The main driver of the higher ex post real returns is the comparatively high coupon these sovereign bonds offer. Beyond the return history itself, there is the fact that emerging and developing economies now account for about two-thirds of global GDP, compared to just one-third 50 years ago, when portfolio diversification was almost entirely a domestic affair. Adding to the attractiveness of a portfolio of emerging-market sovereign securities, its returns are not perfectly correlated with equity returns. Moreover, there is evidence that creditor rights and enforcement powers in external sovereign debt markets have increased in the wake of recent US court judgements.
These findings are not an invitation to embrace indiscriminate risk taking. Another wave of sovereign defaults may be ahead of us, and sovereign bonds can become highly illiquid in distress. Nonetheless, our results highlight the long-term gains from diversification into a growing but relatively under-studied asset class. And for pensions, the risks of relying on assets that offer negative or only very low long-term real returns are no less serious, especially as they compound over time.
Carmen M. Reinhart is professor of the international financial system at Harvard University's Kennedy School of Government.
Christoph Trebesch is professor of macroeconomics at the Kiel Institute for the World Economy.