Global diversification—the idea of spreading your risks and returns across domestic and international markets—is a basic principle of investing. But while many investors have signed on to the idea of diversifying their stocks, their bond portfolios are often highly concentrated in the U.S.1
What you should know is that just as with stocks, broadening your bond horizons can help you maximize returns while potentially reducing volatility. Diversification may be particularly important now, as the landscape for interest rates—and bond opportunities—begins to change.
Different economic drummers
Since the global recession in 2008, central banks have aggressively used monetary policy to try to stimulate economic growth. The two main tools at their disposal have been quantitative easing (QE) (massive bond-buying programs) and interest rates cuts, often down to zero and even below. These measures are designed to infuse economies with cash, encouraging people and companies to spend, borrow and invest.
Monetary policy has had a big impact on world financial markets, boosting stock prices and pushing down bond yields. Today, however, responses by central banks have been more varied, as individual economies grow at different rates.
You can see that divergence in the interactive above. The U.S. Federal Reserve, which ended its QE in October 2014, is moving to gradually raise its target interest rate (although we expect rates to stay relatively low). The European Central Bank, meanwhile, is faced with flagging growth and the new challenge of Brexit; the ECB is buying trillions of euro in bonds, and has committed to continue through at least March 2017. Other countries, such as Canada, haven’t engaged in QE, but are cutting rates.
Make friends with diversification
What might these varying trends mean for bond investors? Essentially, that as the world has gotten more complex, it may no longer be enough to simply own U.S. bonds.
Although diversification doesn’t guarantee a profit or protect against a lost, it can both expand your access to return potential when yields are low and also help improve your risk profile as markets become more uncertain. A global bond ETF like iShares Core International Aggregate Bond ETF (IAGG) can be a low-cost way round out a U.S.-centric portfolio.
This article was produced on behalf of iShares by Quartz creative services and not by the Quartz editorial staff.
1) Source for stocks: ici.org; for bonds: Morningstar Direct. Both as of 12/31/2015.
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