This is a guest post from Douglas J. Peebles, Head of Fixed Income at AllianceBernstein. The piece reflects his own opinion and is not endorsed by Reuters. The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Global bond funds continue to attract strong inflows as near-zero interest rates lead many investors to look abroad for assets with attractive yields. As we’ve argued before, global bonds provide many important benefits, but it’s crucial that investors select the right type of fund.
Not all global bond funds are cut from the same cloth. One key consideration that investors often overlook is the extent to which the fund elects to hedge its currency exposure. When a domestic currency depreciates – as it did for US-dollar–based investors during most of the period between 2002 and 2008 – foreign currency exposure can help boost returns from holding global bonds.
This is fine while the good times last. But it’s important to understand that currencies are extremely volatile – much more so than bonds – and adverse movements in currencies can quickly swamp the income and price gains generated from holding global bonds. As such, for investors looking at their global bond allocations as a hedge for their equity risk, choosing not to hedge against currency swings could have disastrous results.
Take 2008, for example. That year, bonds rallied strongly across the developed world, providing valuable diversification for investors smarting from heavy losses in their equity portfolios…if investors were hedging the currency exposure in their global bond allocations. Those who didn’t got a lot more volatility than they had bargained for, and—depending on their base currency—may have been faced with significant losses in their bond portfolios as well as in their stock portfolios.