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Talk to UsThe pros and cons of currency hedging are a frequent topic in equity portfolios, but the subject arises less frequently for bonds. In our view, this is an important omission.
Source: Bloomberg, GSAM, covering the five-year period Dec. 31, 2010 through Dec. 31, 2015. Volatility is a statistical measure of the dispersion of returns for a given security or index. See end notes for index definitions and important disclosures. Past performance does not guarantee future results, which may vary.
We think of currencies’ impact on bond allocations as a “blunt-force instrument.” In contrast to the lighter impact on equities, currencies can drive a large portion of the month-to-month movement of a bond allocation. Exhibit 1 shows that over the period 2011-15, currency moves drove about half the volatility of the unhedged global bond index, versus only about one-tenth the volatility of an unhedged approach to global equities.
For many investors, core bonds play a risk-managing role in the overall portfolio in comparison to more volatile equity and low-quality fixed income. If currency exposures cause an increase in risk, the allocation may work against these investors’ intended goals. Unhedged global bond portfolios have often delivered less attractive risk-adjusted returns than a hedged equivalent. Over the five years ending Dec. 31, 2015, hedged global bonds returned 3.9%, while unhedged global bonds returned 0.9%.
As a result of this lower return plus higher volatility, unhedged global bonds’ risk adjusted returns (or “Sharpe ratio”) have lagged behind (the unhedged index’s Sharpe ratio is 0.19 over the period, versus 1.68 for the hedged index).
For these reasons, we believe a currency-hedged approach to global bond portfolios may be attractive to a range of investors. Currency-hedged global bonds can be (1) an effective way to seek additional sources of return, (2) a source of new income potential in today’s low-yield environment, and (3) an intelligent response to the often unattractive risk-reward profile of currency exposures in global bond portfolios.
