VWOB or BNDX: Which International Bond ETF Is the Better Buy?

If you're feeling uneasy about the economy due to recent oil price shocks, or are concerned that U.S. tech stock valuations are too high, buying bonds can be a good way to diversify your portfolio. But if you want to invest in international bonds, it's important to understand the risks.

One easy way to buy international bonds is to choose the Vanguard Total International Bond Market ETF (NASDAQ: BNDX). This bond ETF has delivered 5.4% average annual returns (by net asset value) for the past three years. If you want even higher yields on your bonds, you could consider the Vanguard Emerging Markets Government Bond ETF (NASDAQ: VWOB).

Let's look at these two international bond ETFs and see which fund might be better for your investment goals.

Image source: Getty Images.

VWOB: Invest in emerging market government debt

The Vanguard Emerging Markets Government Bond ETF is an international bond ETF that lets you own government debt from emerging markets, such as Saudi Arabia, Mexico, Turkey, Indonesia, and the United Arab Emirates. VWOB holds a total of 902 bonds and charges an expense ratio of 0.15%.

This emerging markets government bond ETF has earned an impressive 9.99% average annual returns (by net asset value) for the past three years, outperforming BNDX. VWOB has also outperformed the U.S.-focused Vanguard Total Bond Market ETF for the past several years.

Unlike U.S. Treasury bonds, which are generally considered among the safest investments, emerging-market bonds can be risky. Several of the top holdings in VWOB are in Middle Eastern countries like Saudi Arabia (13.5% of the fund), Turkey (6.4%), the United Arab Emirates (5.6%), Qatar (3.8%), and Bahrain (2%), which could be hurt by the Iran war.

On Vanguard's risk/reward scale, VWOB is rated 3 out of 5, marking it as a higher-risk investment than BNDX (which is rated 2 out of 5). If emerging market economies struggle from the Iran war, oil price increases, or other future problems in the global economy, these countries' government debts might become less valuable for bond investors.

Even if the Iran war ends tomorrow, emerging market bonds have another risk: About 41% of the bonds in VWOB have a credit rating of BB or lower. That means the bonds are below investment grade, also called "speculative grade" or "junk" bonds. Buying speculative grade bonds is like lending money to a risky borrower -- you can earn a higher yield on your money, but only if you accept a higher risk of not getting your money back.

BNDX: Broadly diversified international bond ETF

If you're concerned about the risks of emerging market debt, the Vanguard Total International Bond ETF can give you a bigger, broader mix of international bonds in your portfolio. This international bond ETF owns 6,612 bonds and charges an expense ratio of 0.07%.

BNDX holds bonds from all over the world, and about 7.5% of the fund's bonds are from emerging markets. But unlike VWOB, BNDX focuses only on higher-quality bonds. About 97% of the bonds in BNDX are rated investment grade (with credit ratings of AAA, AA, A, or BBB), and none are "speculative grade" or "junk" bonds.

Top countries represented in BNDX include France (12.2% of fund holdings), Japan (10.8%), Germany (10%), Italy (8%), and the United Kingdom (8%). When you invest in BNDX, most of your money is buying bonds from governments in developed economies that are generally considered to be stable, low-risk borrowers. BNDX also includes corporate bonds in Industrial (6.7% of fund), Finance (6.7%), and Utilities (1.6%) sectors.

VWOB or BNDX: Head-to-head comparison

Ready to choose which bond ETF to buy? Here's a quick side-by-side breakdown:

Data source: Vanguard.

If you believe that emerging market debt can keep outperforming the rest of the world, VWOB could be a better bond ETF to buy. But if you want a more broadly diversified portfolio of international bonds at a lower fee, BNDX could fit your goals. Personally, I own the Vanguard Total International Bond ETF, but not VWOB. It can feel frustrating to miss out on the high returns that VWOB has delivered in recent years, but I prefer to limit my risk-taking when buying bonds.

Ben Gran has positions in Vanguard Charlotte Funds-Vanguard Total International Bond ETF and Vanguard Total Bond Market ETF. The Motley Fool has positions in and recommends Vanguard Total Bond Market ETF. The Motley Fool has a disclosure policy.