A key trend in bond investing today is that many clients want more performance from their fixed income allocation.

A key trend in bond investing today is that many clients want more performance from their fixed income allocation. The growth of fixed income markets, with more companies issuing more debt, and the development of bond derivatives markets has provided fund managers with more opportunities to meet this increasing demand for returns.

However, when volatility is low and when fixed income markets are challenging portfolio managers you could be forgiven for wondering how they can continue to provide the sort of returns investors have come to expect.

Fixed income markets are displaying these very characteristics at the moment, particularly in sterling, but there is a simple solution to the challenge and it lies in constructing a portfolio that has the capability to look for investment ideas on a global basis rather than just remaining confined to a single, narrow market. In current market conditions a diversified basket of global bonds is better equipped to meet investor demand than one focused solely on one market. And it is possible to construct a portfolio of this nature that has the broad risk characteristics demanded by sterling clients.

Two headwinds faced by bond investors are low volatility and rising interest rates. Volatility has been falling across all the major bond markets – the UK, US, euro zone and Japan – and this can be problematic because it is correlated to opportunities to trade. Fewer trades mean fewer opportunities to add value and provide clients with returns.

The role of interest rates in bond investing can be complex but one key feature is that rising interest rates erode capital gains. For many reasons all four central banks in the main bond markets have made significant raises since the beginning of 2006, the Bank of Japan even ended its long-standing zero interest rate policy.

The sterling bond market is comparatively small and whilst funds that limit themselves to this universe can benefit from good performance they can also suffer when conditions are inclement. Given this landscape the case for a world tour of bond investment ideas is compelling. The more opportunities that can be unearthed and included in a portfolio, the better chance it has of performing.

One of the reasons to complement a holding in sterling bonds with global fixed income is the sheer number of opportunities available. Measured by the number of investment grade corporate bond issues, the euro market is over three times larger than sterling and the US dollar market is nearly four times larger.

The euro bond market, for example, presents a particularly interesting case for diversification. Over a third of European corporate debt is now issued by companies from outside the European Union, with one in ten being US companies. It is a well balanced market with non-government debt at around 40 per cent (up from 8 per cent in 1996) and sovereign debt down to just 60 per cent (from 92 per cent in 1996) of the total market.

The euro market for structured debt and asset backed securities, which have the potential to offer bond investors higher yield and lower volatility than straight corporate debt, is now nearly as large as the market for corporate bonds (14.5 per cent compared to 15.6 per cent of the total market respectively).

The diversification play is more interesting if we look further eastwards and this is where detailed research and analysis is essential. Russian, Kazakh and Ukrainian banks have recently been issuing interesting bonds and Western banks have been quick to see the region as an expansion opportunity. If you invest in the bonds issued in these markets you can pick up yield – particularly if the banks are then acquired by a larger player from the West, which is exactly what happened in 2005 when BNP Paribas acquired Ukrainian bank UKRSIB.

In the US, investors in corporate bonds are benefiting from higher yields than those offered by sterling corporate bonds as spreads are wider, (in both the investment grade and riskier high yield sectors). This phenomenon has not yet been hurt by gathering predictions of a slowdown in the US economy.

The Japanese bond market is showing interesting signs of life with improvements in economic growth and an end to a prolonged period of damaging deflation. Interest rates are being raised to more normal, positive levels and the corporate environment is strengthening. Against this backdrop, there is an increasing issuance of bonds by banks and insurance companies which give investors opportunities that have been lacking through much of the last 15 years.

The idea of stepping outside core sterling markets has been embraced by many investors, such that today, many sterling bond funds have varying degrees of latitude to go global, either by selecting sterling securities that have been issued by international entities or by looking at ideas in the US dollar, euro or yen markets.

When one market offers limited prospects of returns portfolio managers need the confidence they can seek ideas from global markets, and they obtain this confidence from the depth and breadth of their research and analysis. More highly skilled analysis usually means more opportunities to select securities that can diversify a portfolio and enhance its returns.

The case for a world tour of bonds, with exposure to a wider range of issuers, economies and yield curves is a persuasive one for investors who want to see their fixed income working harder for them.