LDI: How Large an Allocation to Global Bonds?

Liability-driven investors can reap significant benefits from globalizing their long-duration bond portfolios, but how much should they sow? How large an allocation to nondomestic bonds is appropriate? Our research suggests that even a modest allocation can meaningfully improve an LDI portfolio’s risk-adjusted return potential.

As we examined in our previous blog, liability-driven investors have been slow to embrace global investing: traditionally, domestic bonds have been considered the best match for long-term liabilities such as pension obligations. However, an allocation to currency-hedged global bonds can help reduce downside risk while capturing most of the upside return potential of domestic bonds, creating an opportunity to improve a plan’s funded ratio.

The key question for liability-driven investors is how large this allocation to global bonds should be. Three of my colleagues—Alison Martier, Erin Bigley and Ivan Rudolph-Shabinsky—have recently published research that sheds some light on this question. Should liability-driven investors convert their entire fixed-income portfolios to global debt?

Our research suggests that the answer is no. There is generally a close correlation between returns for domestic-only long bonds and hedged global bonds, but the gap between the two can at times be quite large.

Over the past 25 years, the largest outperformance margin for domestic bonds over global bonds was 13.2% for a US dollar–based investor and 9.5% for a euro-based investor. However, the biggest gap for sterling- and yen-based investors was nearly 20%—and in the UK and Japan the correlation between domestic and global bond returns is lower. So where is the sweet spot that allows the liability-driven investor to capture the advantage of going global? To answer this question, we looked at various combinations of domestic and nondomestic bonds, as the display below shows.

Finding the Ideal Allocation to Nondomestic Bonds

Adding even 10% to 20% of nondomestic bonds significantly improves the risk-adjusted return potential of a portfolio. The incremental improvement in return/risk ratio from adding more nondomestic exposure generally diminishes after reaching a 50/50 blend, our research suggests.

The appropriate allocation, of course, varies depending on each investor’s risk tolerance and specific home country. For example, a sterling-based investor might find a larger exposure more attractive, whereas a yen-based investor might find a smaller exposure to global bonds appropriate. The key takeaway though, is that in these four regions, liability-driven investors can benefit from an allocation to global debt.

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—Fixed Income
Douglas J. Peebles is Chief Investment Officer, a Partner of the firm, and Head of Fixed Income, focusing on AB’s 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 the firm in 1987, Peebles has held several leadership positions, including director of Global Fixed Income (1997¬–2004), co-head of Fixed Income (2004–2008), and his current position (Head of Fixed Income), which he assumed in 2008. 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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