The Greenest Bond Pastures Are Global Bonds by Scott DiMaggio, AllianceBernstein.
With improving jobs data in the United States, our conviction that a Fed rate hike is imminent has increased. Whether the central bank raises official rates in June or later this year, the days of zero-percent rates in the US are coming to an end. What’s an investor to do?
Don’t Fence Me In
Does this mean investors should dramatically reduce duration? Sell a portion of their fixed-income portfolio? Abandon interest-rate exposure altogether? How should they protect what is meant to be the “safe” part of their overall portfolio?
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We believe that bonds should continue to play a role in portfolio allocation. However, rather than staying locked into a US-only fixed-income source of bond beta, our research indicates that the better beta source is the global fixed-income markets.
And that’s not just over historical time periods. Today, it may be timelier than ever.
While US growth continues to improve—warranting removal of monetary stimulus—languishing growth and low to negative inflation in other parts of the world mean more stimulus is required.
This year to date, 21 central banks have eased monetary policy, including several that have engaged in some form of quantitative easing. We expect this trend to continue in 2015, with rate cuts in Canada and Australia, and quantitative easing in Europe and Japan. The developing world also should continue to see lower rates and increased central bank liquidity.
Just Say No to Currency Risk
But what about currencies? We’ve been beating the drum for a long time that there is a big difference between currency-hedged global bond investing and unhedged global bond investing, depending on the desired risk preference of the investor. Want a core bond solution? Go hedged.
Today, there’s even more to consider. First, we’re expecting a stronger US dollar. That alone argues that global bonds should be purchased on a fully currency-hedged basis. Second, other central banks are cutting rates. That makes currency hedging even more compelling, because that should continue to drive those countries’ or regions’ currencies lower.
Right now, for example, when US investors buy an unhedged German Bund, they find themselves in negative yield territory due to the European Central Bank’s decision to cut its deposit rate below zero. US investors actually give up income to own the unhedged bond. But when the euro is hedged out against the US dollar—a process that is quick, easy and cost effective—the investor picks up roughly 0.75% annually.
For years now, investors have been told “don’t fight the Fed.” Maybe instead they should be told to “float with the current” set by the central banks. And a good way to do it is by investing in currency-hedged global bonds.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
Scott DiMaggio is Director of Global and Canada Fixed Income at AllianceBernstein.