Investment Focus
Strength in Diversity: The Case for
Investing in Global Fixed Income
A well-managed allocation to global fixed income can play an important role in an investor’s portfolio. The world
economy, despite turbulence over the past several years, continues to grow and evolve, offering opportunities to
rotate through interest rates, credit, and currency markets. A skilled manager can improve a total portfolio’s risk-return
profile through skilled security selection, investing in low-correlated and unsynchronized markets, and adding value
through currency management.
2
Introduction:
The Opportunity in Global Bonds
The global fixed income market has grown rapidly over the past two
decades. Today, the Barclays Capital Global Aggregate Bond Index is
more than twice the size of its US counterpart. An allocation to global
bonds, both listed and unlisted, can offer a number of advantages over
an allocation to a single-country index, including:
• Higher potential returns from an expanded country and credit
universe;
• Return diversification based on multiple interest rate and economic
environments;
• Flexibility through active management to potentially avoid
benchmark concentration risk while accessing out-of-benchmark
opportunities;
• Enhanced returns through currency management.
Global fixed income positions should be carefully managed—both at
the security level as well as in regard to their relationship to the rest of
the portfolio. While some global bonds offer higher yields, they often
reflect greater, or different, risk. At Lazard, our global fixed income
strategies integrate macro market and trend analysis with bottom-up
security research. Our goal is to combine the traditional benefits
offered by domestic fixed income with the opportunity to capture
higher returns.
Home Alone
Home-country bias can result in missed opportunities. An investor who holds the bonds of just one country is tied to its economic
cycle, inflation, yield curve, and monetary policy. With global bonds,
however, the investor can diversify exposure to different drivers of performance. For example, as the US Federal Reserve is expected to start
raising rates in the near future, many other central banks of both large
and small countries will likely remain accommodative for some time.
While global capital markets are integrated and some macro factors
may have an impact across countries, these factors typically diverge
over different time horizons. An investor with a local concentration
would be unable to benefit from favorable results elsewhere. In the
past two decades, for example, US bonds were the lead performers just
three times in a group of 11 nations (Exhibit 1).
Investing globally in fixed income significantly broadens the opportunity
set. The Barclays Capital Global Aggregate Bond Index—with 16,000
issues and a market value near $43 trillion—has almost twice as many
securities and is nearly two-and-a-half times the market value of the
Exhibit 1
There Are Different “Winners” and “Losers” Every Year
Local Currency Performance of Select Countries in the Citigroup World Government Bond Index
1995
1996
1997
1998
1999
2000
2001
2002
Sweden
Italy
United
Kingdom
United
Kingdom
Japan
United
States
Canada
United
States
20.20
21.90
14.76
19.55
4.83
13.48
7.50
11.64
Canada
Sweden
Italy
New
Zealand
Norway
Australia
Italy
Australia
20.03
18.25
13.82
14.23
2.64
13.39
6.90
9.55
New
Zealand
United
States
2003
2004
2005
2006
2007
Norway
Sweden
United
Kingdom
New
Zealand
United
States
11.08
8.47
8.00
4.02
9.00
New
Zealand
Italy
New
Zealand
Canada
6.49
8.40
7.25
3.54
2008
2009
2010
2011
Australia
Italy
United
Kingdom
United
Kingdom
2012
2013
2014
Italy
Italy
Italy
20.19
8.27
7.26
16.90
20.90
7.30
15.37
Canada
New
Zealand
France
New
Zealand
New
Zealand
France
Japan
United
Kingdom
5.02
17.64
2.97
6.86
14.71
10.00
2.21
14.92
United
Kingdom
Sweden
Norway
Germany
Australia
Australia
Australia
France
