International bonds declined in U.S. dollar terms for the first quarter of 2013 as the depreciation of several major currencies against the dollar more than offset modest gains in local currency terms. Japan's new leadership signaled a policy shift toward higher growth and inflation targets, causing the yen to plunge. The euro fell in the face of political instability in southern Europe and a banking crisis in Cyprus, while the British pound declined after a major credit rating agency retracted Britain's coveted AAA rating. In emerging markets, benign inflation and an ongoing search for yield continued to drive performance as most markets generated positive returns.
The International Bond Fund returned −3.33% in the quarter compared with −3.51% for the Barclays Global Aggregate ex USD Bond Index and −1.91% for the Lipper International Income Funds Average. For the 12 months ended March 31, 2013, the fund returned 0.63% versus −0.71% for the Barclays Global Aggregate ex USD Bond Index and 3.22% for the Lipper International Income Funds Average. The fund's average annual total returns were 0.63%, 2.36%, and 5.41% for the 1-, 5-, and 10-year periods, respectively, as of March 31, 2013. The fund's expense ratio was 0.83% as of its fiscal year ended December 31, 2011.
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The International Bond Fund charges a 2%
redemption fee on shares held 90 days or less.
The performance information shown does not reflect the deduction of the redemption fee;
if it did, the performance would be lower.
The portfolio's underweight allocations to the Japanese yen and British pound boosted results as both currencies lost considerable ground to U.S. dollar. An overweight allocation to the Mexican peso was also a particularly strong contributor. Country selection had little net impact as gains from Mexican government bonds and peripheral Europe were offset by positions in Japanese and poorly performing Brazilian bonds. Exposure to European high yield and U.S. dollar-denominated emerging markets corporate bonds, which are not included in benchmark, added to returns over the quarter. Underweight allocations to European securitized bonds detracted as this subset of investment-grade credit outperformed conventional corporate bonds.
Developed markets bonds are likely to remain at low yield levels due to the continuation of stimulative monetary policies by most central banks. The risk of a eurozone breakup has fallen, but we have yet to see much evidence of significant economic improvement in the region. We have selective underweight allocations to France and Belgium and now maintain neutral duration allocations to Spain and Ireland with an overweight allocation to Italy. The default outlook for European high yield corporate bonds for 2013 remains benign, and we expect yields in investment-grade corporate bonds to remain more or less constant. Over the near term, we expect muted performance in emerging market sovereign bonds denominated in local currencies, but we see opportunities in attractively valued inflation protected bonds from Brazil and Mexico.