The most common goals for fixed-income investors are stability, generating income and diversifying their equity exposures. Our research suggests that they can achieve all three goals more efficiently if they don’t remain wedded to their traditional approaches and benchmarks.
Stability. Investors whose main goal is safety tend to purchase short-maturity bonds, since shorter maturities are less sensitive to increases in inflation expectations or interest rates. Traditionally, this has been done by holding domestic bonds only. However, focusing on the bonds of just one country can create excessive concentration risk. This is an especially important consideration today, when many developed nations face the risk of credit downgrades. An approach that incorporates short-maturity global sovereign bonds could do a better job lowering volatility, because it would mitigate a broader set of risks, our research suggests.
High Income. Many investors seek a steady stream of income from their bond holdings—often to support spending in retirement. Income-oriented investors have traditionally focused on high-yield corporate bonds, usually from their home region; in the US, they often favor municipal bonds in taxable accounts.
We think investors should consider seeking income from a wider variety of sources—not necessarily one sector, region or quality rating. For example, they might benefit from global high-yield funds that take advantage of opportunities in emerging-market debt, even if emerging-market bonds are not in their benchmark.
Core. Many investors want something between stability and high income: a “core” bond portfolio that helps diversify their exposure to risky assets such as equities. Core bond portfolios—which focus primarily on investment-grade debt and often include sizeable allocations to government bonds—typically perform well when risk aversion is high.
But our research suggests that for this purpose, too, the traditional reliance on domestic bonds merits reconsideration. A portfolio of global bonds dynamically managed to seek the best opportunities around the world would provide greater diversification benefits. Historically, global bonds have generated comparable returns to the domestic bonds in most developed markets, with lower volatility, if their currency risk is hedged, as the display below shows.
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.
Douglas J. Peebles is Head of Fixed Income at AllianceBernstein.