15.40
2.78
6.20
14.26
5.50
0.10
12.07
Australia
France
Australia
Sweden
New
Zealand
Italy
Canada
France
Canada
United
States
19.85
11.94
13.24
13.86
-0.55
11.64
6.73
9.49
5.61
7.48
7.02
3.12
4.70
United
States
Canada
Canada
France
United
Kingdom
Canada
France
United
Kingdom
Sweden
Norway
Italy
Australia
New
Zealand
United
States
Germany
Canada
Sweden
New
Zealand
Norway
Sweden
18.30
11.83
9.73
12.59
-1.20
10.50
5.72
9.47
4.86
7.44
5.97
2.06
3.91
13.89
1.95
6.18
13.82
5.48
-0.47
11.69
Italy
Canada
Sweden
Norway
France
France
Germany
Australia
Sweden
Norway
United
Kingdom
New
Zealand
United
States
United
States
Germany
France
Australia
12.19
-1.46
9.63
5.71
9.31
3.98
7.34
5.73
0.81
3.69
13.58
1.10
5.81
9.61
4.50
-0.50
11.13
Italy
Australia
France
United
Kingdom
Australia
Germany
Japan
France
Germany
United
Kingdom
New
Zealand
Germany
3.86
7.26
5.47
0.50
3.69
12.30
0.89
5.23
9.60
2.73
-1.73
10.33
Italy
Australia
United
States
17.31
11.75
9.64
France
New
Zealand
Sweden
Germany
Germany
United
Kingdom
Germany
New
Zealand
17.01
9.05
7.85
10.94
-2.08
8.99
5.39
9.06
Germany
New
Zealand
Germany
Germany
Canada
Germany
Japan
Japan
Canada
United
Kingdom
Australia
Canada
Norway
Germany
Norway
7.31
4.57
9.05
3.78
7.01
5.38
0.30
2.64
12.00
-0.81
5.11
9.54
2.30
-2.24
9.34
Sweden
Norway
Germany
France
Sweden
Norway
Norway
Canada
Canada
New
Zealand
5.22
-0.01
1.99
11.83
-1.19
4.95
7.98
2.18
-2.28
8.21
United
States
Canada
-2.65
7.46
United
Kingdom
Norway
Norway
Australia
United
States
16.50
8.46
7.24
10.35
-2.45
Germany
United
Kingdom
France
United
States
Australia
France
Australia
Sweden
Australia
United
Kingdom
16.27
7.41
7.15
10.00
-2.45
7.18
4.03
8.94
2.65
6.61
New
Zealand
Germany
New
Zealand
Canada
Sweden
Italy
Japan
Norway
United
States
New
Zealand
Norway
Germany
Sweden
Norway
Canada
Sweden
France
United
States
13.55
7.29
6.69
9.41
-2.51
6.91
3.35
8.83
2.27
5.34
3.53
-0.36
1.79
10.62
-1.71
2.94
4.59
1.97
Canada
United
Kingdom
United
States
United
States
France
France
Italy
Australia
Japan
Japan
Japan
Sweden
United
States
8.03
2.09
3.53
2.80
-0.44
1.72
5.81
-2.60
2.40
2.20
1.78
-2.88
4.92
Italy
Italy
Sweden
United
Kingdom
Japan
-0.82
-5.73
1.25
-4.09
4.86
Japan
Japan
Japan
Norway
Italy
Norway
United
Kingdom
13.29
5.26
6.60
4.42
-2.59
6.45
3.08
United
States
Germany
Japan
France
Japan
Sweden
Japan
Japan
Japan
Japan
Italy
Italy
Japan
United
States
2.73
6.16
0.50
-2.95
2.13
3.06
3.19
-0.74
1.26
0.72
-0.65
1.59
3.72
-3.69
As of 31 December 2014
The table shows annual total returns of 11 major components of the Citigroup World Government Bond Index Unhedged (WGBI Unhedged), in local currency terms. The WGBI Unhedged
covers the most significant and liquid government bond markets, currently including 23 government bond markets, worldwide. Credit: Callan Associates Inc. and the Callan Periodic Table
of Investment Returns. The performance quoted represents past performance. Past performance is not a reliable indicator of future results. For illustrative purposes only. This information
is not representative of any product or strategy managed by Lazard.
Source: Citigroup
3
Barclays Capital US Aggregate Bond Index.1 This wide choice of investments—including both developed and emerging markets—is especially
important today given the fluid global macro landscape. In addition, the
global bond market is much larger than what is listed in the indices and
therefore offers skilled investors even more opportunities.
The return pattern of global bonds is different from US bonds, which
can provide diversification benefits in a total bond context and relative to other assets. Historical correlations of global bonds versus US
and global developed markets equities show that global bonds have
maintained diversifying characteristics (Exhibit 2). Global bond performance, hedged back to US dollars, also provides diversification benefits
as it tracks US bonds over many periods, but with lower volatility.
