Canadian pension plans have become more global on the equity side over the past decade, but many haven’t crossed the border beyond domestic fixed income strategies.

Avoiding global fixed income markets, however, limits the potential for strong risk-adjusted returns over the long term. Underexposure to the wide spectrum of fixed income investments could mean pension plans are missing out on the opportunities for alpha.

Many bond managers see global fixed income as a source of additional returns and opportunistic investing, an alternate means of taking advantage of currency movements and economic growth around the world. But global fixed income maintains its traditional role of building portfolio diversity, too. In the last two decades, the Canadian stock market was in negative territory for seven of those years. During those years, the global bond asset class delivered positive returns—mostly in double digits—and even outperformed Canadian bonds in all but one of those seven years, according to Morningstar research.

Investing in global fixed income is a great means to expand a portfolio’s opportunity set, even in today’s complex market. And plan sponsors can take advantage of a vast range of global fixed income securities with an acceptable level of risk.

10 Ways to Reduce Risk and Enhance Returns With Global Fixed Income

1. Risk reduction: Adding global fixed income positions to a portfolio may potentially reduce volatility as economic conditions and business cycles in different countries vary widely.

2. Portfolio diversification: Adding global fixed income exposure may further improve the diversification and returns of a traditional single-country fixed income strategy.

3. Record of low correlation: Investing in both core and non-core fixed income sectors may provide enhanced diversification regardless of the prevailing interest rate environment. Diversifying a fixed income portfolio that is heavily weighted in the traditional core sectors by adding low-correlation sectors may help reduce a portfolio’s overall volatility while increasing total return.

4. Why diversify? Because winners rotate: Within the global bond market, the world’s best-performing one has varied from year to year. This record should encourage pension plans to re-evaluate their home-country bias when considering fixed income allocations.

5. Exposure to multiple drivers of return: In each country, investors can look at interest rate, sovereign credit or currency to add alpha to their portfolios. This wide opportunity set gives investors exposure to multiple levers to generate returns. One country’s circumstances provide the framework for identifying investment opportunities primed for interest rate and currency changes. These strategies can combine global fixed income instruments with derivatives to help isolate risk exposures within a country’s yield curve, currency or sovereign credit, thus providing compelling total return opportunities.

6. Looking abroad for returns: Going global gives investors a chance to look around the world for opportunities; not all countries are alike. In a country with faltering economic growth and slower inflation, interest rate declines may be on the horizon, which would increase the prices of the country’s local market debt.

7. Hedge against inflation pressures: Historically speaking, inflation expectations tend to drive interest rates. A global fixed income strategy may reduce, eliminate or provide negative duration exposure in countries where higher government bond yields are likely to materialize.

8. Currency appreciation: Exposure can be built either by owning an unhedged position in bonds or by using currency forwards. If currency is a concern, hedging can be used to reduce the risk.

9. Sovereign credit: A country’s credit worthiness is a key component in overall valuations and a risk that an investor can potentially benefit from over time. Hard currency denominated developing market debt would be an example of an isolated risk exposure within a country’s sovereign credit risk.

10. Interest income: Yields are another attractive aspect of global fixed income investing. Developing market bonds tend to offer higher yields than those from many developed markets. Attractive yields may be further enhanced by currency dynamics where each component of the return is evaluated and exploited separately.

While countries and regions recover from the unprecedented global downturn, geographic diversification makes sense from a risk standpoint and potential return vantage point. Now is the time for pension plans to be evaluating their approach and exposure to global fixed income. BC

Michael Reed is vice-president and institutional portfolio manager with Franklin Templeton’s fixed income group.
mreed@franklintempleton.ca

Copyright © 2020 Transcontinental Media G.P. This article first appeared in Benefits Canada.

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