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Global Bonds – Not what they used to be

July 28, 2016  | by James Meisner, Vincent Kravec

Fixed Income

A constant topic of conversation in the financial media in recent years has been the degree to which central bank intervention across the globe has suppressed volatility in the markets and has caused global bond yields to fall to historically low levels. Some market veterans with a long-term perspective shake their heads in disbelief at current levels, warning others like a modern-day Cassandra, that bond investors will be in for a world of hurt once yields begin to rise.

On the other hand, you have those in what we’ll call the “Chuck Prince Crowd” who believe that “as long as the music is playing, you've got to get up and dance.” Whichever end of that continuum you might find yourself closer to, the fact remains that bond investors are forced to be “price-takers” as a result of price-insensitive central banks crowding out fundamental investors in the fixed income markets.

What we will do in this Insights Blog post is take a look at a few characteristics of the Citi World Government Bond Index (WGBI) and share our thinking on whether a dedicated allocation to WGBI-benchmarked funds is compelling at this point.

In the chart below we show the historical yields of Citi WGBI Index as well as the ex-US WGBI index. As you can see, index yields have been in an unmistakable downward trend since the credit crisis, driven lower by ballooning central bank balance sheets, global growth fears and most recently, “Brexit” concerns. At the end of June, the yield on the WGBI was about 0.59 percent, as JGB and Bund yields (together representing about 30 percent of the WGBI) plunged into negative territory, closing June at -0.22 and -0.15 percent, respectively. Taking a look at WGBI yields with U.S. Treasuries removed (WGBI ex-U.S.), reveals that the yield on offer across the rest of the constituent countries comes in at an even more paltry 0.34 percent.

CH1-Global-Bonds

A deeper dive into global yields further highlights the perceived lack of value. While we mentioned the unprecedented dive into negative territory for German and Japanese 10-year yields, even Italy, with a weight of 7.5 percent within the index, now trades at a lower yield than the U.S. 10-year Treasury. Recall that Italian, along with other “peripheral European” government bond yields, spiked higher during the 2011-12 European banking crisis, before ECB President Mario Draghi issued his famous “Do whatever it takes” proclamation in July of 2012.

CH2-Global-Bonds

Given the continued turmoil in the European Union and other global concerns, U.S. dollar-based investors (and those with liabilities denominated in dollars) must question whether appropriate compensation is being paid for the interest rate and currency risk undertaken by an investment program benchmarked to the WGBI.

An additional concern we have about the WGBI is the trend in the index’s duration. All other things equal, the lower the coupon rate on a bond the longer the duration. What we can see from the chart below is that the unmistakable trend in duration of the WGBI is higher, and most recently it was approaching eight years.

CH3-Global-Bonds

For U.S. dollar based investors who are familiar with the Barclays U.S. Aggregate Bond Index, duration has also crept higher, but at a more measured pace. To invest in a program focused on this index, you are benchmarking your risk/reward considerations in part on acceptance of interest rate sensitivity of approximately 5.5 years, significantly lower than the duration level of the WGBI.

One further consideration. While the WGBI enjoyed a strong return of 11.3 percent for the fiscal year ending June 30, its longer term performance has lagged that of the Barclays U.S. Aggregate Index, as shown in the chart below which compares the 5-year cumulative total returns of the two indices. This may be a good time to jump off the WGBI train after a good run.

CH4-Global-Bonds

So what are we suggesting? While U.S. dollar-based investors have historically looked for a diversification benefit from WGBI-benchmarked investment programs, at this stage in the global rates cycle, it is a challenging proposition to consider investing in a WGBI-benchmarked investment program given the paltry yields on offer, the increased interest rate sensitivity and the foreign exchange risk that is undertaken as a result of allocating to this type of program. We would suggest that these issues are weighed carefully on a go-forward basis, given that we believe it is possible to find more compelling risk/reward opportunities in U.S. markets, as well as select global markets that are not well represented by the WGBI.

Authors

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Vincent Kravec is a member of the Commonfund Asset Management Investment team and is primarily responsible for investment monitoring, manager sourcing, rebalancing and reporting for investment portfolios with a focus in fixed income and credit strategies. Prior to joining Commonfund, Vincent was with Lazard Asset Management as a member of the Fixed Income operations staff. While at Lazard he was a trading assistant on the Emerging Markets team. He was also a supervisor in Fixed Income Accounting and had responsibilities in trading operations involving allocating trades and resolving trade problems for corporates, treasuries, municipals, asset backs and FX trading desks. Previous experience includes positions at Morgan Stanley, Alliance Capital and Evaluation Associates. Vincent earned his M.B.A. in from New York University’s Stern School of Business and his B.A. from Fairfield University. He is also a CFA charterholder.
Vincent Kravec
Director, CFA
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James F. Meisner is a member of the Commonfund Asset Management Investment team and is primarily responsible for asset allocation, manager sourcing, due diligence, and investment monitoring for investment portfolios. He serves as a member of the Commonfund Asset Management Investment Committee. Prior to joining Commonfund, Jim spent twelve years at RBS Greenwich Capital, where he was Managing Director and head of research for the Portfolio Strategies Group. Prior to that, he was head of futures and options research at Yamaichi America and at Merrill Lynch Capital Markets. Jim began his business career at the Chicago Board of Trade, where he was involved in the introduction of options on bond futures. Earlier, he was an Instructor in Statistics at the University of Chicago Graduate School of Business (now the Booth School of Business). He received an AB in mathematics and an MBA in finance from the University of Chicago, and he completed coursework and examinations for a Ph.D. in econometrics as well.
James F. Meisner
Managing Director

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Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.