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GDP VS MARKET CAP
BOND INVESTORS ARE RETHINKING INDEX WEIGHTING
While bond investors are searching for yield, traditional benchmarks continue to apply a market capitalisation
approach to index construction, favouring issuers with the highest debt burdens. GDP-based approaches offer
a new take on index weighting.
Evi C. Vogl
CEO, Pioneer
Investments
Germany
means GDP as a metric for the economic capacity or
performance of a country. A higher GDP means higher
tax revenues, and thus a higher level of income available for interest and redemption payments. To map
global economic power as closely as possible, such an
index should also include countries like China, India,
Brazil, Mexico and South Korea, together contributing
more than 20 percent to global GDP1.
Figure 2: GDP Weighted Approach Delivered
More Yield Without Increasing Credit Risk
5.00
4.50
GDP-weighted
4.00
3.50
3.00
2.50
2.00
1.50
1.00
JP Morgan Customised GDP Weighted Index
T
raditional bond benchmarks are market capitalisation-weighted and give the highest weighting to issuers with the highest debt. More than
90% of weightings are concentrated in the massively
indebted US, Europe and Japan (see Figure 1). At the
same time, the quantitative easing programmes run
by the Fed, BoJ, BoE and ECB have in effect removed
the typically positive correlation between debt and return levels. Interest rates have hit record lows, market
mechanisms have been distorted.
It is time for a fresh approach to weighting
It comes as no surprise that investors are turning to
new benchmarks for their bond investments, with
prominent investors leading the way. The Government Pension Fund of Norway, for example, has
shifted the weighting of its bond portfolio away from
market capitalisation. And large index providers such
as Barclays, Citigroup, JP Morgan or Research Affiliates have presented new weighting concepts for bond
investments.
For bond indices, there are many alternatives to
the traditional market cap weighting. With a “fiscal strength” weighting, for example, issuers with
the best ratings and lowest gearings account for the
largest weightings. However, precious few countries
have retained a top rating from all major agencies, and
some of those are small countries such as Denmark,
Singapore or Switzerland, whose bond volumes are inadequate to satisfy large institutional investors. Also,
there are many ways of defining financial strength,
which may potentially tarnish transparency in index
construction.
GDP-weighted indices reflect economic potential
A more promising – and more viable – approach is
weighting indices based on fundamental factors that
do not focus on a country’s debt, but rather on its debtservicing capacity. For sovereign issuers, this usually
One of those GDP-weighted indices is the JP Morgan
Customised GDP Weighted Index, developed by Pioneer Investments together with JP Morgan. This index
is limited to G20 countries with an investment-grade
rating, and thus meets the minimum credit quality
requirements of many investors. It is rebalanced on a
quarterly basis, allowing for current individual developments in issuers’ economic strength to be taken into
account.
A closer look at the country allocation and a comparison with the BofA ML Global Government Bond
Index reveals a broader diversification in the GDPweighted index: at the expense of Japan, the US and
Europe, and in favour of various emerging markets.
Figure 1: A Different Approach to Sovereign
Debt Management
Market Cap Approach*
GDP Weighted Approach**
Other
3
US
38
Europe
35
Japan
25
Diversification
Other
38
Europe
21
US
32
Japan
9
*Based on BofA ML Global Government Bond Index as 31 July
2015. **Based on JP Morgan Customised Global GDP-Weighted
Index Basket as at 31 July 2015.
Some investors may be surprised to learn that the
average rating of the JP Morgan Customised GDP
Weighted Index is only slightly weaker than that of
the BofA ML Global Government Bond Index, for example (AA- vs. AA, see Figure 2)3. However, its yield
is significantly higher: as at 31 July 2015, the JP Morgan Customised GDP Weighted Index yielded 2.68
percent, while the BofA ML Global Government Bond
Index yielded 1.06 percent3 (see Figure 2). The level of
volatility is also comparable.
Market cap-weighted*
0.50
Rating: AA-
2.68%
Yield
Gap =
1.62%
1.06%
Rating: AA
0.00
30.09.05 30.03.07 30.09.08 31.03.10 30.09.11 29.03.13 30.09.14 31.07.15
Source: Pioneer Investments, Bloomberg and BofAML as at 31
July 2015. *GDP-weighted based on JPM Customised Global GDP
Weighted Index Basket which has been back tested to 2005 by
JP Morgan. **BofA ML Global Government Bond Index. Ratings
given are as rated by Moody’s Investor Service, the Standard &
Poor’s or Fitch’s as applicable.
Investment solution
To enable institutional investors in government bonds
to benefit from a GDP-weighted approach to portfolio
construction, Pioneer Investments launched a Global
GDP-weighted Government Bond strategy in April
2015. The core portfolio is based on the JP Morgan
Customised GDP Weighted Index, with countries
such as China, India or South Korea – where no freelytradable cash bonds are available – replicated through
derivatives. The performance of the core portfolio
should match that of the GDP Weighted Index. Lead
portfolio managers Tanguy Le Saout, Head of European Fixed Income, Cosimo Marasciulo, Head of European Government Bonds, and their European Investment Grade Fixed Income Team employ a distinctive
approach to investing, focusing on the separation of
alpha from the core strategy by actively seeking out
the most attractive markets. The process is based on
a series of alpha overlays covering diverse opportunities within fixed income such as inflation, currency,
relative value, sovereign spreads, credit spreads and
volatility. The emphasis is on taking small amounts of
risk across many uncorrelated positions. This unique
portable alpha approach enables client portfolios to
benefit from the depth of expertise within the fixed
income team and to ensure diversification and risk
control of alpha sources – ultimately capturing the
upside, limiting the downside.
FOOTNOTES
1 Source: World Bank, as of 31 December 2014.
2 Ratings by Moody’s Investor Service, Standard & Poor’s or Fitch’s,
as applicable. As of 31 July 2015.
3 Sources: Pioneer Investments, Bloomberg, BofA ML. As of 31 July
2015.
DISCLAIMER
Unless otherwise stated all information and views expressed are those of Pioneer Investments as at 7 September 2015.
These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will
perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up
and could result in the loss of all capital invested.
Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies.
Pioneer Oct 2015.indd 49
11/09/2015 15:55