If we take even a brief high-level view of the overall asset allocation of Canadian pension plans, we can see a disparity between what plans hold and the actual composition of the global marketplace. For example, Canadian bonds only account for approximately 2% of the global fixed income marketplace,1 yet account for virtually all of the bond exposure in Canadian pension plans.2
This is a particular cause for concern when you consider that long-term Canadian government bond yields are lower than those of other countries, including emerging markets, other industrialized nations and even fellow G-7 members.3 Accordingly, underexposure to the wide spectrum of fixed income investments could mean Canadian pension plans are missing out on the opportunities for alpha that global bonds can provide.
Evolving roles for global bonds
The global fixed income universe looks a lot different now than it did 30 years ago. Back in the 1980s the traditional role of global fixed income was primarily to dampen volatility from equity investments and provide income and liquidity. However, as more countries began to open themselves up to investment and more capital markets worldwide became viable investment options, the role of global fixed income evolved to include enhanced return potential through diversification. Currently, many managers see global fixed income as a source of additional returns and opportunistic investing, as alternate means of taking advantage of currency movements and economic growth around the world.
That is not to say that global fixed income has lost its role in reducing portfolio volatility. In the last two decades, for example, there have been seven years where the Canadian stock market has been in negative territory. During those periods, the global bond asset class delivered positive returns, mostly in double digits, and even outperformed Canadian bonds in all but one of those seven years.4
Foreign fixed income in today’s economic environment
However, despite the asset class’ low-volatility characteristics, global bonds also hold a favourable long-term performance record, particularly when compared to Canadian and global stocks on a risk–return basis.5 Furthermore, the recent global credit crisis has changed the nature of the world economy and, accordingly, changed where investors look for the most promising fixed income opportunities.
Although nearly all countries were impacted by the harsh economic conditions of 2008, emerging markets overall were impacted less and are recovering faster than their industrialized counterparts.6 The massive bank writedowns at the heart of the credit crisis were nearly all tied to the United States, United Kingdom and euro-area Europe, with only half these expected losses realized to date.7 This shift in global fortunes increasingly points to emerging economies and other non-traditional markets as places where fixed income investors will increasingly find the best future opportunities.
For Institutional investor use only
The information presented herein is considered reliable at the present time, however, we do not represent that it is accurate or complete, or that it should be relied upon as such. Speculation or stated beliefs about future events, such as market and economic conditions, company or security performance, upcoming product offerings or other projections represent the beliefs of the author and do not necessarily represent the views of Franklin Templeton Investments Corp. General business, market, economic and political conditions could cause actual results to differ materially from what the author presently anticipates or projects. The information presented is not a recommendation or solicitation to buy or sell any securities.
1 Bank for International Settlements, as of June 30, 2009.
2 2008 Canadian Pension Fund Overview, Canadian Institutional Investment Network.
3 Bloomberg as of December 31, 2009.
4 Morningstar Research, as of September 30, 2009, in Canadian dollar terms. Global bonds measured by the JP Morgan Global Bond Index, Canadian bonds by the DEX Universe Bond Index and Canadian stocks by the S&P/TSX Composite Total Return Index.
5 Morningstar Research, as of December 31, 2009. Global bonds measured by the Citigroup World Global Government Bond Index, high yield credit measured by the Credit Suisse High Yield Index, emerging market bonds measured by the JP Morgan Emerging Market Bond Index Government (EMBIG), global stocks measured by the MSCI World Index, U.S. stocks measured by the S&P 500 Index.
6 2009 International Monetary Fund, World Economic Outlook, October 2009.
7 2009 International Monetary Fund, Global Financial Stability Report, October 2009.
Michael Reed is Vice-president, Portfolio Specialist with Franklin Templeton Fixed Income Group®