The benefits of looking beyond borders in fixed income

With developed market bond yields sitting near zero, pension plan sponsors seeking better returns and increased portfolio efficiency may find what they’re looking for in global fixed income, said Gregor Dannacher, global corporate credit portfolio specialist for the fixed income division at T. Rowe Price.

When speaking at the Canadian Investment Review’s Global Investment Conference in September 2020, Dannacher highlighted how globalizing fixed income allocations can provide return potential and diversification benefits. “Most Canadian investors have already embraced globalizing their equity allocation,” he said. “Now the time has come to make similar shifts within fixed income allocations.”

Plan sponsors can take several routes to incorporating global fixed income in their portfolios, including using global multi-asset credit or a subset of it — global high yield, Dannacher noted.

Many other developed markets offer higher yielding opportunities when looking at select 10-year global government bonds hedged to Canadian dollars. Further, when considering yield-to-maturity across various fixed income sectors, global high yield offers more yield and income potential, with slightly more volatility compared to many other sectors.

Further, when comparing the rolling 12-month correlation of global high yield and emerging markets to the broad Canadian market up to the end of July 2020, it’s clear the markets are moving in different ways most of the time, Dannacher added.

And while multi-asset credit or global high-yield allocations introduce more credit risk to an overall portfolio, the extra yield picked up can help smooth out overall returns and lead to more portfolio efficiency, he said, noting multi-asset credit also generates equity-like returns with half the volatility of equity.

Dannacher cited a T. Rowe Price study on forecasting fixed income returns. “The yields you invest at today and the subsequent return experienced over the next five to ten years is very highly correlated, somewhere between 75 and 98 per cent correlation depending on the fixed income sector. To me, that is an incredibly good crystal ball.”

Applying this insight to today’s reality, with government or investment-grade-type bonds yielding one to three per cent and multi-asset credit yielding four to six per cent, these are the good indicators for return expectations in the years ahead, he said. “Further if you assume the same sort of standard deviation of returns going forward, you will find that the efficiency or Sharpe ratios of global [multi-asset credit] sectors screen well. Conversely, some of the lower-yielding sectors may not be able to generate appealing absolute return streams most institutional investors need to meet their constituent or plan objectives.”

Duration is a hidden risk lurking in the lower-yielding bond sectors, Dannacher said. Plus, for plan sponsors looking to global high yield, the opportunity set has expanded over the past 10 to 15 years to over $5 trillion and the credit quality of the market has materially improved too. But differences do exist across regions, industries and companies, he added, noting flexible, active asset managers can take advantage of inefficiencies. “One of my favourite sayings in investing in credit is, ‘Delivering returns is not only just about what you own in a portfolio, but it’s also about what you avoid.’”