Fixed Income
HOW BRINGING FLEXIBILITY TO
BOND PORTFOLIOS CAN ACHIEVE
DIFFERENT OUTCOMES
August 2016
Arif Husain, CFA
Head of International Fixed Income
Steven Huber, CFA
Portfolio Manager
Over the past few years, there has been
much discussion about the need for
investors to bring greater flexibility and
global reach to their bond portfolios.
There is good reason for this: The era
of ultra-accommodative central bank
monetary policies is still with us, meaning
that yields remain at or near recordlow levels. At the same time, ongoing
concerns over the state of the Chinese
economy, the low oil price, and the Fed’s
likely rate-hiking path mean that market
volatility is never very far away.
During periods like this, when yields are
low and spiking volatility is an ever-present
threat, traditional benchmark-based
approaches to bond investing may no
longer provide investors the expected risk
and return characteristics that they have
historically received. This puts pressure
on investors to find new ways of sourcing
alpha and reducing the downside risk in
their overall portfolios. A logical way to
achieve this is to adopt a more flexible
approach that considers a broader range
of fixed income instruments and countries
that are less correlated to major bond and
equity markets.
However, adding more flexibility and
diversification to a portfolio can mean
many different things. There is no single
answer to the challenge posed by
today’s difficult investment environment—
an investor seeking primarily to generate
higher returns is likely to adopt a very
different approach to one whose main
objective is to protect capital and reduce
downside risk. Fortunately, the sheer
choice available today means that a
wide array of approaches exists to help
fixed income investors achieve their
goals. In this article, we focus on two
T. Rowe Price funds that invest across
sectors, countries, and currencies but
have differing time horizons and seek to
achieve different outcomes: our Global
Multi-Sector Bond Fund and our Global
Unconstrained Bond Fund.
LOOKING ACROSS SECTORS FOR
STRONGER RETURNS
The Global Multi-Sector Bond Fund
dynamically invests across all fixed
income sectors globally, all quality
ratings, and all countries and currencies
using a risk/return framework. The
investible universe is oriented toward
credit sectors across the full quality
spectrum, with the flexibility to reduce
risk and invest in higher-quality, liquid
sectors when credit valuations are not
compelling, thus providing some degree
of tactical downside risk management.
Although the fund uses the Barclays
Global Aggregate ex-Treasuries Index
hedged to the U.S. dollar as its
benchmark, it invests across many
sectors, securities, and currencies
outside of the benchmark and typically
allocates based on return potential rather
than with reference to the benchmark.
While the benchmark is higher quality
and lower yielding than our portfolio
in most environments, we believe that
FIGURE 1: GLOBAL MULTI-SECTOR BOND HISTORICAL SECTOR ALLOCATION
GLOBAL MULTI-SECTOR BOND FUND TARGET WEIGHTS—LIQUIDITY AND HIGH GRADE
CREDIT SECTORS
As of May 31, 2016
Global Treasury/Agencies
U.S. CMBS
U.S. IG Corporates
U.S. ABS
U.S. MBS
Euro Corporates
Month End Target Weight (%)
40
FED
QE1
Greece I
QE2
U.S. Debt
Ceiling
QE3
“Taper
Tantrum”
ECB
QE
RMB
Deval.
30
20
10
0
11/08
12/09
12/10
12/11
12/12
12/13
12/14
12/15 5/16
GLOBAL MULTI-SECTOR BOND FUND TARGET WEIGHTS—RETURN SEEKING SECTORS
EM Local
Loans
EM U.S. Dollar Sov/Corp
Convertibles
High Yield
Month End Target Weight (%)
40
FED
QE1
Greece I
QE2
U.S. Debt
Ceiling
QE3
“Taper
Tantrum”
ECB
QE
RMB
Deval.
30
20
10
0
11/08
12/09
12/10
12/11
12/12
12/13
12/14
12/15 5/16
Source: T. Rowe Price.
Past performance cannot guarantee future results.
Emerging and/or developed non-dollar cash bonds may be either unhedged or currency-hedged.
seeking opportunities in the higheryielding, lower-quality sectors such
as high yield, bank loans, convertible
bonds, and emerging markets provides
the opportunity for alpha generation
and attractive risk-adjusted returns.
In this context, security selection
utilizing “best ideas” is a key element of
portfolio construction, and we believe
this plays to the strengths of our global
research platform. Sector exposures are
diversified, and currency and interest
rate exposures are also integrated in a
similar framework, utilizing a best-ideas,
return-seeking, diversified framework.
P R I C E P E R S P E C T I V E®
The fund’s primary focus is to seek out
areas of the global bond market with
higher risk-adjusted return potential,
which at times may mean increased
exposure to credit spreads, interest rates,
or currencies. With this exposure comes
higher risk—for example, credit markets
are often positively correlated to equities,
which may result in drawdowns during
periods of stock market volatility. But
risks are not always purely economic—for
example, investing in emerging markets
brings added legal and regulatory risks
that our research team is focused on
understanding and managing.
