Exploring the Benefits of Global Fixed Income for US Investors

Exploring the Benefits of Global Fixed Income for U.S. Investors

April 2015

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Investors continue to grapple with historically low US interest rates and the exposure they should take in portfolios to US aggregate benchmarked fixed income.

Boston — Investors continue to grapple with historically low US interest rates and the exposure they should take in portfolios to US aggregate benchmarked fixed income.

We believe that increased exposure to international fixed income offers investors a number of benefits, particularly when the volatile effects of currencies are hedged.

While developed market global interest rates typically move in the same direction as those in the US, the magnitude will vary and the moves will not always be exactly one for one. This varying degree of correlation and volatility can lead to pronounced differences in a country’s fixed income returns year to year, offering the benefit of diversification, but also the opportunity for adept active managers to benefit from country rotation to increase returns. Figures 1 and 2 give the returns of various countries in 2014 on a currency hedged basis.

Figure 1

The US fixed income market comprises only approximately 40% of the global fixed income universe (see figure 3) and in addition, the pace of growth in credit and securitized markets outside of the US continues to grow, offering a much broader opportunity set to generate returns.

Figure 2

Without simply allocating to higher volatility market segments on a structural basis, the reduced exposure to either high yield corporate or emerging market debt ensures a portfolio invested in primarily developed market, investment grade rated bonds. This can result in stronger risk-adjusted returns than the US aggregate benchmark, but with a similar volatility profile, an important consideration during periods of severe market stress.

Looking ahead to continued central bank divergence and Fed tightening

As the Fed begins to normalize policy, it is important to note that global central banks such as the European Central Bank (ECB) or Bank of Japan (BOJ) and others will likely be much slower to remove policy accommodation, hence potentially limiting the downside in international fixed income markets.

A global portfolio, with the ability to fully hedge non-US dollar currency exposure can continue to offer investors the benefit of interest rate diversification without the material increase in volatility that may arise from unhedged currency exposure.

Increased divergence within central bank policy globally, in particular divergence between the US Fed and most of the rest of the world, can provide a rich backdrop of opportunities for active, tactical managers to deliver stronger risk-adjusted returns.

The structural advantages of a global approach are further accentuated by looking ahead to an environment where the US Federal Reserve may be the first major developed central bank to begin tightening policy while many other major developed market central banks continue on an easy monetary path to varying degrees.

US investors face a challenge not only due to the low level of domestic interest rates but also with understanding how US fixed income may fare in a portfolio context with US equities in the face of Fed policy tightening or other turbulent events. Moving to a global approach on a hedged basis provides investors with a portfolio that exhibits similar risk characteristics as dedicated US Fixed Income, however with the potential for increased diversification and return generation.

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As of July 17, 2015

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