As US Treasury yields continue to plumb record lows, some have quipped that government bonds have gone from offering risk-free returns to “return-free risk.” Indeed, when interest rates inevitably rise from their current levels, bondholders face the prospect of poor or even negative returns.
One way for investors to mitigate such a risk is by globally diversifying their bond holdings.
Currency-hedged global bonds have historically been much less risky than unhedged global bonds, while delivering competitive returns, as we’ve written before here. Furthermore, hedged global bonds have captured most of the upside of US bond returns while offering greater resilience in down markets.
Since 1990, US bonds have averaged returns of 2.5% in positive-return quarters; global bonds offered 2.3% in the same quarters, capturing 92% of the upside of US bonds, as the display below shows. That’s because global government bonds tend to move together in widespread flights to quality. This year, for example, German Bunds have followed US Treasury yields to record lows.
In adverse bond markets, however, there has historically been a greater performance gap, with global bonds faring significantly better than US bonds. While US bonds declined 1.1% on average in down quarters, global bonds lost only 0.7%. That’s 62% of the downside of US bonds—a significant advantage.
The reason? A diversified global strategy has been effective historically because economic cycles aren’t perfectly synchronized across countries. This means that interest-rate cycles differ, too. A global approach allows investors to reduce their portfolio’s sensitivity to the rate cycle of their home market.
Of course, diversification does not eliminate the risk of losses, but given the benefits that we’ve outlined, we think it’s prudent for investors to think about going global in their bond holdings.
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 Chief Investment Officer and Head of Fixed Income at AllianceBernstein.