated funds saw 16 out of 17 funds lose money, with an average loss of 3.81% for the underperforming funds. The worst hit was the Kesem Active International Dollar Bond fund, with a negative return of 6.18%. In the broader foreign currency-exposed category, 17 out of 20 funds posted losses, averaging 3.62%, led by the IBI International Euro Bond fund which lost 7.5%. Even currency-hedged funds, designed to mitigate exchange rate fluctuations, experienced losses, with 12 out of 13 funds showing negative returns, averaging 1.72%, indicating that the strengthening shekel was not the sole cause of poor performance.
The primary driver for the bond market downturn appears to be a shift in expectations regarding U.S. interest rates, with investors now pricing in a longer period of high rates due to persistent inflation. This is compounded by the large U.S. deficit and the need to issue significant amounts of debt. Additionally, increased borrowing by tech giants for AI investments and a global shift away from U.S. debt by some countries and institutional investors seeking alternative assets are increasing the supply of bonds while reducing demand, pushing yields higher and prices lower. This effect is particularly pronounced in long-term bonds, where a 1% rise in yield can lead to approximately a 10% drop in price. Unlike direct bondholders who may hold until maturity, mutual fund investors see daily fluctuations in their investment's value, often leading to realized losses when they sell.