Lowering volatility with a global approach to fixed income
In the latest edition of Ahead of the Curve in partnership with MFS Investment Management, senior managing director Benoit Anne explores the benefits of adding global bonds to a portfolio.
Investors and financial advisers should consider looking beyond Australia and adopting a global allocation to fixed income. This can enhance diversification and potentially lower volatility, according to MFS Investment Management.
While advisers may prefer to rely on familiar homegrown options, solely allocating to Australian bonds within their fixed income allocation could leave investors with a lack of diversification and mean they potentially miss out on attractive yields from fixed income sectors around the globe.
Instead, global bonds can help to lower portfolio volatility and provide investors with a diversified range of fixed income assets.
At one end of the global risk spectrum sits low-risk government bonds and US Treasuries while for investors who are willing to take more risk, local currency emerging market debt would be a potential option, along with global high yield bonds. In the middle, opportunities can be found in global corporate bonds, mortgage-backed securities (MBS) and securitised debt.
Speaking to Money Management, Benoit Anne, senior managing director and head of market insights at MFS, said: “There are so many benefits to having a global approach to fixed income. When you only have a home bias, you can miss out on a lot of global opportunities. The benefit of this broad diversification is that there are lots of macro developments that are unsynchronised and a global manager is going to be able to take advantage of those discrepancies and divergences.
“For example, the Federal Reserve is set to cut its policy rate quite aggressively over the next year but the European Central Bank is no longer looking to lower its interest rate anymore. So this creates a big divergence in monetary policy, a big driver for currency movements and opportunities for active managers.”
The second benefit of an allocation to global fixed income sits within the broader range of investment options that advisers open themselves up to which can simultaneously reduce the risk level of a portfolio.
“Global bonds broaden your investable universe quite considerably as you are no longer restrained by a finite number of securities in the domestic market which can create concentration problems. Corporates may also opt to issue bonds in multiple different currencies and being invested globally means the manager is going to be able to invest in the particular issuance and currency that better suits their portfolio.
“Your risk may be higher if you invest only in Australia so you can lower or risk manage your volatility with a global mandate.”
Another factor at play is that public fixed income is offering more attractive starting yields at this point of time than in the recent past and offers an alternative to the popular private credit funds given it lacks the illiquidity problems affecting that asset class. While private credit has seen high demand in recent years, regulatory concerns raised by ASIC more recently combined with questions about their transparency have left some Australian investors hesitant to invest.
“Private credit has been tremendously popular in the past decade and it really took off at a time when yields in public fixed income were terribly low so it made total sense” Anne said. “We believe that now the situation has changed dramatically and yields in public fixed income are a lot higher.
“We have seen some concerns emerging around portfolio liquidity and some headlines suggesting some cracks may be appearing in private credit. It still makes sense as part of a broad strategic asset allocation but public fixed income could be considered as an attractive alternative.
“What we are hearing from clients is that they are no longer looking to increase their private credit exposure, they say they have enough so there’s seemingly a change of appetite.”
Using global bonds in portfolios
At MFS, the firm runs a range of diversified multi-sector fixed income products and Anne said these vehicles allow investors to focus on their clients’ needs rather than worrying about the underlying asset allocation. We believe having a manager who can tactically switch between the different sectors of fixed income at the opportune time is an advantage compared to an adviser trying to navigate them all by themselves and needing to stay across all the market movements.
“Using multi-sector vehicles provides another lever to generate returns, the manager can decide when to switch between sectors based on market fundamentals. How much we allocate to one sector depends on the level of investor needs and on market conditions, for instance the global backdrop is looking friendly right now so we are buying fewer government bonds and prefer global corporates which in our view are positioned to do well.”
When considering a potential global bond allocation compared to researching a domestic vehicle where advisers may already have a pre-existing underlying knowledge, Anne recommended it was essential to ensure the respective portfolio management team was backed by a strong research team given the differences between the various markets.
“The knowledge base of the management needs to be higher, they need to have deep research capabilities especially if you are considering areas like emerging market debt because different exposures can hurt you if you don’t have investment staff on the ground in those areas or know what you are doing.”
While some commentators have disparaged the 60/40 allocation more recently, Anne maintains it remains a worthwhile investment allocation.
“Fixed income remains a safer asset class than equities and can be useful to manage your defensiveness. It can also outperform equities in times of market stress so yes, at this point in time, I would say 60/40 remains attractive."
Anne also addressed the cash vs. fixed income debate. “Compared to being in cash or term deposits, the yields are considerably higher and with central banks cutting rates then the returns on cash will go down further over time whereas you can get a capital appreciation in your bond portfolio as rates move lower."
For more in the Ahead of Curve series, click here to listen to the podcast with MFS Investment Management's managing director James Langlands and senior Evidentia consultant Ron Mehmet and click here to read about how advisers can best select a fixed income fund.
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