Despite bond yields at historical lows and interest rates rising in the US, bonds still have a role to play in diversified portfolios as a way of mitigating the shocks from volatile equity markets, global asset manager AllianceBernstein (AB) said today.
“The notion that bonds can still have an important role to play in portfolios may surprise many investors—particularly those focused on home-country markets,” said John Taylor, AB’s London- based Portfolio Manager—Fixed Income, while visiting Australia this week to see clients.
“It’s no secret, however, that looking beyond the front door to global bond markets can help investors improve their risk-adjusted returns.”
Taylor noted that many investors have become wary of holding bonds since the global financial crisis, in the aftermath of which interest rates in many developed countries have fallen dramatically and central-bank buying of government bonds has forced yields to record lows.
He added, however, that it was important to understand that “not all bonds are created equal”.
“Although the bonds referred to in media headlines are usually government securities, bond markets are actually quite diverse. In addition to government bonds, they include corporate bonds or credit and other, more specialized, securities, such as mortgage-backed bonds.”
This diversity becomes even greater when global bond markets are taken into account. Global government bonds include those issued by sovereign borrowers in most if not all developed economies and many emerging economies, too.
Typically, this results in a greater opportunity to reduce risk and improve returns, arising from the fact that different countries tend to be at different points in their economic and monetary-policy cycles at any given time.
“This is particularly the case now, when global divergence in policy cycles lies behind much of the volatility being experienced by financial markets,” said Taylor.
“For example, although the Fed is raising rates in the US, Japan is still in the middle of a quantitative- easing programme—indeed, the Bank of Japan recently became even more accommodative by introducing a negative interest-rate policy—and we expect Europe to expand its quantitative-easing programme in March.
“In other words, even if interest rates in one country keep rising, those in other developed markets may fall—and create actionable opportunities for bond investors. The same may be true for emerging- market bonds, yields on which have risen recently, to the point where some reversion to more normal levels might be expected.”
The same held true when non-government or corporate bonds were taken into account.
Taylor noted research by AB which showed that an investment into global government bonds hedged back into Australian dollars between January 2001 and December 2015 resulted in annualized returns of 7.63% compared to 6.14% invested in Australian government bonds.
The global investment also had lower volatility than the Australian one, resulting in a risk-return ratio of 2.59 compared to 1.45 for the domestic investment.
A comparison between currency-hedged investment into the broad global bond universe (government and non-government bonds) and broad domestic universe yielded similar results: the returns for the global investment were 7.83% while those for the domestic investment were 6.40%. The risk-return ratios were 2.83 and 1.86 respectively.
“For these reasons, we believe that bonds in today’s market conditions have still much to offer investors in terms of portfolio diversification and income enhancement, subject to certain provisos,” said Taylor.
“These are that the investment strategies are active, global, multi-sector, well-researched and well- managed, and include currency hedging and suitable measures for managing liquidity risk.”
Source: AB
