When an investor allocates more of their portfolio to global bonds, they gain exposure to a greater number of securities, inflation and economic environments, and cycles from a wider range of markets beyond their borders.
The added diversity can reduce the risk of an investor's fixed interest portfolio, without necessarily decreasing the expected returns.
Our latest research analyses data from Canada, the United States, the United Kingdom, the euro area and Australia. We find that the diversification benefits can be achieved across all of these markets, with one critical qualifier: the key to the diversification potential of global bonds is to hedge the currency exposure back into the investor's local currency.
This paper evaluates several alternative index-weighting methodologies commonly used in the global sovereign and U.S. corporate marketplaces.
Common alternative weighting methods result in a shift away from the risk - reward characteristics of the market, introducing elements of active risk and risk-factor tilts into the index-construction process.
These alternative weighting methods rely on a very narrow selection of risk factors (including country risk, sector risk, interest rate risk, and credit risk) compared with using a market-capitalization-weighted benchmark approach.
We conclude that alternative indexes do not represent a better way to measure the performance of a market, but merely a re-weighting of risk within that market.
At first blush, it may appear as though the fixed interest market is less liquid than it has been in the past. Corporate bond markets have grown considerably over the last several years, just as dealers' appetite to hold bonds in inventory to facilitate trades has diminished.
This shift in dynamics, though undeniable, is not a harbinger of doom, nor is it the end of the story. Rather, it's the beginning of a new chapter that highlights the resiliency of the financial markets and the imagination of many of its participants. The market and its participants are doing what they always do - adapting, innovating, and evolving.
We believe that these changes born of regulatory reform and monetary policy - including electronic trading and increased competition - will stick. And we conclude that there is even more we can do to capitalise on the developments that have already taken hold.