Weapons of Mass Depreciation
Coverage of the 2013 Global Investment Conference
BY Julie Salsbery | June 26, 2013
All-time low interest rates, central bank activism and dramatic shifts in growth and debt dynamics have transformed the risks and returns of global fixed income markets. Indeed, today’s challenging investment environment demands an active, global approach and better methods of diversification. And while investors have been living with punishingly low interest rates in Japan for decades now, the post-crisis collapse of nearly all developed market sovereign yields is a new and more challenging reality.
Weapons of mass depreciation
When the global financial crisis hit in 2008, central banks around the world slashed policy rates to historic lows and pledged to hold them there indefinitely. But when it became clear that the traditional tool of cutting interest rates would not be sufficient to spark a resumption of growth, central bankers were forced to take new and more drastic measures. Their next move was the deployment of ”quantitative easing” – the expansion of central bank balance sheets through the purchase of financial assets, with the ultimate goal of suppressing all interest rates by pushing investors further out on the yield curve and into riskier asset classes. The most recent effort to kick-start growth has been through blatant attempts to weaken domestic currencies – or what some have termed global currency wars. While there are no signs of full-fledged war as yet, there has been a proliferation of “weapons of mass depreciation”: lower rates, heightened rhetoric, tighter regulation and now direct intervention.
Unfortunately all of these policymaking tools have come up short and the global sands have continued to shift. The developed world still suffers from sluggish growth and rising debt, while growth and debt dynamics remain much healthier in emerging market countries.
Although such “hyperactive” monetary policies and divergent trends in growth and debt create challenges for investors, they also present opportunities. Reorienting domestic fixed income portfolios is the first step to dealing with these problems. Given rising levels of public debt, most domestic bond indices have become heavily weighted toward low yielding Treasury instruments – those also most likely to suffer if interest rates rise. In this environment it’s risky to be dependent on a single yield curve; investors would be better served by diversifying across a variety of global bonds.
How investors gain global exposure warrants consideration. Traditional, market capitalization-weighted indices face concentration risks. The U.S., Japan and Europe, for instance, compose 89% of the J.P. Morgan Global Government Bond Index. And unfortunately, those three regions suffer from low interest rates and heavy policy experimentalism, not to mention the fact that they are most at risk of ongoing credit downgrades.
Faced with such risks, investors should choose an active management approach to global bonds so that their portfolios are not unnecessarily tied to flawed indices. They should also consider a better approach to benchmarking their global bond investments. What investors need are smarter ways to gain global diversification and the ability to cast a wider net to protect against rising risks and capture upside potential.
One approach is to move away from traditional debt-weighted indexes and toward an income-weighted approach that focuses on a country’s ability to pay its debts. Gross domestic product (GDP)-weighted indices transform global fixed income exposures by focusing on growth. They also offer a better balance between developed markets and emerging markets. At the same time, folding in a multi-sector approach across global regions can potentially further enhance diversification and increase yield.
Faced with low interest rates, central bank policy activism and multi-speed growth, investors need to be active, go global in their bond portfolios, and be ready to embrace new benchmarks that can both diversify risks and enhance returns.
Julie Salsbery is Senior Vice President, Global Product Manager, PIMCO