LDI: The Case for Going Global in Bonds

Despite compelling evidence in favor of global diversification, investors in many markets around the world continue to have a strong “home bias”—a preference for domestic over foreign assets. Nowhere is this tendency more apparent than in the ranks of liability-driven investors. But our research shows that LDI investors, too, can reap significant benefits from going global.

On the surface, liability-driven investors’ preference for domestic bonds makes good sense. The primary concern of liability-driven investors, after all, is not maximizing returns, but ensuring adequate funding levels to match long-term liabilities such as pension obligations. The current value of these liabilities is generally sensitive to domestic interest rates—hence the common assumption that the purchase of long-duration domestic bonds is the best way to reduce the risk of funding shortfalls.

But is it possible to improve the investment outcome by going global? Three of my colleagues—Alison Martier, Erin Bigley and Ivan Rudolph-Shabinsky—have recently published research indicating that investors in several of the world’s major markets have historically been able to achieve comparable returns—with significantly lower volatility—by globalizing their long-duration bond portfolios, as the display below shows.Hedged Global Bonds: Historically Less Volatile than Home-Country Bonds

For liability-driven investors, however, absolute returns and volatility are less important than minimizing mismatches between assets and liabilities. For this reason, we looked at the actual pattern of long-dated bond returns. For investors based in the US, Canada, Japan, UK and the euro area, we found that the returns of domestic and currency-hedged global bonds were highly correlated. This suggests that by adding an allocation to global bonds, there is an opportunity to improve the risk/return profile of an LDI portfolio without creating a sizable gap between liabilities and assets.

Importantly, we also found that when the returns of one country were at an extreme—either positive or negative—the global average was less extreme. This shouldn’t come as a surprise, since global returns are the average of several countries, reflecting the benefits of diversification. But it suggests that exposure to global bonds can mitigate the impact of very weak or even negative domestic returns.

And that seems especially relevant today. Given the current market environment—with yields on bonds near historical lows in many developed nations—domestic bond returns are likely to be very low or negative once interest rates eventually begin to rise to more normal levels. Although returns for global bond portfolios are also likely to be weak, history suggests that they may suffer less than domestic-only portfolios, reducing downside risk. Of course, liabilities tend to closely track domestic bond returns, so when domestic yields rise and produce negative returns, liabilities may also decline. But a global bond portfolio could take advantage of this opportunity to improve a plan’s funding ratio by “losing less.”

All told, we think these are compelling reasons for liability-driven investors to consider an allocation to hedged global debt. What should the size of this allocation be? We’ll consider this and other aspects of the use of global bonds for LDI in future posts.

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

Chief Investment Officer—AB Fixed Income
Douglas J. Peebles is the Chief Investment Officer of AB Fixed Income and a Partner of the firm, focusing on fixed-income investment processes, strategy and performance across portfolios globally. As CIO, he is also Co-Chairman of the Interest Rates and Currencies Research Review team, which is responsible for setting interest-rate and currency policy for all fixed-income portfolios. In addition, Peebles serves as Lead Portfolio Manager for AB’s Unconstrained Bond Strategy, and focuses on managing the firm’s strategic client relationships. In 1997, he pioneered AB’s highly successful and innovative approach to global multi-sector high-income investing, which is now being adopted by other firms. Since joining AB in 1987, Peebles has held several leadership positions, including director of Global Fixed Income (1997–2004), co-head of AB Fixed Income (2004–2008) and Head of Fixed Income (2008–2016). He holds a BA from Muhlenberg College and an MBA from Rutgers University. Location: New York

Ivan Rudolph-Shabinsky, CFA

Portfolio Manager—Credit
Ivan Rudolph-Shabinsky is a Senior Vice President and Credit Portfolio Manager, focusing primarily on the Low Volatility High Yield Strategy and the Short Duration High Yield Fund on the Luxembourg-domiciled fund platform, designed for non-US investors. He is a member of the Credit and High Yield fixed-income portfolio-management teams, and a member of the internal Credit Research Review Committee, the primary investment policy and decision-making committee for all AB’s credit-related portfolios. Rudolph-Shabinsky joined the firm in 1992 as a portfolio manager, and managed the Stable Value and Inflation-Linked Bond strategies. He has held other leadership posts at the firm, including head of Product Development and head of Product Management. Rudolph-Shabinsky has also authored or co-authored a number of papers, including “Beyond Interest Rate Anticipation: Strategies for Adding Value in Fixed Income” (2000) and “Assigning a Duration to Inflation-Protected Bonds” (1999), both published in the Financial Analysts Journal. He also co-wrote “Managed Synthetics,” published in The Handbook of Stable Value Investments (1998), and “LDI: Reducing Downside Risk with Global Bonds” (2012), published in The Journal of Investing. Rudolph-Shabinsky has written many blogs highlighting the risks in bank loans and in high-yield CCC-rated bonds. He holds a BA in economics and Soviet/East European studies from Cornell University and an MBA from Columbia University, and is a CFA charterholder. Location: New York

Alison M. Martier, CFA

Senior Managing Director—Global Fixed Income Business Development
Alison M. Martier is a Senior Managing Director for Global Fixed Income Business Development and a Partner at AB. She previously served as senior portfolio manager and director of the Fixed Income senior portfolio manager team. Martier was director of the firm’s US Multi-Sector service from 2002 to 2007. She joined the firm in 1993 from Equitable Capital, where she began as a trader in 1979 and was named portfolio manager in 1983. She is the co-author of “LDI: Reducing Downside Risk with Global Bonds,” published in The Journal of Investing. Martier holds a BA in economics from Northwestern University and an MBA from New York University’s Stern School of Business, and is a CFA charterholder. Location: New York

Erin Bigley, CFA

Senior Portfolio Manager—Fixed Income
Erin Bigley was named a Senior Portfolio Manager for the Fixed Income team in 2008 and is a member of the firm’s Responsible Investment Committee. She joined the firm in 1997 and previously served as a portfolio manager and trader for the Global and Canadian bond strategies. Bigley also spent two years based in London as the global head of Fixed Income business development for institutional clients. She is the co-author of “LDI: Reducing Downside Risk with Global Bonds,” published in The Journal of Investing. Bigley holds a BS in civil engineering from Villanova University and an MBA from the Massachusetts Institute of Technology’s Sloan School of Management. She is a CFA charterholder. Location: New York

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