Across the two centuries under study, a global portfolio of external sovereign bonds shows favorable riskreturn properties compared with other financial assets, with substantial variation in relative performance across time. On average, only US equities and the portfolio of advanced country equities show a higher return. In the full sample, the return on external sovereign bonds is significantly higher than that of US corporate bonds, UK equities, US or UK government bonds and that of the portfolio of domestic sovereign bonds from 16 countries. Our external bond portfolio also shows a high Sharpe ratio, on the same level as US equities, and exceeding that of the other asset classes. The CAPM analysis in Appendix B7 further suggests that the beta for this asset class is low, especially in the historical sample (well below 0.5), suggesting that external bonds provided a diversification service with respect to US/UK equities.

In the modern period (post-1994), foreign-currency sovereign bonds fare even better (Panel B in Figure 14 and Table 7). The Sharpe ratio is highest among the asset classes under study and the returns exceed those on US and UK equities, on US corporate bonds, and on advanced country equity and domestic bond portfolios. High average coupon rates during the modern period coupled with the paucity of serious credit events have delivered a high ex-post return for this asset class in the past three decades. However, this does not imply that this benign combination is set to become the “new normal” for the sovereign bond market, as rising debt difficulties in developing countries can morph into defaults abruptly (Reinhart, Reinhart, and Trebesch 2018).

# 6.3. Total returns during major financial crises

We next examine the performance of each asset class around selected major crises in financial center(s) that have different features, as to their global effects. In particular, we compare the cumulative total return of US stocks, US Treasuries, and external sovereign bonds (our sample of serial defaulters) three years before and after (i) the New York Panic of 1907 (crash month: October), (ii) the Great Depression (crash month: October 1929), and (iii) the recent Financial Crisis (crash month: Sept. 2008). Figure 15 shows the resulting monthly return series, indexed to 100 in the starting month of the crisis. The results from these case studies are broadly in line with the aggregate statistics summarized above. External sovereign bonds show higher cumulative returns than stocks in two of the three spells (by the end of year three). The returns on our global portfolio also tend to be less volatile than those of stocks. Compared with US Treasuries, external sovereign bonds fare better in 1907, but significantly worse during the Great Depression. In the Financial Crisis of 2008, external sovereign bonds deliver worse returns compared with US bonds at the height of the crisis, but subsequently show a much better performance.

Summing up, these findings suggest that sovereign bonds of periphery countries can provide investors with a viable diversification strategy and, absent a surge in the incidence of default, comparatively high returns. The high average coupon payments on external sovereign bonds help to stabilize total returns when prices are volatile.

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