Managers that are able to skillfully expand their opportunity set and include more breadth of investment options have the ability to add more value. Unfortunately, the options for adding value in the domestic bond market are limited, especially in comparison to global bond markets, which have historically held a broader range of value added strategies.

Three Bond Portfolio Scenarios
As a leader in investment research, Russell Investment Group is constantly analyzing ways to add value to our clients' portfolios. In light of this ongoing commitment to research, Greg Nott, a Canadian fixed income portfolio manager and David Wong, a research analyst, created three bond portfolio scenarios in an effort to answer the question: "How much does a global component in a Canadian bond portfolio benefit investors?"

The three scenarios were based on data from 1993 to February 2004 and were devised accordingly:

A Strategic Global Approach: 75% Canadian Benchmark, 25% Global Benchmark. An Active Global Approach: 75% Canadian Benchmark, 25% Active Global Management (i.e. where the global manager will be 50% invested in global bonds at their most bullish, and only 10% invested in global bonds at their most bearish, skill level set to 60%). An Active Global Approach with Emerging Market Debt (EMD): Same as #2, except at the global manager's most bullish, they will invest 50% in global bonds including 3% EMD, at a 60% skill level.

Each scenario was evaluated on a hedged currency basis so that the results consisted of actual returns to the global bonds with no foreign exchange fluctuations factored in. Additionally, all of the returns were adjusted for duration so that the results were not impacted by differences in duration across markets. The RBC CM Canadian Bond Market index was used to represent the Canadian benchmark, while the Lehman Global Aggregate Bond index was used as the global index source.

SCENARIO 1:
75% Canadian benchmark, 25% Global benchmark (Passive)

The first scenario reveals the impact of injecting a bond portfolio with a 25% static global fixed income component.

December 1994 vs. December 2003

The second scenario examines how much value a more active global bond approach might have. For this scenario, the study assumes a multi-manager approach, with 75% to a Canadian index manager, and 25% to a global manager that will actively rotate between the Canadian benchmark and the global benchmark. This is similar to Russell's fund construction. When the manager is bullish on global bonds, they'll have approximately 50% of their portfolio in global bonds and 50% in the Canadian benchmark. In general, when the manager is bearish, they'll have only 10% in global bonds and 90% in the Canadian benchmark. For this scenario, the skill level of the manager was set at 60%, which means they will make the decision to be in global bonds correctly 60% of the time.

Scenario 2 Results:
Sweet Country Music


Conclusion: A Return and Risk Justification for Active Global Bond Management

"In this scenario, the manager will be active in allocating to the global component. The result is a positive alpha of 5bps at the Total Portfolio Level, well ahead of the passive global allocation of -36bps. In addition, as well as providing positive alpha, this active allocation has a portfolio standard deviation below that of a pure Canadian benchmark, similar to what we observed in Scenario 1. So, in this scenario, we have observed both added alpha and a reduction in portfolio risk," said Greg Nott.

Note: At the managers most bullish, 50% will be invested in global bonds including 3% EMD. At the managers most bearish, only 10% will be invested in global bonds with no EMD exposure and a 60% skill level.

The third scenario is similar to Scenario 2, except the manager can now add a 3% weight to EMD at their most bullish position. The skill level is once again set to 60%.

Scenario 3: Results
The Impact of Emerging Markets Debt


Conclusion: More return and slightly more risk when you increase breadth in Active Global Bond Management

Just a small bit of EMD, 3% at the manager level and 0.75% on the total portfolio level, boosted returns by 4 bps above what a global allocation would have added, for a total of 9 basis points of alpha. This was done with the manager purely being bullish on global and EMD bonds at the same time, with the global piece having skill at the 60% level. It should be noted that this scenario did well because EMD outperformaned in this time period and not because of the manager's additional skill at timing EMD exposure

Russell's Bond Strategy
In order to add a global component to the Russell Canadian Fixed Income Fund and the Sovereign Canadian Fixed Income Pool, Russell employs Pacific Investment Management Company (PIMCo) as a global fixed income manager.

PIMCo's mandate is benchmarked against the RBC CM Canadian Bond Market index. However, they are charged with looking to invest outside of Canada (i.e. outside of their benchmark) when and where they see value. PIMCo also has skill in allocating within countries and sectors, and also adds value through issue selection.

The firm's global bond investing capabilities has added value to Russell's portfolio over the past few years and has contributed to a richer opportunity set in both