Macro Risk
A global bond allocation may increase exposure to countries with high debt-to-GDP ratios, as well as countries with higher political risk. This may increase the possibility of default risk in times of market stress. Conversely, it’s worth noting that in times of market stress, many global investors look to U.S. Treasury bonds as a safe haven.
Negative Yield
Further complicating the prospects for investment in global bonds is the current exposure to $9 trillion in negative-yielding securities. Negative yield means that investors buying debt now, and holding that debt to maturity, will receive less than they paid – clearly not a favorable outcome for plan participants.
Limited Effect on Risk-Adjusted Returns
We believe that the case to justify introducing an asset class into a TDF has to be strongly positive. However, our analysis indicates that the case for adding global bonds is weak indeed. When we analyze both historical performance and forward-looking market assumptions of various asset classes, in our opinion, replacing domestic bonds with an unhedged global bond exposure essentially offers no compelling return benefit, and in fact potentially produces inferior risk-adjusted returns in an asset allocation strategy. Adding hedged global bonds potentially improves risk-adjusted returns modestly – but hedging comes with added complexity and cost. Overall, the risk, return and diversification characteristics of the hedged global bond allocation are similar to that of domestic bonds. Simply put, in our view there is no strong incremental benefit in “going global.”
The Bottom Line
Our TDFs, like most, currently have their highest exposure to fixed income assets for those individuals at or in retirement – a period of particularly heightened risk sensitivity. Changes to the TDF allocation need to be weighed carefully and increasing risk, such as through currency exposure or regional political risk, should be carefully considered.
The TDF asset mix will always be a delicate balance, with nothing less than the retirement security of participants at stake. Our bias will be to avoid adding a new asset class unless, having considered all factors, we believe the anticipated improvement in risk-adjusted returns is sufficiently robust -- a position supported by careful analysis that always looks deeper than apparent advantages to identify the subtle risks, both for plan sponsors and for participants, that can lurk within an asset.
Matthew O'Hara is managing director and global head of investment research for the Lifetime Asset Allocation Group, BlackRock.