We manage portfolio risk by analyzing
risk contribution at the sector, currency,
country, and security levels. In addition to
quantitative ex-ante and ex-post analysis
of risk factors, we also quantify risk
attributable to each of our investment
themes, with these themes reflecting our
outlook and assessment of key drivers
of return given the current investment
environment. We seek to take more risk
tied to those themes where we have
the highest conviction, reflecting the
expectation of better risk/return prospects.
The fund also diversifies between
sectors, countries, and currencies.
Although up to 65% of the fund can be
allocated to below investment-grade
funds, heavy concentrations in single
sectors are typically avoided, with sector
exposures above 20% uncommon
unless return prospects appear
unusually attractive. Security selection is
key to generating returns in fixed income
by not only identifying best ideas but
also by avoiding deteriorating credits
(see Figure 1).
In addition, we closely monitor the
fund’s overall exposure to risk on an
uncorrelated basis. This is because
correlations across risk sectors in
credit, currencies, and rates can exhibit
atypically high levels of correlation in
stressed environments, which are more
common than might be suggested by a
normal distribution. We tactically manage
our overall portfolio risk higher or lower
depending on the attractiveness of the
market compensation for taking risk.
This provides some downside risk
management with the ability to invest
heavily in higher-quality, liquid government
bonds in times of stress, although this
protection is tactical rather than structural
in nature and will not capture all periods
of stress, particularly those stresses driven
by unanticipated risk events. This is the
trade-off for maintaining a typically higheryielding, return-seeking portfolio.
2
curve positioning, currency relative value,
credit stock picking, and so on. Unlike the
multi-sector fund, which utilizes sectors as
a higher return driver, the unconstrained
fund invests mostly in government bonds,
and therefore its credit beta tends to
be limited.
SEEKING TO DELIVER STABLE
RETURN AND DIVERSIFICATION AWAY
FROM EQUITIES
The Global Unconstrained Bond Fund is
similar to the Global Multi-Sector Bond
Fund in that it is designed to provide
clients with a smart way of accessing
our best ideas from across the globe.
However, it differs in that its time horizon
is shorter and it is intended to generate
a much smoother pattern of returns,
avoiding the kind of drawdowns that
might occur within a longer-time-horizon,
return-seeking fund as well as providing
stability at times of equity corrections.
The Global Unconstrained Bond Fund
also differs from the Global Multi-Sector
Bond Fund in that it makes an even
greater use of defensive positioning to
stabilize performance at times of market
stress. The absence of a benchmark for
the fund provides us with the freedom
to do this as it means there are no
constraints on the type and volume
of instrument we use. Hedging is
implemented via plain vanilla derivative
instruments to ensure that the risk is
adequately balanced at all times, limiting
potential drawdowns and providing
protection at times when risky markets
suddenly correct (see Figure 2).
The main way the fund achieves this is
by seeking alpha—uncorrelated returns—
from a number of different sources,
including country positioning; currency
management; and, to a lesser extent,
credit bond selection. These sources of
alpha can be used to explore a variety of
different themes, from tactical interest rate
duration, sovereign relative value, yield
By diversifying widely across government
bonds, currencies, and credit and
deploying derivatives adopting short
positions where appropriate, the fund
seeks to create a diversified pool of alpha
that provides a smoother distribution of
returns. This limits the potential impact
from a scenario of rising interest rates while
at the same time offering diversification
and performance stability for the periods
of equity corrections. Throughout our
processes, we seek to capitalize on the
bottom-up fundamental research that our
analysts carry in the sovereign space as
well as in credit markets.
We believe that relative value
opportunities will always be present in
the marketplace—as such, we commit
substantial resources in support of
proprietary, fundamental research to help
uncover and exploit these opportunities.
Systematic risk management ensures
that the fund is well balanced and that
performance remains robust under
different market risk scenarios.
FIGURE 2: PERFORMANCE VERSUS EQUITY MARKET DRAWDOWNS
Description
Negative Equity Return
Position
on Chart
Start of Decline
Trough
Number of Consecutive
(Tradable) Days
S&P
500
Global Unconstrained
Bond Rep. Portfolio
1
Monday, July 20, 2015
Tuesday, August 25, 2015
26
-12.04%
-0.30%
2
Tuesday, December 1, 2015
Thursday, February 11, 2016
49
-12.64%
-0.91%
3
Wednesday, June 8, 2016
Monday, June 27, 2016
13
-5.52%
1.18%
27%
24
21
18
15
12
9
6
3
0
-3
-6
-9
16
Ju
n-
M
ay
-1
6
6
r-1
Ap
6
ar
-1
M
5
Fe
b1
-1
6
3
Ja
n
15
cDe
5
5
-1
ct
O
No
v-1
5
p1
Se
15
2
Au
g-
5
Ju
l-1
15
Ju
n-
M
ay
-1
5
5
Ap
r-1
5
5
M
ar
-1
Ja
Global Unconstrained Representative Portfolio (LHS)
S&P 500 Index (RHS)
1
Fe
b1
15
9%
8
7
6
5
4
3
2
1
0
-1
-2
-3
n-
Flight path of returns since January 30, 2015
RETURN ANALYSIS—GLOBAL UNCONSTRAINED BOND FUND VERSUS S&P 500
As of June 30, 2016
Past performance cannot guarantee future results.
