Global fixed income is an asset class in which prudent active management can provide ample scope for additional return above a simple passive approach without taking undue risk. In order to stretch returns, many asset managers quickly establish a structural overweight to higher yielding and sometimes relatively illiquid corporate or emerging market issuers.
“While there is certainly a place for investment in such assets, they can often negate the traditional role of fixed income, which is to provide a cushion against the downside of risky assets,” Wakefield said. “High quality fixed income should be in place when an investor needs it most.”
Of course, for U.S. dollar-based investors, an allocation to global fixed income brings with it currency exposure. But currency risk can either be mitigated via hedging or productively managed to provide an additional source of potential return.
Strategic and tactical
The strategic case for global fixed income rests on diversification. Wakefield said that because the global bond asset class encompasses a wide range of countries, it can provide opportunities for diversification versus domestic bond portfolios. The characteristics of global bonds also provide excellent diversification against riskier asset classes such as equities and high yield credit, he said.
Historically, global bonds have outperformed during short-term periods of market turmoil. As a result, they can help stabilize portfolios during times of crises like today. By their very nature, market crises are unpredictable and will always occur. Global bonds, therefore, should act like an insurance policy ― helping to cushion against losses in riskier asset classes.
What’s more, high-quality global bonds tend to be countercyclical and as such offer excellent long-term diversification benefits to domestic portfolios. Although global bonds underperformed in the 1995-1999 and 2010-2014 periods when equities did well, they outperformed in 1990-1994 and 2000-2004 when equities underperformed. (See table.) Global bonds can therefore reduce the volatility of domestic portfolios. Over the longer term, global bonds have outperformed U.S. bonds and can therefore enhance a portfolio’s risk/return characteristics.