Are tariffs a sign to go global in fixed income? | Insight Investment

As global trade rebalances, global fixed income strategies may offer compelling diversification, more robust risk-adjusted returns and additional scope to target the trade war’s winners and losers.

Time to consider global diversification amid trade wars?

US fixed income investors have a strong home bias.

Pension plans have 85% of their fixed income in US assets¹ and US aggregate bond ETFs have 2.5x the AUM of their global counterparts². The US market, being the world’s largest and deepest, has also often benefited from significant foreign demand.

However, trade wars may force a measure of rebalancing. Lower US imports imply fewer US dollars circulating abroad to be reinvested into the US, potentially increasing the relative appeal of global fixed income.

Figure 1: Tariffs may encourage fixed income investors to diversify globally³

Global exposure may have already benefited investors this year looking to manage the transition to the new global trade regime.

Following President Trump’s “Liberation Day” tariff announcements on April 2, the S&P 500 Index experienced its 4^th-worst two-day return since the 1980s and a peak-to-trough drawdown of 12.1% (Figure 2 – left). During this, US Treasury yields unexpectedly rose, failing to fulfil their traditional safe haven role, in contrast to many other government bond markets (Figure 2 – right).

Figure 2: Non-US fixed income exposure may have offered equity diversification during the “Liberation Day” sell-off⁴

The Treasury market sell-off was the result of multiple factors in our view such as a “dash for cash,” rising inflation and term risk premia, as well as anticipation of lower foreign demand.

Although we believe that US Treasuries remain the “ultimate safe haven”, bouts of similar volatility cannot be ruled out, particularly given uncertainty around tariffs and fiscal policy. In our view, global fixed income can potentially offer another dimension to diversification against equity market risk, removing the need to rely on one central bank or one yield curve.

US bonds have historically underperformed global bonds

Global exposure may not have only been beneficial during “Liberation Day”

Within the Bloomberg Global Aggregate Bond Index (global agg), the US segment⁵ has never been the top performer over the last 20 calendar years (Figure 3) and has failed to crack the top 10 on 12 occasions – or more than half the time.

Figure 3: The US has never been the top performer in the global agg over the last 20 calendar years⁶

The global agg has also delivered stronger risk-adjusted FX-hedged returns than the Bloomberg US Aggregate Bond Market (US agg) over the last 20 years (Figure 4 – left). Further, global markets have delivered positive returns since the pandemic, unlike the US agg (Figure 4 – right). This is partly attributable to exposure to central banks that were able to cut rates earlier and more forcefully than the Fed over the last two years.

Figure 4: The Global agg has delivered stronger risk-adjusted returns than the US agg over 20 years and since the pandemic⁷

Global exposure may mean more alpha opportunities

Global fixed income pricing can often be inefficient (partly a result of siloed allocations across countries).

Credit spreads can diverge for little to no fundamental reason across global regions (Figure 5, left chart). Spreads can also diverge within the same issuer’s bonds issued in different currencies, despite the credit risk being the same (Figure 6, right chart). Skilled and well-resourced security selection-focused investors can seek to exploit these inefficiencies through relative value trades.

Figure 5: Diverging spreads can provide compelling opportunities for active managers⁸

Further, with tariffs set to bite, we expect that there will be winners and losers across the globe. A global strategy managed by a large, global team may be well placed to take advantage through regional and / or sectoral overweight and underweights.

Although flexible domestic strategies may offer some managers flexibility to target global alpha opportunities, The Bloomberg Global Aggregate Bond Index may offer the greatest platform to trade across, covering over $70trn in market value outstanding (Figure 6).

Figure 6: Active investors have a larger universe to target relative value opportunities⁹

Conclusion: Is global fixed income the new core?

Considering global fixed income should not mean ignoring the US in our view. It remains the deepest market, and we continue to see US fixed income as attractive given the potential for the Fed to resume cutting rates as growth slows. Further, many of our favorite fixed income opportunities include US areas such as Agency MBS.

However, we believe investors may want to consider global fixed income their new core, to maximize diversification and open the door to a wider range of alpha opportunities.