Sources: Reuters and T. Rowe Price.
P R I C E P E R S P E C T I V E®
3
INVESTOR RISK PROFILE KEY
The contrasting approaches of our
Global Multi-Sector Bond and Global
Unconstrained Bond Funds are a good
illustration of how adding characteristics
such as diversity and flexibility to a
portfolio can result in different strategies.
As a return-seeking fund with a duration
range of three to seven years, the Global
Multi-Sector Bond Fund is designed for
investors who seek higher returns over
the long term and are able to accept
some volatility along the way; as a nonbenchmark-based fund with a duration
range of less than one to six years, the
Global Unconstrained Bond Fund seeks
to deliver more predictable returns
by mitigating market volatility through
broader diversification.
Unconstrained Bond Fund uses them
more extensively than the Global MultiSector Bond Fund. A decision to invest
in either fund will therefore be partly
dependent on the investors’ individual
risk profile. Ultimately, however, the
choice will be based primarily on the
desired outcome—return generation or
downside risk management. By creating
bond portfolios with greater flexibility,
both outcomes can be achieved.
Both funds employ derivatives for
hedging purposes, although the Global
Important Information
GLOBAL MULTI-SECTOR BOND FUND PERFORMANCE
As of June 30, 2016 (NAV, total return)
Annualized
Three Months
Year-to-Date
One Year
Three Years
Since Inception
12/15/08
Five Years
Global Multi-Sector Bond Fund
3.12%
6.50%
5.60%
4.23%
4.24%
7.46%
Barclays Global Aggregate ex Treasury Bond
USD Hedged Index
2.19
4.93
5.71
4.58
4.44
5.39
30-Day
SEC Yield
3.15%
—
GLOBAL UNCONSTRAINED BOND FUND PERFORMANCE
As of June 30, 2016 (NAV, total return)
Annualized
Three Months
Year-to-Date
One Year
Since Inception
1/22/15
Global Unconstrained Bond Fund
1.14%
2.50%
4.32%
4.59%
3 Month LIBOR in USD
0.16
0.31
0.48
0.42
30-Day
SEC Yield
1.70%
—
30-Day SEC Yield
w/o Waiver°
1.14%
—
Current performance may be higher or lower than the quoted past performance, which cannot guarantee future results. Share price, principal value,
and return will vary, and you may have a gain or loss when you sell your shares. The performance information shown does not reflect the deduction of
any redemption fee; if it did, the performance would be lower. To obtain the most recent month-end performance, or to request a prospectus, which
includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing, please
visit our website or contact a T. Rowe Price representative at 1-877-804-2315. The average annual total return figures include changes in principal value,
reinvested dividends, and capital gain distributions. Prior to July 1, 2015, the Global Multi-Sector Bond Fund’s name was Strategic Income Fund.
°Excludes the effect of contractual expense limitation arrangements.
Call 1-800-225-5132 to request a prospectus or summary prospectus; each includes investment objectives, risks, fees, expenses
and other information that you should read and consider carefully before investing.
Diversification cannot assure a profit or protect against loss in a declining market. Yield and share price will vary with interest rate changes. Investors should
note that if interest rates rise significantly from current levels, bond fund total returns will decline and may even turn negative in the short term. High-yield bonds
carry greater default risk than higher-rated bonds along with greater liquidity risk. To the extent the funds hold foreign bonds, they will be subject to special risks,
including potentially adverse political and economic developments overseas, greater volatility, lower liquidity, and the possibility that foreign currencies will decline
against the dollar. The funds’ investments in emerging markets are subject to the risk of abrupt and severe price declines.
Each fund’s use of derivatives may expose it to additional volatility in comparison to investing directly in bonds and other debt securities. Derivatives can be illiquid
and difficult to value, may involve leverage so that small changes produce disproportionate losses for the fund, and any instruments not traded on an exchange are
subject to counterparty risk. The Global Unconstrained Bond Fund’s principal use of derivatives involves the risk that interest rate movements, changes in currency
values and exchange rates, or the creditworthiness of an issuer will not be accurately predicted, which could significantly harm performance and impair efforts to
reduce overall volatility.
The Global Unconstrained Bond Fund is “nondiversified” so its share price can be expected to fluctuate more than that of a “diversified” fund.
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action. The views
contained herein are those of the authors as of August 2016 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities
or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or
class of investor. Investors will need to consider their own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.
Past performance cannot guarantee future results. All investments involve risk. All charts and tables are shown for illustrative purposes only.
T. Rowe Price Investment Services, Inc., Distributor.
CZBMXF3HF
2016-US-24649
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