Do You Know Where Your Global Bond Money Goes?

More and more investors are globalizing their bond portfolios these days—with good reason. But when it comes to reducing risk, active management is essential. The French presidential election is just one reason.

Bond investors are going global today because they want more choices at a time when business cycles, monetary policies and yield curves are diverging. That makes sense. Global exposure offers a bigger opportunity set and diversification of interest-rate and credit risk.

But there are different ways to get that exposure—and they’re not created equal. For example, a passive strategy that tracks a global bond index actually limits choice.

Why? Because lower-yielding debt is overrepresented in global bond benchmarks. Japan, for example, accounts for a large share of the global bond universe because it issues a large amount of debt. But for maturities out to eight years, Japanese government bonds (JGBs) offer negative yields.

Now consider Australia. It’s only about 1% of the global bond market. But its bonds yield roughly 2% more than JGBs at every point along the curve. For many investors, parking nearly 20% of their money in Japanese debt and 1% in Australian may not offer the best trade-off between risk and return. But that’s the trade-off those who invest passively are forced to make.

Unlike JGBs, Japanese inflation-protected bonds, whose principal value is linked to the inflation rate, do look attractive today. That’s because expansionary fiscal policy at home and improving growth abroad have economists pricing in faster growth and inflation in Japan. But passive investors can’t take advantage of these securities because they’re not in the global benchmark at all.