Global fixed income markets have evolved rapidly over the past two decades, greatly expanding both the size and the diversity of the opportunity set. At the same time, many pension plan sponsors around the world have been shifting their focus from benchmark-sensitive strategies to objective-driven ones. Customized global fixed income strategies may help Canadian pension sponsors leverage both trends. This approach can create portfolios that better match specific sponsor objectives, such as target risk, while a global multi-sector approach can provide access to a wider range of potential return and diversification opportunities.
Historically, Canadian pension plan sponsors have viewed fixed income primarily as a hedge against equity risk, and have limited their allocations set to domestic investment grade instruments—an understandable policy, given their liability structures. However, also given the expansion in global sovereign, investment grade credit and high yield market capitalization, the opportunity costs of a Canada-only portfolio have increased dramatically—this at a time when many Canadian plans face serious funding pressures.
A customized global fixed income approach provides portfolio managers with greater flexibility to exploit potential sources of return, such as duration, credit and currency exposure. This is important at a time when diverging interest rates cycles, across both the developed and the emerging markets, are creating potentially attractive opportunities for tactical allocation.
Despite this, U.S. and Canadian plan sponsors have been relatively slow to adapt to the expansion of the global fixed income markets. As of June 30, 2014, foreign bonds accounted for only three percent of the value of Canadian pension assets, 2.1% of U.S. corporate DB plan assets, and 2.3% of U.S. public plan assets (Statistics Canada, Pensions & Investments).
But sponsor attitudes are changing. A recent T. Rowe Price survey of 40 major Canadian pension plans found that more than 90% predicted that, ten years from now, global bonds will represent a more significant allocation in pension plan fixed income portfolios.
Greater exposure to non-Canadian fixed income assets does not necessarily have to mean increased portfolio risk, making them appropriate for a wide range of plan sponsor objectives. The primary goal of global fixed income portfolio construction should be to clearly define the investment objective, with benchmark determination as the last step.
Broad allocation ranges among sectors within a defined risk budget can result in improved opportunity capture and risk-adjusted returns.
Peter Austin is Head of Fixed Income Solutions, Fixed Income Division, T. Rowe Price