Which factor could diminish returns on international bonds for US investors?

Adverse currency fluctuations can significantly impact the returns on international bonds for US investors because bond yields are often denominated in the local currency of the issuing country. If the currency of the bond loses value relative to the US dollar, the returns when converted back to dollars will decrease. For example, if an investor purchases a bond in euros and the euro declines in value against the dollar by the time the bond matures or pays interest, the investor will receive fewer dollars upon conversion, reducing the overall returns from the investment.

In contrast, geographic distance from the issuer primarily affects the costs and risks associated with investing in bonds rather than directly influencing returns. While low interest rates in the home country may make international bonds more attractive, they do not inherently reduce returns. Lastly, lack of liquidity in foreign markets can present challenges for trading but does not directly diminish the returns on the bonds themselves. Thus, adverse currency fluctuations are a direct and impactful factor on the returns on international bonds.