When evaluating the role of global bonds in portfolio allocation, it is useful to analogise it to th...
When evaluating the role of global bonds in portfolio allocation, it is useful to analogise it to the role of global equities in an equity portfolio. As US equity-only captures 20% of the global equity market, investing in global equities allows exposure to the remaining 80% of the market.
In the same vein, US international debt securities account for only 20% of the worldwide total, leaving 80% of the market untapped. In fact, over half the countries in the world have functional and accessible bond markets that can provide added sources of diversification and alpha to a global bond portfolio.
There is a misconception that US treasuries drive the international market and, therefore, broad exposure is unnecessary.
For example, over the 12 month period ending in September 2006, the difference between the best and worst performing bond markets on a total return basis was 50 percentage points, with Indonesia returning 46.05% and Hungary returning -3.95%. This illustrates the differing currency and interest rate cycles worldwide, which present investors with opportunities to weather downturns while minimising volatility.
At times, even benchmark allocations do a poor job of capitalising on such opportunities, because they are dominated by exposure to the three largest debt markets, the US, EU and Japan.
Global fixed income's potential for generating high alpha comes from its capacity to offer investors access to a broad range of interest rate, currency and sovereign credit opportunities. Each source of alpha can be evaluated and exploited separately in order to maximise risk-adjusted returns. Such precision investing is possible because of the wide variety of investment instruments that allow investors to capitalise on specific insights.
If there is an interest rate opportunity in a given country but the currency has no value, bond exposure can be hedged into another currency. Additionally, the precise duration exposure can be isolated by positioning along the yield curve. In cases where the currency has value but interest rates are overvalued, short duration exposure in local currency denominated bonds can provide carry and currency exposure without taking interest rate risk.
The current environment of high liquidity, low risk aversion and often tight valuations in the major sovereign debt instruments makes such evaluation and investment necessary in order to provide consistent and strong risk-adjusted returns.
An active, fundamental, and benchmark unconstrained portfolio gives investors the flexibility to properly diversify, pursue risk-adjusted total returns and adjust their holdings to anticipated shifts in investment opportunities. We believe that by diversifying exposure over a broad range of countries and currencies while maintaining an investment grade weighted average credit quality, it is possible to generate excess returns without excess risk; an extensive research platform is needed to leverage global and local expertise.
Over the medium term, we continue to anticipate US dollar depreciation due to the magnitude and sustainability of funding for the US current account balance.
Large and growing current account deficits in the US have been the inverse of Asia's surpluses. Asia's significant current account surpluses and corresponding high savings and underinvestment have left Asia well-positioned for strengthening domestic demand dynamics, which should be supportive of local currencies. Additionally, the huge pool of financial resources in Asia is already funding investment growth and supporting domestic demand.
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