LDI: More on Going Global in Bonds

For liability-driven investors, exposure to global bonds offers important benefits: a strong correlation to domestic debt, with greatly reduced volatility. However, these are not the only positives. Today, we’ll look at some other important benefits—such as greatly expanding the investable universe and offering a natural hedge against the tail risk of a domestic credit crisis—and then examine some of the practicalities of introducing global bond allocations within an LDI framework.

Although tail-risk events are—by definition—rare, recent financial problems in Greece and several other European nations, and the resulting turbulence in their government bond markets, have made sovereign credit risk a more prominent issue for investors. For liability-driven investors in these countries, the traditional approach of immunizing liabilities through exposure to domestic-only debt could be very risky.

US investors don’t share the same level of concern about a domestic credit crisis, and US Treasuries do still rally during flights to quality, but the risk of a credit event is not zero. The US faces a significant structural budget deficit, which is projected to increase as spending on Social Security and Medicare accelerates in the latter part of this decade.

The current assumption is that the threat of a potential crisis will ultimately spur the US government to act, but if the current political divide were to result in a deadlock preventing meaningful deficit reduction, further credit-rating downgrades could ensue, and financing costs could escalate as investors require greater compensation for holding US debt.

In any of these cases, exposure to global bonds offers what amounts to a natural hedging strategy against domestic tail risk: global bonds offer a high correlation to domestic long-term bonds but have historically protected against large downside losses in domestic bonds.

Another important benefit of going global is that it greatly expands the universe of investable bonds, as three of my colleagues—Alison Martier, Erin Bigley and Ivan Rudolph-Shabinsky—note in recently published research. This is especially relevant to investors using LDI strategies, since the supply of longer-dated bonds—the best match for long-term liabilities—is relatively scarce in many markets. While long bonds make up nearly half the market in the UK, they account for less than a third of the domestic markets of the US, the euro area and Japan, as shown in the display below. Investors in any of these regions could more than triple their long-maturity investment universe by looking globally.

Domestic Markets Constrained by Limited Supply of Long Bonds

Having looked at the benefits of going global and the sizing of the appropriate global allocation in earlier blog posts, let’s conclude this series by asking how investors can go about introducing a global allocation to their fixed-income portfolio.

  1. Investors can add an international component to their asset allocation. This involves adding a portfolio of only nondomestic bonds. The investor (rather than the portfolio manager) must then monitor and adjust the size of the allocation to nondomestic bonds versus domestic bonds.
  2. Investors can make a global allocation. In this case, nondomestic bonds are part of the portfolio benchmark and therefore allocations are strategic in nature. The portfolio manager can actively shift allocations within the portfolio between domestic and nondomestic bonds.
  3. Investors can permit the opportunistic use of nondomestic bonds within their domestic portfolios—a “core plus” approach to an LDI portfolio. In this case, the portfolio manager allocates between domestic and nondomestic bonds, but nondomestic bonds are not part of the benchmark; therefore, these allocations are tactical rather than strategic.
The specific solution will vary depending on the circumstances of the investor, but in general, our research strongly suggests that the evidence in favor of adding a global bond allocation to LDI portfolios is compelling.

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

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

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

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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