Falling Rates Volatility Fixed Income Blog

Overcoming Inertia: How Home Bias Hurts US Investors

17 July 2024
4 min read
Starling flying out of a tree cavity
John Taylor| Head—European Fixed Income; Director—Global Multi-Sector
Nicholas Sanders, CFA| Portfolio Manager—Global Multi-Sector
Tom Nicol| Investment Strategist—Emerging Market Fixed Income

US investors often stick to US markets. But that could be a costly mistake—especially today.

Compared with US bonds, global bonds hedged to the US dollar have historically been less volatile and generated higher risk-adjusted returns. That’s not the only reason that a home bias may present significant opportunity costs: hedged global bonds also have demonstrated better defensive characteristics than US bonds.

We saw this most recently in 2022—the worst year on record for bond markets. During that year, hedged global bonds outperformed US-only bonds due to the scale of the global bond market and the benefits of diversifying across globally disparate business and policy cycles.

That hedged global bonds outperformed US bonds during a downturn is not surprising given hedged global bonds’ track record of providing attractive up/down capture ratios relative to US bonds (Display). In fact, over the past 40 years, hedged global bonds have captured 86% of gains when US bonds rallied. Conversely, when US bonds sold off, hedged global bonds experienced just 66% of that downturn.

Historically, Global Bonds Have Diversified US Bond Risks
Bars showing hedged global bonds outpacing US bonds while capturing 86% of market upside and 66% of downside over 40 years

Historical analysis does not guarantee future results. 
US bonds are represented by the Bloomberg US Aggregate Index. Hedged global bonds are represented by the combination of the FTSE World Government Bond Index Hedged from February 1985 through December 1989 and the Bloomberg Global-Aggregate Total Return Index Value Hedged USD from January 1990 through present. Up capture represents the percentage of market gains captured when the US Aggregate Index return is positive. Down capture represents the percentage of market losses captured when the US Aggregate Index is negative. An investor cannot invest directly in an index, and its performance does not reflect the performance of any AB portfolio. The unmanaged index does not reflect fees and expenses associated with the active management of a portfolio. 
As of June 28, 2024 
Source: Bloomberg, FTSE and AllianceBernstein (AB)

We’re now facing a different environment than in 2022, when central banks began to aggressively hike rates to stem the inflationary tide. Global yields are coming off their highest levels in a decade, monetary and fiscal policies are diverging globally, and unique credit opportunities offer new sources of alpha. We think all these conditions favor global fixed-income exposure.

Global Yields Are at 10-Year Highs—for Now

After years languishing at historically low—and even negative—levels, bond yields have climbed to heights not seen in more than a decade. The yield on the 10-year Treasury bond alone is more than eight times what it was four years ago, and global bond yields have followed suit.

In today’s market, a global approach to bond investing may boost yields even further, provided holdings denominated in foreign currencies are hedged back to the US dollar. This is done using currency forwards and futures that eliminate foreign-exchange volatility. Given interest-rate differentials between other markets and the US, hedging may also result in higher yields, as it does today. On a hedged basis, nearly all non-US developed-market government bonds provide higher yields today than the 10-year Treasury bond (Display). A good example can be seen in Japan, where hedging boosts the low-yielding Japanese 10-year government bond yield from a mere 1.05% to 6.68%.

Hedging Can Lift Global Bond Yields
Table demonstrating how hedging to US dollars can boost otherwise low global 10-year government bond yields

Current analysis does not guarantee future results. 
Credit rating is represented by Bloomberg methodology. Hedged yields are hedged to US dollars.
As of June 28, 2024
Source: Bloomberg, Moody’s Investors Service, S&P and AB

Over time, higher yields resulting from currency hedging have the potential to meaningfully affect a bond portfolio’s return.

Diverging Monetary and Fiscal Policies Point to Diversification

But global yields may not be at these levels for long. Already, some developed-market central banks have begun to cut interest rates. The Swiss National Bank has pared rates twice this year, while the Bank of Canada and the European Central Bank have also begun the process of monetary easing. 

Policymakers in other countries have taken a more cautious stance. The Federal Reserve could take action on interest rates in the third quarter, while the Bank of England is expected make its first cut in September. Nor are the world’s central banks all moving in the same direction. The Bank of Japan hiked rates in March for the first time in 17 years, and Chinese policymakers have been cutting rates for several years already. This divergence reflects different inflationary trends and policy aims and offers fixed-income investors an added source of diversification.

