By Alison Martier and Seth J. Masters
US defined contribution (DC) plan sponsors large and small are seeking ways to help plan participants achieve better outcomes. Over the last 30 years, compelling evidence has accumulated that suggests currency-hedged global bonds may be an important part of the solution.
We believe that DC plans should globalize some or all of their fixed-income assets. We’ve recently co-authored a white paper explaining our research. It illustrates the superior risk/return profile of hedged global bonds over US bonds, among other advantages.
Our paper also identifies how much of an allocation to global bonds is appropriate and outlines ways in which plans can globalize with minimal disruption to participants.
More Opportunity to Add Value
The most obvious potential benefit to globalizing comes from a significantly increased opportunity set. As of year-end 2012, the Barclays US Aggregate Bond Index represented $15 trillion in outstanding debt and about 8,000 issues. Its global counterpart, the Barclays Global Aggregate Bond Index, chalked up $39 trillion and more than 14,000 issues.
That’s a much bigger pond for active managers to fish in.
Even when looking only at the historical dispersion of returns among developed-country sovereign bonds, the difference between the best-performing country and the worst-performing country is striking. For example, in 2011, the UK outperformed both Japan and the euro area by 13.5%.
In most years, the gap between the sector returns of the typical US core or core-plus option—the returns of US Treasuries, agencies, mortgages, corporates and other sectors in the US Aggregate, for example—would be just a couple of percentage points between the best- and worst-performing sectors.
So having such a large gap between country returns provides much more potential opportunity for an active manager to add value: to use research to overweight countries that are likely to perform better and to underweight those countries that are likely to underperform.
A Potential Risk Reducer
But the ability to add value through active management is not the only advantage to globalizing. The historical “up/down capture” of hedged global bond returns compared with US returns is very compelling. We sorted quarterly returns from 1993 through 2012 into periods when the US Aggregate was positive and periods when it was negative.
We were keen to know just how well or how poorly the US Aggregate did during those periods, and to know the same for the hedged Global Aggregate.
We found that when the US Aggregate was positive, it returned, on average, 2.2%. The hedged Global Aggregate performed almost as well during those same quarters, capturing 95% of that performance. We call that the “up capture.”
When the US Aggregate was negative, it returned, on average, –0.9%. While the hedged Global Aggregate was also negative, its “down capture” was just 67%.
That’s a notable skew. Investors preserved more of their capital during down periods by allocating assets away from the US into countries where rates weren’t rising as much, or where they were stable or even declining.
We can also look at this from the perspective of risk mitigation. Using the sovereign bonds of the US, UK, Germany, Italy and Japan since 1970, we conducted a correlation analysis, as shown in the display below.
(click to enlarge)Not only can we see that overall correlations were low between non-US debt and US Treasuries (evidence of an ongoing significant diversification benefit), but we see that during extreme down months for US Treasuries, correlations shrank. That means investors got more risk mitigation from being global when they needed it most.
We’re not done making the case for going global. In next week’s post, we’ll compare US bonds, unhedged global bonds and hedged global bonds in terms of risk-adjusted returns to see how these options have stacked up historically.
If you simply can’t stand the suspense or would like to explore our research in greater depth, we invite you to read our white paper, Global Bonds: A Better Solution for DC Investors.
Disclaimer: The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Alison Martier is Senior Portfolio Manager—Fixed Income at AllianceBernstein, and Seth J. Masters is Chief Investment Officer of Defined Contribution Investments and Asset Allocation at AllianceBernstein and Chief Investment Officer of Bernstein Global Wealth Management, a unit of AllianceBernstein.