Bonds, particularly global bonds, can play an important role in a well-diversified portfolio by helping to reduce volatility.
Contrary to popular perception, a global bond portfolio is typically less risky than a Canadian bond portfolio – provided the currency exposure is hedged. Chart 1 illustrates that in almost every year since 1998, a portfolio of Canadian dollar-hedged global government bonds had lower volatility than a portfolio of Canadian government bonds. The currency hedging aspect of this example is important because a currency-hedged portfolio significantly reduces volatility over time.
Chart 1: Global bonds have generally been less volatile
Hedged Global Government Bonds are represented by the FTSE World Government Bond Index. Canadian Government Bonds represented by FTSE TMX Canada All Government Bond Index.
Source: Morningstar Direct, December 2017
This chart illustrates this significance on a long-term basis. Over the past 20 years, an unhedged global government bond portfolio had an annualized volatility of 9.5%, while on a fully hedged basis, it had less than one-third of the volatility, at 2.9%. For local context, a Canadian government bond portfolio had a long-term annualized volatility of approximately 3.9%.*
|Jan. 1995 - Dec. 2019||Global government bonds (C$ Unhedged)||Global government bonds (C$ Hedged)|
|Average Annual Return||7.0%||7.3%|
|Worst 12-Month Return||-14.3%||-3.0%|
|Standard Deviation (Volatility)||8.8%||3.4%|
*Annualized volatility of the Canadian government bond portfolio is represented by the FTSE TMX Canada All Government Bond Index for 20 years ending December 31, 2017.
Global government bonds are represented by the FTSE World Government Bond Index. All returns are annualized.
Source: Morningstar Direct.
The FTSE World Government Bond Index, which represents the world's government bond market, is enormous. It holds 1,023 bonds for a total market value of nearly US$22 trillion. As shown in Chart 3, Canada represents only 1.8% of this overall global bond universe, while the U.S. and qualifying countries from the eurozone represent the largest components, each over 33%. Exposure to the vast market available outside of Canada provides greater diversification opportunities.
Chart 3: Canada is only a small share of the global bond market
*The FTSE EMU Government Bond Index (EGBI) consists of EMU-participating countries that meet the WGBI criteria for market inclusion: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Netherlands and Spain.
**Others include the following countries: Australia, Denmark, Malaysia, Mexico, Norway, Poland, Singapore, South Africa, Sweden and Switzerland.
Source: London Stock Exchange Group, as of December 31, 2017.
Although yields are low in most global economies, the risk and return potential can vary significantly from region to region. Chart 4 shows how wide the range of outcomes has been and that Canadian government bonds seldom lead the way. This demonstrates that a diversified, global approach to bonds can help provide greater return opportunities.
Chart 4: Global bonds offer more diversified return potential
The wide dispersion of returns from global government bonds can offer greater opportunities
Source: London Stock Exchange Group, RBC Global Asset Management, as of December 31, 2019. Universe consists of FTSE WGBI EGBI (Eurozone), FTSE WGBI Canada, FTSE WGBI US, FTSE WGBI UK, and FTSE WGBI Japan denominated in local currency.
Uneven economic growth and inflation across countries and regions present opportunities for global bond investors. Working in a global bond universe and understanding the global monetary policy landscape both enable active bond managers to take advantage of investment opportunities that can provide downside protection with the potential for some capital appreciation.
Chart 5 illustrates this opportunity by depicting the current monetary policy landscape of major economies around the world (tightening/loosening). As central bank policies in different regions diverge across the tightening-loosening spectrum, a wider range of investment opportunities is presented to global fixed income investors.
Chart 5: Monetary policy diverging around the world
Information as of March 31, 2018. For illustrative purposes only. Source: RBC Global Asset Management.
Diversifying your bond portfolio by taking advantage of global bond markets can be a winning strategy that helps reduce risk and enhance return potential. Global bonds not only provide diversification opportunities, but can also offer a wider range of potential returns than Canadian bonds, helping you meet your long-term investment goals.
Talk to your advisor about how global bonds may be able to enhance your portfolio.