How much global is the right amount to add to core bond portfolios? Is there an optimal amount that improves potential risk-adjusted return?
In recent posts, we established that going global diversifies interest-rate and economic risks, and increases the opportunity set; that it helps buffer some of the downside risk that US-only portfolios are likely to experience over the short term when rates begin their climb; and that hedged is better than unhedged or cross hedged when stability’s the objective.
We made a strong case for a hedged global portfolio as having a better risk-adjusted return, or Sharpe ratio, than either an unhedged global portfolio or a US-only one, placing it squarely in the targeted “core” bond volatility range, where it can serve as an investor’s anchor to windward against equity-market volatility.
In other words, adding hedged global bonds strengthens your core bond mandate.
How Much Hedged Global Is “Just Right”?
As shown in the Display below, there is no sweet spot. Any incremental addition of global bonds can be beneficial to risk-adjusted return. We plotted the historical risk and return of portfolios with different allocations to US bonds and hedged global bonds, ranging from 100% in US to 100% in global.
The more global the portfolio, the higher the risk-adjusted return, as represented by the rising diagonal line. Simply put, it just gets better. As little as a 10% allocation to global can improve outcomes. In our view, a 50% allocation is a realistic target. And a 100% commitment would be commensurately better.
So whether you mix a little hedged global into your solution or completely reformulate it, adding global bonds should improve outcomes over the long term—but particularly in today’s environment, where global bonds can buffer some of the interest-rate risk of traditional US-only core bond strategies.
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.