Benefits of Active Management
Countering Benchmark Drawbacks
While more and more investors are considering passive vehicles for their
investments, we believe active management may be the most effective
way to access global fixed income. Because passive indices are capitalization weighted, the bigger (i.e., more indebted) issuers have the larger
weights. More than one-third of the Barclays Capital US Aggregate, for
example, was represented by US Treasuries as of March 2015. Investors
in vehicles that match this index are thus taking on significant exposure
to US Treasuries, which may be an unwanted concentration.
The significant amount of US Treasuries in the Barclays Capital US
Aggregate is a result of issuance in recent years, and it is an important
reminder that bond benchmark characteristics are not static. Since
the onset of monetary easing, benchmark yield and duration have
moved in virtually opposite directions. That is, yields have trended
lower while duration has become longer. For investors, this means
more interest rate sensitivity and less compensation via income. This is
potentially a dangerous proposition in today’s low-rate environment.
An active approach to global bond investing can help counter many
drawbacks in benchmarks. Active managers can diversify country/sector
exposure to avoid undesirable concentrations that can arise from capitalization weighting. Interest rate risk can be dampened through careful
duration and yield curve management at a local country level. Managers
can also potentially add value through out-of-benchmark securities and
take into account a security’s potential characteristics, such as liquidity,
that a passive index cannot. In addition, passive vehicles often cannot
replicate benchmarks because some securities may not be widely available or suitable for investors.
Expanded Credit Opportunities
As we already noted, the global bond market is much larger than what
is represented in the indices. Generally, “benchmark-eligible” issue size
must be at least $500 million, which excludes a substantial number
of potentially attractive bond issues. Considering securities outside
of the benchmarks can significantly expand the number and types
of opportunities available to managers. Credit, or non-government
bonds from around the world have increased in importance as issuance has flourished over the past decade in sectors such as corporates,
sovereign external debt, supranationals, agencies, and mortgages. An
investor’s ability to focus on global credit cycles and exploit mispriced
credit spreads at the country and currency level is another tool that
can potentially add value compared to a credit strategy that is purely
Exhibit 2
Global Bonds Can Provide Diversification Benefits Relative to
Other Asset Classes
Correlation of Bond Indices, US, and Global Equities: January 2000–April 2015
Global
Bonds
Global
Bonds
(Hedged)
US Bonds
Global
Equities
Global
Bonds
1.00
Global Bonds
(Hedged)
0.66
1.00
US Bonds
0.70
0.94
1.00
Global
Equities
0.29
-0.11
-0.04
1.00
US
Equities
0.17
-0.16
-0.09
0.97
US
Equities
1.00
Global Bonds = Barclays Capital Global Aggregate Bond Index
Global Bonds (Hedged) = Barclays Capital Global Aggregate Bond Index (Hedged USD)
US Bonds = Barclays Capital US Aggregate Bond Index
Global Equities = MSCI World Index
US Equities = S&P 500 Total Return Index
Data in US dollars. MSCI World Index includes dividends net of withholding tax. The
performance quoted represents past performance. Past performance does not guarantee future results. Diversification neither assures profit nor protects against losses in
declining markets.
Source: Barclays, Bloomberg, MSCI, Standard & Poor’s
Exhibit 3
Credit Opportunities Are Global
GE Bonds Offer Different Characteristics in Different Parts of the World.
Five-Year Maturity GE Bond Spreads vs. Local Government Bonds
(bps)
120
90
60
30
0
Japan
Mexico Europe Canada United United Australia Sweden
States Kingdom
As of 24 August 2015
Data show the option-adjusted spread.
The securities mentioned are not necessarily held by Lazard for all client portfolios,
and their mention should not be considered a recommendation or solicitation to purchase or sell these securities. It should not be assumed that any investment in these
securities was, or will prove to be, profitable, or that the investment decisions we
make in the future will be profitable or equal to the investment performance of securities referenced herein. There is no assurance that any securities referenced herein are
currently held in the portfolio or that securities sold have not been repurchased. The
securities mentioned may not represent the entire portfolio.
Source: Bloomberg
domestic. For example, the characteristics offered by GE bonds can
vary in different parts of the world (Exhibit 3).
