Major sovereign bond1 markets outside the US are awash with low—and in some cases negative—yielding bonds. Many global central banks have extended their previously accommodative policy stances by further slashing rates in response to the COVID-19 pandemic. Despite this, fixed income can continue to play a vital role in asset allocation, with investors valuing the role bonds can play in income, liability matching,2 and diversification.
In the prevailing environment of depressed yields, clients may find it useful to clarify the role of their global sovereign fixed-income allocation within long-term strategic objectives. For example, their objectives may be:
- Yield/return enhancement, or
- Diversification, quality, and liquidity
Clients may also wish to assess their appetite for, and the impact and risk of, available potential yield enhancement solutions, such as:
- Extending duration3
- Lowering credit quality or liquidity characteristics
- Varying the currency exposure
- Adopting an active approach, such as cash management, overlay hedging,4 duration, and relative value strategies.5
Currency hedging6 has an important impact on the yield from global fixed-income allocations through liability matching and helping to reduce volatility. An additional feature is that it can be used to help enhance long-term yield. For example, consider the yield generated by hedging negative-yielding global bonds back to an investor’s base currency. Figure 1 compares the yields of 5-year sovereign bonds in local currency terms and the yield when hedged back to US dollars.
Five-year sovereign yields when hedged to US dollars
Source: Bloomberg and Wellington. Data as of 3/31/2020. Past performance does not guarantee future results.
In this example, when an investor hedges a non-US dollar currency back to US dollars, the additional yield earned on the currency-forward contract more than offsets the negative yield on the underlying sovereign holding in the non-US dollar currency. Taking the Swiss franc as an example, a 5-year Swiss franc yields approximately -0.51%. On a USD-hedged basis however, the Swiss franc yields approximately 0.83%, which is a premium relative to the US 5-year (0.40%).
Currency hedging can help offset a negative yield and also tactically turn a negative yield into a positive one in certain currencies.
Depending on an investor’s domestic market, currency hedging could be used as a tool to not only help reduce volatility but also potentially take advantage of yield differentials. This can help offset a negative yield, and can tactically turn a negative yield into a positive one in certain currencies. Strategies that have the ability to invest in a global opportunity set and take advantage of this yield pickup may be well positioned to diversify sovereign exposure.
Currency hedging is complicated and can be risky. It may be prudent to pursue this strategy through an active mutual fund manager with the resources and expertise to take advantage of yield differentials.
% (as of 4/30/2020)
Average Annual Total Returns % (as of 4/30/2020)
|Hartford World Bond I||-0.34||2.00||3.09||2.27||---||3.10|
|FTSE World Government Bond Index||3.21||7.97||4.24||2.98||---||---|
|Morningstar World Bond Category||-2.59||1.45||1.71||1.32||---||---|
% (as of 3/31/2020)
Average Annual Total Returns % (as of 3/31/2020)
|Hartford World Bond I||-1.95||0.45||2.60||1.82||---||2.94|
|FTSE World Government Bond Index||2.00||6.17||4.27||2.96||---||---|
|Morningstar World Bond Category||-5.07||-1.33||1.46||1.34||---||---|
Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted.
1 A sovereign bond is a debt security issued by a national government.
2 Liability matching is an investment strategy that seeks to match future asset sales and income streams against the timing of expected future expenses.
3 Duration is a measure of the sensitivity of an investment's price to nominal interest-rate movement.
4 Overlay hedging involves strategies designed to protect investors from unfavorable currency swings and to create profit opportunities from favorable currency movements.
5 A relative value strategy is a management investment approach that seeks to exploit differences in the price or rate of the same or similar securities by buying one security and selling the other.
6 Currency hedging occurs when an investor enters into a financial contract to help protect against changes in currency exchange rates.
Important Risks: Investing involves risk, including the possible loss of principal. Security prices fluctuate in value depending on general market and economic conditions and the prospects of individual companies. The Fund may allocate a portion of its assets to specialist portfolio managers, which may not work as intended. • Fixed income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. • Foreign investments may be more volatile and less liquid than U.S. investments and are subject to the risk of currency fluctuations and adverse political and economic developments. These risks may be greater for investments in emerging markets or if the Fund focuses in a particular geographic region or country. • Investments in high-yield (“junk”) bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. • Mortgage-related and asset-backed securities’ risks include credit, interest-rate, prepayment, and extension risk. • Derivatives are generally more volatile and sensitive to changes in market or economic conditions than other securities; their risks include currency, leverage, liquidity, index, pricing, and counterparty risk. • The Fund may invest in a smaller number of issuers, so it may be more exposed to risks and volatility than a more broadly diversified fund. • Restricted securities may be more difficult to sell and price than other securities. • Obligations of U.S. Government agencies are supported by varying degrees of credit but are generally not backed by the full faith and credit of the U.S. Government. • Diversification does not ensure a profit or protect against a loss in a declining market.
The views expressed herein are those of Wellington Management, are for informational purposes only, and are subject to change based on prevailing market, economic, and other conditions. The views expressed may not reflect the opinions of Hartford Funds or any other sub-adviser to our funds. They should not be construed as research or investment advice nor should they be considered an offer or solicitation to buy or sell any security. This information is current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management or Hartford Funds.
All rights in the FTSE World Government Bond Index (the “Index”) vest in the applicable company in the London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”) which owns the Index. FTSE® and Russell® (together “FTSE Russell”) are trademarks of the relevant LSE Group company and are used by any other LSE Group company under license. The LSE Group does not accept any liability whatsoever to any person arising out of the use of, reliance on or any error in the Index. The LSE Group makes no claim, prediction, warranty or representation as to the results or the suitability of the Index for the purpose to which it is being used by Hartford Funds.