Fiscal policy, too, is tacking in different directions. With roughly half of the world heading to the polls this year, election cycles could hasten stimulative fiscal policies in some cases. But the pace of spending will likely differ by region. In the US, fiscal spending has yet to pull back in response to inflationary pressures, while eurozone countries are generally exercising more fiscal discipline. The fiscal picture is a decidedly mixed bag across emerging markets.

These trends underscore ongoing policy desynchronization, which has important investment implications. In any market, investors can realize diversification benefits from investing globally, but that benefit may be even more powerful when the world’s central banks forge their own paths. And when yields come down, bond prices rise—although in our view that will happen in overseas markets sooner than it will in the US.

Today’s global fixed-income markets also provide opportunities to add alpha from security selection. By itself, the broad-based Bloomberg US Aggregate Index allows for alpha because of the varied sectors within it—all subject to different kinds of market risk. But when you add to the mix globally divergent market cycles across multiple sectors, those opportunities become even greater, in our view. Currently, we view European corporate debt as particularly compelling, and we also see select emerging-market corporates as well positioned.

Currency Hedging Is Key

Despite opportunities available globally, fixed-income investors may be wary of foreign currency volatility, which can lead to a home bias. That’s why we believe core-bond investors should fully hedge their non-US holdings into US dollars. Careful hedging strategies can eliminate currency volatility (Display), thus preserving bonds’ role as ballast against equity market volatility—a primary core-bond mandate.

Hedged Global Bonds Have Been Less Volatile
Lines showing that hedged global bonds exhibited less volatility than unhedged global and US bonds over a 32-year period

Historical analysis does not guarantee future results.
US bonds are represented by the Bloomberg US Aggregate Index. Global bonds hedged are represented by the Bloomberg Global-Aggregate Total Return Index Value Hedged USD. Global bonds unhedged are represented by the Bloomberg Global-Aggregate Total Return Index Value Unhedged USD. An investor cannot invest directly in an index and its performance does not reflect the performance of any AB portfolio. The unmanaged index does not reflect fees and expenses associated with the active management of a portfolio.
Through June 28, 2024
Source: Bloomberg and AB

We think the time is right for core-bond investors to move beyond their home biases. Hedged global bonds have historically outperformed US bonds, and with less volatility. By hedging non-US holdings back into US dollars, fixed-income investors can realize the many benefits of global diversification without assuming undue levels of risk.

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.

About the Authors

John Taylor is Director of Global Multi-Sector at AB. He is a member of the Global Fixed Income, UK and European Fixed Income, and Absolute Return portfolio-management teams. As a member of the Absolute Return portfolio-management team, Taylor is also the lead portfolio manager across the Diversified Yield Plus Strategies. Prior to this, he was responsible for the management of single-currency portfolios.

Taylor joined the firm in 1999 as a fixed-income trader and was named in Financial News's 40 Under 40 Rising Stars in Asset Management in 2012.

Nicholas Sanders is a Vice President and Portfolio Manager at AB, and a member of the Global Fixed Income, Absolute Return, UK Fixed Income and Euro Fixed Income portfolio-management teams. Since 2013, he has been responsible for the analysis of sovereign and other liquid markets globally, with a focus on the European market. Prior to that, he worked as an associate portfolio manager on the Asian Fixed Income team, where he was responsible for analysis of and trade execution for local and global fixed-income markets. Sanders joined AB in 2006, and served as team leader of Servicing & Controls within the Australian & New Zealand Operations Group. Before joining the firm, he worked in both Australia and London as a pricing and valuation analyst. Sanders holds a BBus in economics and finance from the Royal Melbourne Institute of Technology (RMIT) and is a CFA charterholder. Location: London

Tom Nicol is a Managing Director and Investment Strategist on AB’s Fixed Income Business Development team, focusing specifically on Emerging Market Fixed Income. In his role, he represents AB’s Emerging Market Strategies and the views of the Portfolio Management team to both internal and external stakeholders. Nicol joined AB in 2018 from BlueBay Asset Management, where he served for five years as an institutional portfolio manager for their Emerging Market Fixed-Income Strategies. He holds an MSc in Economic History from The London School of Economics and Political Science. Location: London