The key benefit of going global with your bond allocation is diversification. Global bonds allow investors to achieve exposure to the interest rate profile, economic cycles and political climate of a wide range of markets outside of the United Kingdom.
To the extent that the events influencing global markets differ from those that drive the UK market, global bonds can be a sensible addition to many investors’ portfolios.
Correlation matters
The global bond market as a whole exhibits a meaningfully different risk profile from the UK market; in other words, global bonds and UK bonds are not perfectly correlated and may go in different directions at certain times.
What matters is not so much how risky a particular investment is in isolation but how much risk it adds to a portfolio. Taking into consideration how they interact, adding global bonds to a UK bond portfolio can actually allow investors to reduce risk without necessarily decreasing the expected return.
By way of illustrating how this can work, the figure below compares yields on 10-year government bonds of the US and UK with the two key southern eurozone economies.
The graph shows how they have diverged wildly over the last four years. Investors who were exposed to only one of these geographies would have experienced volatility in both price and income streams.
An investor, on the other hand, who maintained a balanced and diversified exposure to global bonds may well have experienced smoother and less volatile returns year over year.
10yr government bond yields March 2008 – present
Source: Bloomberg. Past performance is not a reliable indicator of future results.
A note on currency risk
Currency risk represents a particular challenge to global bond investors. Research suggests that short-term currency movements follow a random walk, making them nearly impossible to predict.
As such, currency seems to provide no value to investors and adds volatility. Investors and fund managers can, however, hedge the currency risk. With hedging costs in the single digits of basis points, the cost of hedging is relatively insignificant in light of the benefits it can bring.
Why not go global?
In 2012, the average UK fixed income investor had 59 per cent of their portfolio invested in UK bonds, a much higher proportion than the 6 per cent share that UK bonds comprise in the global bond market. Our analysis calls this overweight into question.
With currency hedged back to sterling, the global bond market can allow investors to expand their opportunity set and benefit from increased diversification.
With the UK market representing a small, concentrated portion of the world’s fixed income securities, we would encourage investors and their advisers to consider how a global bond allocation may help them meet their investment objectives.
If you would like to know more about global bonds, you can find the full research report here.
Important information
This article is designed only for use by, and is directed only at persons resident in the UK. The information on this document does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this document when making any investment decisions. The material contained in this document is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.
Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.
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