Big deviation Swiss Gov Bonds / Global Gov Bonds

Investing / Portfolios
1

Hi everyone, I’m planning to allocate 40% of my portfolio to government bonds.

After reading the forum and doing some additional research (Vanguard), it seems that it is generally agreed to hedge bonds to avoid currency risk. Additionally, according to financial theory, hedged global bonds should provide the same return as local government bonds while improving diversification.

The two bond funds that I considered are:

When comparing those two I saw that there is a big difference in performance, which seems to contradict the previous statement that hedged global bonds should behave similarly to local ones. The SBI 7-15 bond has a slightly longer duration (9,81 vs 7,36 years), so I would expect some small differences, but not to this extent.

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Is the reason for the remaining performance deviation related to hedging?

Given the large bond allocation in my portfolio, I’m wondering what to do:

  • Swiss Gov 7-15 contains only 8 bonds from one (very safe) country, which might not be diversified enough, the advantage is that there is no hedging involved.

  • Global Gov Bonds contains over 1,000 bonds from multiple countries, however it performed significantly worse. Additionally, it has an even smaller fund size than SBI 7-15 (330 vs 414 million CHF).

I also considered the iShares Aggregate Global Bond Fund. However, it includes company bonds and therefore credit risk. The advantage is that it is even more diversified with over 13,000 Bonds, but it will have higher drawdowns during financial market meltdowns.

What would you do in my situation? Is it to be expected that Swiss Government Bonds will keep outperforming Global ones for some specific reason?

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I mainly use CHCORP but I don’t have such a high need of bonds like you. So not much of a worry.

For 40% bond allocation - perhaps good to use a mix of following

  • Swiss government bonds
  • Swiss corporate bonds
  • global sovereign bonds hedged
  • global corporate bonds hedged

I suggest to look for some examples in Finpension default portfolios. They are generally all hedged. You won’t be able to get same ISINs as they are reserved for large investors but something similar might be available.

3

Thank you very much for your input. I had a look at Finpension’s high bond allocation portfolios. They are using 4 funds with a combination of corporate and government bonds (roughly 50/50). I guess I will just use an Aggregate Global bond fund hedged to CHF to keep things simple.

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This is only the case if the forward contracts of the currency hedge match the duration of the bonds (and there is no difference in credit rating). However, I think hedged funds use rolling short term forward contracts for hedging (e.g. 3-month contracts that are continuously renewed), not duration matching.

Changes in expected long term interest rates affect the market value of bonds. These changes can differ among gov bonds of different countries and currencies. With a hedged global gov bond fund you’re still exposed to changes in expected interest rates of other countries. That’s one part of the diversification you get but this can be positive or negative.

Another part of diversification is that gov bonds of other countries may have a different credit rating. A lower credit rating should lead to higher returns even after hedging.

I’m definitely not an expert on bonds, though. If anyone sees a mistake in the above, please correct me.

I have about a 20% bond allocation with the following parts:

  • 5% iShares Core Global Aggregate Bond ETF hedged to CHF (AGGS)
  • 5% CSIF Bond Switzerland AAA-AA
  • 10% CSIF Bond Switzerland AAA-BBB 1-5

AGGS is the fund with the highest risk but combined with the AAA-AA fund, the average credit risk should be a bit more reasonable. The credit risk of AAA-BBB 1-5 should have a bit lower impact due to the shorter duration. Overall my goal was to have a modified bond duration of about 1 for the whole portfolio, i.e., an interest rate change of 1 percentage point should result in roughly 1% gain or loss of the portfolio value.

I don’t know whether this combination is really a good idea but I believe the risk is low enough and that’s the point of these bonds in my portfolio.

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