Indeed, it is something we believe investors should actively consider.
Hedging costs
The cost to hedge foreign currency bond funds back to GBP is essentially the government interest rate differential, so at the end of April 2023, it cost around 60bps to hedge back from USD to GBP.
However, fixed income assets in USD have a higher yield to begin with, as risk assets are priced off a higher risk-free rate. Therefore, the hedging cost nets out and you should invest in the region where you see the highest potential returns going forwards.
To prove this, we can see six-month periods where US high yield outperforms GBP high yield by plus 2 per cent, even after hedging costs are applied – so holding the higher-yielding US assets with a stronger outlook cancels out the hedging costs and generates a better overall return.
The same can be seen in the investment grade market.
But putting return potential to one side, we believe the real benefit is the additional diversification that currency exposure brings, even if overall performance is neutral, your portfolio risk will be lowered.
While UK fixed income presents opportunities, underlying market risks could leave your portfolio unduly exposed to concentration and duration risk.
We believe evaluating your fixed income allocations through a global lens provides the best way to optimise risk-adjusted returns.
Al Cattermole is a portfolio manager and global credit analyst at Mirabaud Asset Management