An additional benefit from a larger opportunity set may be enhanced
income, as skilled security selection can increase a portfolio’s current
yield relative to a benchmark. This is especially important given the
downward pressure on yields in recent years.
4
The Currency Question
Global fixed income has exposure to foreign currencies—in fact, the
volatility from bond components (price and coupon) is small compared to the volatility from currency fluctuations. As a result, many
observers believe that global bond strategies should be hedged from a
currency perspective. In our view, however, unhedged versions may
also be well suited for investors if they are carefully managed. In a lowyield environment, currency exposure can actually add value over full
market cycles.
On a rolling three-year return basis, unhedged and hedged index
performance vary over different market cycles. These fluctuations
may provide opportunities within a global fixed income context—
especially related to currency exposure and cycles (Exhibit 4). In our
analysis, the unhedged version actually outperformed the hedged
version in about 58% of the monthly observations (each reflecting a three-year rolling return result) since 1993. Investors may be
influenced by the strong dollar trend in 2014 and early 2015, but we
believe the cycle will ultimately shift again, providing opportunity to
profit from currency exposure.
Active managers have more opportunities to add value compared to
passive managers and, importantly, indices do not reflect transaction
costs, which can be a significant drag on performance over the long
term. A benchmark’s currency exposure is driven by its country weights,
which cannot be altered by passive investors. In hedged indices, the
hedging methodology is also passive. In contrast, an active manager
can tailor the strategy’s currency exposure and find unique ways to add
value—providing the ability to be both defensive and opportunistic.
Our Approach
Lazard manages global fixed income strategies with the goal of enhancing returns by rotating through global bond and credit markets, and
taking currency risk when appropriate. As an active manager, we
conduct global macro-market and trend analysis, and we research individual securities using a rigorous bottom-up credit process.
Our investment framework identifies six broad sources of returns:
country allocation, yield curve positioning, duration exposure, sector
allocation, security selection, and currency exposure. These sources are
systematically integrated into our portfolio construction process. We
can be flexible and tactical, by continually assessing the market environment from a global and local perspective, taking into account the
impact of capital flows, market positioning, and investor sentiment.
We also monitor relative values from a global perspective (interest
rate, credit, and currencies), and unique nuances and factors that
drive asset prices for each country. We avoid what we believe are
overcrowded or “consensus” ideas, and seek opportunities that other
investors may be overlooking. If our view of an individual security is
not constructive, we will not invest in it regardless of its inclusion in a
benchmark. Before implementing any trades, we perform qualitative
research (i.e., liquidity, market positioning) and quantitative analysis
(i.e., scenario and break-even analyses, correlations) to fully understand and monitor risk in the portfolios.
Exhibit 4
Active Managers Can Take Advantage of Changing Market
Leadership
Rolling 3-Year Performance, Unhedged minus Hedged (%)
24
18
Unhedged Outperforms
12
6
0
-6
Hedged Outperforms
-12
-18
1995
1999
2003
2007
2011
2015
As of 31 July 2015
Data time period from January 1993 to July 2015.
Unhedged = Barclays Capital Global Aggregate Bond Index; Hedged = Barclays
Capital Global Aggregate Bond Index (Hedged USD). The performance quoted represents past performance. Past performance is not a reliable indicator of future results.
The indices above are unmanaged and have no fees. One cannot invest directly in an
index. Not intended to represent any product or strategy managed by Lazard.
Source: Bloomberg
Our portfolios are constructed with cash bonds. We think this is an
important differentiator for many investors, as implementations with
derivatives can introduce basis and counterparty risk.
The universe, or opportunity set, for our strategies is unconstrained
and applies to both absolute and relative return mandates. An absolutereturn orientation relates to how we think about risk management, or
risk calibration, which may differ from our relative return mandates.
Essentially, an absolute return mandate is designed to produce a positive return regardless of market conditions. Therefore, we believe it is
critical to understand the various layers of risk within the context of risk
control. For example, we utilize stop losses on currency exposures since
currencies are generally the largest source of volatility for a global fixed
income portfolio. Maintaining a shorter duration, or more defensive
interest rate profile, may also be part of our risk management process
in today’s volatile rate environment, as is monitoring and managing
sector/spread risk. Depending on the market environment, the portfolio holdings and positioning may not necessarily differ from a relative
return mandate, but risk management will likely be very different.
