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Research Summary

  • Liability-Driven Investing

LDI: Reducing Downside Risk with Global Bonds

Senior Portfolio Manager– Fixed Income
Portfolio Manager– Credit
Senior Portfolio Manager—Fixed Income
May 10, 2012

Despite compelling evidence in favor of global diversification, investors in many markets around the world continue to have a strong “home-country bias”— a preference for domestic over foreign assets. Nowhere is this tendency more apparent than in the ranks of liability-driven investors. But our research suggests that LDI investors, too, can reap significant benefits from going global.

Long-maturity hedged global bond returns are highly correlated with domestic bond returns and offer lower volatility. Crucially, global bonds tend to outperform when domestic bond returns are weak, offering better downside protection in a rising rate environment. At the same time, a portfolio of hedged global bonds tends to capture most of the upside gains of a domestic government bond portfolio. Exposure to global debt also offers what amounts to a natural tail-risk hedging strategy against a domestic credit crisis.

Overall, our research suggests that the increased diversification achieved by adding some exposure to long-maturity hedged global debt can improve the risk/return characteristics of an LDI portfolio over the traditional domestic-only approach. This is especially appealing in the current low-interest-rate environment.

Hedged Long-Term Global Bond Portfolios
Annualized Returns and Volatility: October 1987–December 2011

Global bond portfolios represented by the Citigroup World Government Bond Index (WGBI) 10+ from October 1987 through December 1998 and the Barclays Capital Global Government/Credit Index (GGCI) 10+ from January 1999 through December 2011; domestic bond portfolios represented by each market’s bonds within the Citigroup WGBI 10+ and the Barclays Capital GGCI 10+. Prior to 1999, euro area is represented by Germany, with returns hedged to a basket of European currencies.
Source: Barclays Capital, Citigroup and AllianceBernstein

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