Improving your bond risk-reward ratio through Canadian beta and global alpha

In a world where economies are diverging, one way Canadian pension plans can balance their risk/reward ratios is to look at global bond opportunities as a source of alpha.

Many parts of Europe, Japan and the developing world are experiencing low growth in contrast to stronger performances in places like the United States and Britain. However, monetary and fiscal policy is moving in a synchronized way and with most interest rates at zero or at least hovering near that level, there are implications for bond portfolios.

“The imbalances of this desynchronized world are global in nature, making it a lot more difficult to have regional or local strategies generating enough return,” said Alan Cauberghs, senior fixed income director at Schroders.

His proposal is to benefit from the correction of these imbalances and look at the global opportunity set to add alpha to a pension portfolio.

One way to fund pension liabilities is through exposure to the Canadian market. The alpha could also come from an international portfolio that could lead to a better risk-reward ratio for the combined portfolio.

In that context, it’s important to think of different alpha sources as opposed to different asset classes. Duration and active duration strategies have a very low information ratio. By adding other sources of alpha such as a currency strategy, the information ratio increases and can become a lucrative source of alpha, said Cauberghs.

Duration strategies, combined with currency and cross-markets strategies, increase the information ratio. Rotating the risk budget between these alpha sources can lead to less directional portfolios than those based on simple asset allocation decisions.

Plans can gain local market exposure by investing in the Canadian bond market, where a portfolio with a tracking error as low as 20 basis points can be constructed through investments in physical bonds. Plans can then seek the alpha on a global basis as investors experience better liquidity and diversification.

“The combination of having a portfolio that matches your liabilities that is invested into cash instruments replicated in the Canadian market and adding on top of that a global fixed income portfolio actually allows you to generate a very acceptable level of returns within a fairly limited risk budget,” said Cauberghs.

All the articles from the event can be found in our special section: 2015 DB Investment Forum coverage.