We believe that investors should not lose sight of the role that fixed
income can play within a total portfolio, especially during periods
of risk aversion. Some unconstrained fixed income strategies carry
the risk that the performance pattern may vary significantly from
a traditional diversified fixed income portfolio. These strategies are
often exchanging interest rate risk for credit risk, with an increasing
correlation to the equity market. Interest rate risk (in a rising rate
environment) can be considered an opportunity cost. With credit risk,
however, a credit event could lead to capital impairment, which has
the potential for a significant loss. Unlike some unconstrained fixed
income strategies, our approach is focused on diversification, while
rotating through global interest rate, credit, and currency markets.
5
Conclusion
We believe that active global fixed income investing offers the potential to improve a portfolio’s risk/return profile and act as a diversifier
to other asset classes, the possibility to invest in low-correlated and
unsynchronized markets, and the ability to add value through currency management. Compared to a strictly domestic portfolio, a
global allocation has a larger opportunity set and has exposure to
several economic and interest rate cycles, potentially raising the likelihood that skilled managers can help investors meet their goals over the
long term.
Notes
1 As of March 2015
Important Information
Published on 28 September 2015.
Information and opinions presented have been obtained or derived from sources believed by Lazard to be reliable. Lazard makes no representation as to their accuracy or completeness. All opinions expressed herein are as of 17 September 2015 and are subject to change.
An investment in bonds carries risk. If interest rates rise, bond prices usually decline. The longer a bond’s maturity, the greater the impact a change in interest rates can have on its price. If you do
not hold a bond until maturity, you may experience a gain or loss when you sell. Bonds also carry the risk of default, which is the risk that the issuer is unable to make further income and principal
payments. Other risks, including inflation risk, call risk, and pre-payment risk, also apply. High yield securities (also referred to as “junk bonds”) inherently have a higher degree of market risk,
default risk, and credit risk. Securities in certain non-domestic countries may be less liquid, more volatile, and less subject to governmental supervision than in one’s home market. The values of
these securities may be affected by changes in currency rates, application of a country’s specific tax laws, changes in government administration, and economic and monetary policy. Emerging
markets securities carry special risks, such as less developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets
of emerging markets countries can be extremely volatile; performance can also be influenced by political, social, and economic factors affecting companies in these countries. Derivatives
transactions, including those entered into for hedging purposes, may reduce returns or increase volatility, perhaps substantially. Forward currency contracts, and other derivatives investments
are subject to the risk of default by the counterparty, can be illiquid and are subject to many of the risks of, and can be highly sensitive to changes in the value of, the related currency or other
reference asset. As such, a small investment could have a potentially large impact on performance. Use of derivatives transactions, even if entered into for hedging purposes, may cause losses
greater than if an account had not engaged in such transactions.
Investments in global currencies are subject to the general risks associated with fixed income investing, such as interest rate risk, as well as the risks associated with non-domestic investments,
which include, but are not limited to, currency fluctuation, devaluation, and confiscatory taxation. Furthermore, certain investment techniques required to access certain emerging markets currencies, such as swaps, forwards, structured notes, and loans of portfolio securities, involve risk that the counterparty to such instruments or transactions will become insolvent or otherwise
default on its obligation to perform as agreed. In the event of such default, an investor may have limited recourse against the counterparty and may experience delays in recovery or loss.
This document reflects the views of Lazard Asset Management LLC or its affiliates (“Lazard”) and sources believed to be reliable as of the publication date. There is no guarantee that any
projection, forecast, or opinion in this material will be realized. Past performance does not guarantee future results. This document is for informational purposes only and does not constitute an
investment agreement or investment advice. References to specific strategies or securities are provided solely in the context of this document and are not to be considered recommendations
by Lazard. Investments in securities and derivatives involve risk, will fluctuate in price, and may result in losses. Certain securities and derivatives in Lazard’s investment strategies, and alternative strategies in particular, can include high degrees of risk and volatility, when compared to other securities or strategies. Similarly, certain securities in Lazard’s investment portfolios may
trade in less liquid or efficient markets, which can affect investment performance.
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