Understanding Global Bond Markets

Executive Summary

Global bond markets represent one of the largest and most diverse pools of investable capital in the world, spanning sovereign debt issued by dozens of national governments, supranational institutions, and a vast universe of corporate issuers across every major industry. For Australian investors, understanding the structure of global bond markets, and the considerations relevant to accessing them, is an important complement to a purely domestic fixed income allocation. This article provides a general overview of how global bond markets are organised and the factors investors should consider before allocating capital beyond Australian borders.

This is an educational discussion of market structure and mechanics, and should not be read as a recommendation regarding any specific market, currency or security.

The Structure of Global Fixed Income Markets

Global bond markets can broadly be segmented into sovereign debt, issued by national governments to fund fiscal deficits and other spending; supranational and agency debt, issued by institutions such as multilateral development banks; and corporate debt, issued by companies to fund operations, capital expenditure or acquisitions. Within each of these broad categories, further distinctions exist based on credit quality, maturity, currency of issuance and the specific legal and structural features of individual instruments.

Developed market sovereign debt, such as that issued by the United States, Japan, the United Kingdom and various European governments, has historically formed the core of many global fixed income portfolios, given the relatively deep and liquid markets these issuers typically maintain. Emerging market sovereign and corporate debt represents a distinct segment, often offering higher yields to compensate for generally higher perceived credit and currency risk, though the specific risk profile varies considerably by country and issuer.

Currency Considerations

A defining feature of investing in global bond markets is exposure to currencies other than the Australian dollar, unless that exposure is specifically hedged. Currency movements can have a significant effect on the total return experienced by an Australian investor, sometimes overwhelming the effect of the underlying bond's yield and price movements. Some investors and fund managers choose to hedge currency exposure back to Australian dollars to isolate the fixed income component of returns, while others deliberately retain unhedged exposure as a further source of diversification, accepting the additional volatility this can introduce.

The decision of whether, and to what extent, to hedge currency exposure within a global fixed income allocation is a meaningful one, and depends on an investor's broader objectives, risk tolerance and views on the diversification benefits of unhedged currency exposure relative to the additional volatility it may introduce.

In global fixed income, currency movements can matter just as much as movements in the underlying bond yield itself.

Why Sovereign Bond Markets Diverge

Although often discussed collectively, individual sovereign bond markets can behave quite differently from one another, reflecting differences in local monetary policy settings, fiscal positions, inflation dynamics and central bank credibility. A government bond market in one country may see yields move in a different direction, or by a different magnitude, than another country's market over the same period, even though both are nominally part of the broader global fixed income landscape. This divergence is one of the reasons global fixed income allocations can offer diversification benefits relative to a purely domestic bond portfolio.

Global Corporate Credit

The global corporate bond market offers exposure to a vast range of industries and credit profiles, from investment grade issuers with well-established balance sheets to high yield issuers offering higher potential returns in exchange for greater credit risk. Global corporate credit markets can provide diversification benefits relative to a domestic-only allocation, given differences in the sectoral composition of corporate issuance across regions, though careful credit analysis remains essential regardless of the market in question.

Illustrative Example

As an illustrative example only, consider a hypothetical Australian investor who allocates a portion of their fixed income exposure to a diversified global bond fund. If domestic Australian bond yields were to move in one direction due to local economic conditions, while yields in another major economy moved differently due to distinct local conditions, the blended global exposure could behave differently from either market considered in isolation, illustrating one rationale for diversification. This example is entirely hypothetical and does not represent actual market conditions or fund performance.

Key Considerations for Investors

• Understand whether your global fixed income exposure is hedged or unhedged with respect to currency, and the implications of that choice.
• Recognise that different sovereign bond markets can behave quite differently, even over the same time period.
• Consider the credit quality distribution of any global corporate bond allocation relative to your risk tolerance.
• Assess whether global fixed income exposure is accessed directly, through managed funds, or through other vehicles, and understand the associated costs and liquidity terms.
• View global fixed income as one component of a broader, diversified portfolio rather than a standalone strategy.

Conclusion

Global bond markets offer Australian investors access to a far broader opportunity set than domestic fixed income alone, spanning diverse sovereign and corporate issuers, currencies and credit profiles. A sound understanding of this structure, and of the currency and diversification considerations involved, is an important foundation for investors considering an allocation beyond domestic markets. This article is general information only and does not constitute personal financial advice; investors should consider their own circumstances and consult a qualified adviser before making investment decisions.

Related topics

Information contained within these insights is provided for general information purposes only and does not constitute personal financial advice, an offer or recommendation to acquire or dispose of any financial product. Investors should consider their individual circumstances and obtain appropriate professional advice before making investment decisions.