Looking to control risk? US defined contribution (DC) plans should consider incorporating currency-hedged global bonds into their core menus and target-date funds (TDFs).
Hedged global bonds can serve as a low-volatility anchor to windward against equity market volatility. And they have historically done a better job of meeting this “core bond” objective than US bonds.
How so? Over the past 20 years, the return of a hedged global bond portfolio as represented by the Barclays Global Aggregate Bond Index (hedged to US dollars) matched that of a US-only portfolio as represented by the Barclays US Aggregate—but with lower volatility. As a result, the risk-adjusted return—or Sharpe ratio—of the hedged global portfolio was higher. For the full period, hedged global bonds delivered a Sharpe ratio of 1.0, compared with US bonds at 0.8 (Display).
And it’s critical—as is clear in the above display—to hedge the currency risk when going global. Controlling foreign currency risk is particularly important for participants approaching or in retirement. A large portfolio shock at this stage of life can lead to a permanent loss of capital, given peak levels of assets and a transition from saving to spending.
Two Approaches to Core Menus
When it comes to the core menu, multimanager design—a growing trend in midsize and smaller plans—can be the key to going global. Many smaller plan sponsors now have the ability to add a hedged global core bond offering as a complement to their US core bond offering. Sponsors can then guide participants toward increasing their allocations to the global core option.
An even more desirable approach is one that larger plan sponsors can execute: incorporating global bonds directly into the core bond option. In this approach, plan sponsors can design their core bond option to better meet participants’ risk and return objectives without creating disruption or confusion for participants.
The Target-Date Solution
Within both customized TDFs for larger plans and packaged-solution TDFs for smaller plans, our research shows that a hedged global bond allocation can improve the glide path, thanks to global bonds’ diversifying and risk-mitigating effect.
We find that a minimum of 50% of the total bond allocation is an attractive allocation to hedged global in a TDF. At less than 50%, meeting investors’ objectives becomes more challenging and less certain; at 50% and above, we preserve purchasing power, avoid sharp market declines and minimize risk of loss.
So tap more deeply into the potential power of diversification—and open a broader opportunity set to active managers—in your core menu or target-date fund. Adding hedged global bonds to US DC plans will help plan sponsors and participants get a better handle on risk.
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.
"Target date" in a fund's name refers to the approximate year when a plan participant expects to retire and begin withdrawing from his or her account. Target-date funds gradually adjust their asset allocation, lowering risk as a participant nears retirement. Investments in target-date funds are not guaranteed against loss of principal at any time, and account values can be more or less than the original amount invested—including at the time of the fund's target date. Also, investing in target-date funds does not guarantee sufficient income in retirement.