The U.S. has long dominated the world's bond market, but globalization and other factors have brought significant changes in the global bond mix and opened new opportunities for those with the know-how and resources to find them.

Bonds issued in the U.S. now account for less than half of the global bond market (see chart), due largely to rising issuance of euro-denominated corporate debt and the decline in U.S. government debt that resulted from budget surpluses. For investors, the growth of the international bond market brings a wealth of new opportunities for diversification that cannot be ignored, particularly in light of the decline in the dollar. In other words, avoiding non-U.S. bonds is no longer an option because it limits investors to only half of the available universe of bonds.

The Issuers: Government Debt's Declining Role

Government debt continues to account for the bulk of the global bond market issuance, but that too is changing. Several factors have contributed to this trend, including the U.S. Treasury debt buybacks and the advent of the euro, which brought fiscal requirements that prompted nearly all euro-member countries to reduce debt and budget deficits.

Japan, which has increased bond issuance in an effort to stimulate the economy, is the one major exception to the trend of reduced government debt among developed nations. And this trend is expected to continue despite the return of U.S. budget deficits, as long-term budget projections remain largely intact and suggest a return to surpluses relatively quickly.

Meanwhile, non-government debt has taken a much larger role in the global bond market, particularly corporate bonds. Domestic and multi-national corporations are increasingly tapping the international credit markets for funds as a result of globalization and a broad decline in interest rates that has made borrowing more attractive. As a result, global corporate issuance has risen sharply, particularly in Europe since the advent of the euro (see chart).

Characteristics of the Major Bond Markets
In the U.S., mortgage-related instruments represent the largest sector of the domestic bond market, accounting for nearly 24% of outstanding debt versus about 20% for corporate bonds and 16% for Treasuries, according to the U.S. Bond Market Association. That's a significant shift from five years ago, when Treasuries accounted for about 31% of outstanding bond market debt and corporates represented 18% of the market. Current issuance remains concentrated in the corporate and mortgage-backed sectors, with federal agencies such as Fannie Mae and Freddie Mac also contributing heavy issuance well above that of the U.S. Treasury.

The European bond market remains dominated by government debt, which represents about 60% of the market versus 29% for corporate bonds and 11% for mortgages. However, corporate debt issuance has surged in Europe, as noted above. German pfandbriefes represent a large sector of the European bond market. There are two types of pfandbriefe:

• Hypotheken pfandbriefe - backed by both mortgage and commercial loans.
• Offentliche pfandbriefe - backed by loans to state and local governments and other
  official institutions.

The Japanese and U.K. bond markets remain similarly dominated by government debt, though corporate issuance is rising in those markets as well.

Risks in Global Bonds
One of the primary risks of investing in foreign bond markets is that returns can be significantly impacted by fluctuations in currency exchange rates, which are notoriously volatile. Sudi Mariappa, PIMCO's head of global bond strategies, estimates that currency positions can be as much as 2.5 times more volatile than bond market positions. Because of this, PIMCO has two strategies for investing in the global bond markets, one of which converts foreign currency back into U.S. dollars through hedging techniques and one of which doesn't. The hedged strategy allows investors to take a position in global bond markets while attempting to limit exposure to potential volatility in currencies.

Another potential risk, common to all bonds, is the possibility that an issuer will default and fail to pay either interest or principal. Government debt is typically judged to be the least likely to default, so it should be noted that non-government debt's increasing share of the global bond market has contributed to a general rise in the market's overall default risk. However, this does not mean that any particular issuer is more or less likely to default, so each must be judged independently and this is why PIMCO maintains a staff of credit analysts to augment the information from credit-rating agencies.

Related articles in the Global Bonds Product Focus:

Expanding Opportunities to Diversify

PIMCO’s Outlook on Global Bonds: Q&A with Sudi Mariappa

PIMCO's Approach to Global Bond Investing: Q&A with Suhail Dada

Global Bond Basics