As interest rates rise in the United States, advisors should consider adding fixed-income investments that are based elsewhere.
Anjali Jariwala, a CFP, CPA and the founder of FIT Advisors in Chicago, thinks that a client’s portfolio should be fully diversified across the U.S. and global markets, in both equity and in fixed income. She invests client portfolios in global bonds because they add diversification.
Global bonds may react differently than U.S. bonds when rates are rising, Jariwala says.
“Global bonds should be hedged back to the U.S. dollar so that you are not exposing yourself to currency risk,” she says.
International bond markets can offer substantial benefits to U.S.-only fixed-income portfolios by improving the risk and return profile, but advisors should first consider the role of bonds in their clients’ portfolios, says Michael Stritch, chief investment officer and national head of investments at BMO Wealth Management in Chicago.
“If they are solely meant to provide ‘sleep well’ funds in the event of negative equity or other market events, then adding non-U.S. exposure, especially lower quality credits, may be suboptimal,” he says.
For those more open to a total return fixed-income approach, Stritch suggests that clients consider a well-diversified pool of U.S. and non-U.S. issuers.
Local currency bonds add potential for additional diversification through exchange rate exposure but increase reliance on country or regional economic performance in addition to the individual corporate credit.
Although other parts of the world might be a few years behind the United States in terms of starting to normalize their interest rates, there are pockets of non-U.S. bonds that offer a real return, says Kevin Meehan, regional president, Chicago, at Wealth Enhancement Group of Itasca, Illinois.
“That’s certainly not the case everywhere though,” he says.
“Also, don’t forget the significant role currency plays in the short term. Whether you invest in a fully hedged portfolio or an unhedged portfolio, the short-term volatility in exchange rates may scare off investors new to the space,” Meehan says.
There appears to be a comfort with owning international and emerging-markets equities, as they have become more mainstream over the years, but fixed income from those regions has not provided the same confidence, says Andrew Cook, a CFP and the principal and director of investment management at Berman McAleer, a Kestra Financial-affiliated firm in Timonium, Maryland.
“From our perspective, a global fixed-income investment should not include a currency hedge or else you are paying a fee to reduce your diversification within the portfolio,” he says.
If clients are not comfortable creating a fixed-income portfolio that incorporates a direct global allocation, advisors may want to consider an unconstrained fixed-income strategy that has the expertise to navigate these areas, Cook says.
This story is part of a 30-30 series on evaluating fixed-income opportunities when rates are rising.