How much global is the right amount to add to core bond portfolios? Is there an optimal amount that improves potential risk-adjusted return?
In recent posts, we established that going global diversifies interest-rate and economic risks, and increases the opportunity set; that it helps buffer some of the downside risk that US-only portfolios are likely to experience over the short term when rates begin their climb; and that hedged is better than unhedged or cross hedged when stability's the objective.
We made a strong case for a hedged global portfolio as having a better risk-adjusted return, or Sharpe ratio, than either an unhedged global portfolio or a US-only one, placing it squarely in the targeted "core" bond volatility range, where it can serve as an investor's anchor to windward against equity-market volatility.
In other words, adding hedged global bonds strengthens your core bond mandate.
How Much Hedged Global Is "Just Right"?
[.] There is no sweet spot. Any incremental addition of global bonds can be beneficial to risk-adjusted return. We plotted the historical risk and return of portfolios with different allocations to US bonds and hedged global bonds, ranging from 100% in US to 100% in global.
The more global the portfolio, the higher the risk-adjusted return, as represented by the rising diagonal line. Simply put, it just gets better. As little as a 10% allocation to global can improve outcomes. In our view, a 50% allocation is a realistic target. And a 100% commitment would be commensurately better.
So whether you mix a little hedged global into your solution or completely reformulate it, adding global bonds should improve outcomes over the long term-but particularly in today's environment, where global bonds can buffer some of the interest-rate risk of traditional US-only core bond strategies.
SCOTT DIMAGGIO, CFA; Director-Global Fixed Income and Director-Canada Fixed Income
ALISON M. MARTIER, CFA; Senior Managing Director-Global Fixed Income Business Development