The construction of GLADI Government follows three steps: (1) regional weights are assigned based upon the relative GDP shares of the respective major regions in the global economy, (2) country weights are assigned to eligible markets that qualify under the investment grade rating, liquidity, and investability criteria, (3) security selection is guided by a set of rules designed to ensure that the index is investable and can be replicated in a portfolio of liquid securities, rather than illiquid instruments that are only theoretically investable. Figure 3 illustrates the process.
Figure 3: Three steps in constructing GLADI Government
Step 1: Regional weights by gross domestic product
Major Regions Weighted by Share of Global GDP
- United States
- Other Industrialized Countries
- Emerging Markets
Step 2: Assign country weights to eligible markets
Qualifying Countries Weighted by GDP Subject to Rating and Investability Criteria
- Credit Rating
- Size of Bond Market
- Number of Bonds in Issue
Step 3: Complete security selection for each country based upon eligibility criteria and market profile
Security Selection Designed for Liquidity and Replicability
- Eligibility Criteria
- Instrument type
- Minimum remaining maturity
- Minimum par outstanding
- Market Profile Process
- Selective set of liquid securities to represent maturity profile of broader market
Step 1: Regional weights
The regional classification distinguishes the major economic regions listed in Figure 3, with the weight of each region in GLADI Government determined by its respective share of global GDP. GDP shares are calculated as the simple average of each region’s share of global GDP for the previous five years, measured in nominal U.S. dollars at market exchange rates. The GDP data come from the International Monetary Fund.
GDP weights are revised annually, with the new weights becoming effective on 31 October of each year. Figure 4 displays the current regional target weights for GLADI Government, based on the annual review that became effective on 31 October 2015.
Step 2: Country eligibility and weights
Within multi-country regions such as eurozone, other industrialized countries and emerging markets, individual countries are further weighted by their share of GDP in each region. To ensure high quality and investability of the index, countries need to meet a series of eligibility criteria to be included:
Credit quality. Eligible countries must be investment grade (BBB- or higher). The average rating from Moody’s, S&P and Fitch is considered when available. Countries downgraded to below investment grade are removed from the index upon monthly reconstitution.
Size of market. Industrialized countries must have a government market greater than 5 billion USD or the local currency equivalent. For emerging markets, the local currency bond markets must be at least 10 billion USD or equivalent.
Number of bonds in issue. A minimum number of three bonds is required for an industrialized country to become eligible; and a minimum number of five bonds is required for emerging markets.
Investability. The market needs to be investable, i.e., markets with significant capital controls and access restrictions or lack of liquidity are not eligible for the index.
Currently qualifying countries and their respective weights are illustrated in Figure 5.
Step 3. Security selection
In order to maximize the replicability and investability of the index, the number of securities selected within each market is limited according to the size of the market and liquidity considerations. When the actual number of securities in the market exceeds the limit, a market profile process is applied to select the securities that will be included in the index. The market profile process refines the universe of eligible securities to identify the most representative and liquid securities, producing an index that is replicable and investable.
There are three eligibility criteria that define the universe of instruments. Securities that become ineligible upon monthly reconstitution are excluded from the index.
- Instrument type. Only fixed-rate, non-callable central government debt qualifies. Index inclusion is limited to bonds with a bullet redemption structure whose principal and coupons are linked to the local country’s or region’s consumer price index.
- Remaining maturity. All government bonds must have at least 12 months remaining until maturity.
- Minimum par amount outstanding. Eligible instruments must have a current par amount outstanding greater than or equal to a minimum amount that differs by local currency.
The market profile process is applied to select countries of GLADI Government. The process involves three steps: (1) create a market structure matrix, which classifies all bonds according to maturity profile; (2) calculate the number of bonds to be selected for the market profile for each maturity band by multiplying its market share by the overall target number of bonds for the country; and (3) select individual securities that are most liquid and representative as measured by amounts outstanding, time since issuance and time to maturity.