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GLADI Government Bond Index

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As soaring public debt levels in industrialized countries threaten sovereign creditworthiness, traditional approaches to asset allocation in indices have been severely compromised – mainly because models based on market capitalizations tend to favor countries with larger debt burdens. GLADI Government provides an alternative to this model, by focusing instead on GDP, and recognizes the need for investors to position their government bond portfolios with an eye toward the evolving global environment.

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A New Approach to Government Bond Indexing

The global economy is in the midst of dramatic transformations that challenge the ability of traditional investment approaches to generate sustainable returns while also managing risks. One profound change crucial to government bond investing is the explosion of public debt levels in industrialized countries. Traditional government bond indexes - by virtue of their market capitalization weighting methodology - have an inherent structural bias to overweight countries with high levels of debt. As concerns about sovereign creditworthiness become increasingly critical to asset allocation, there is greater urgency for an alternative to traditional approaches.

Through its unique construction methodology, GLADI Government recognizes the need for investors to position their government bond portfolios within this changing global environment. Several core features distinguish GLADI Government from traditional government bond indexes, including:

GDP 

An innovative GDP-weighting methodology that is designed to avoid the disadvantages of traditional indexes based solely on market capitalization weighting.


Emerging Markets 

A continuum in coverage from developed to emerging markets, capturing the fuller set of global investment-grade opportunities and avoiding a lopsided weighting toward developed markets.


Inflation 

A global beta that evolves with the world’s economic structure, providing broad exposure to a diversified basket of global currencies, especially currencies of creditor countries in the emerging world.

Advantages of GDP Weighting

GLADI Government weights index countries based on gross domestic product (GDP) as an alternative to the market capitalization weights used by most existing government bond indexes. GDP weighting offers a number of relative potential benefits:

1. Higher Allocation to Low-Debt Countries. Because larger stocks of debt mean higher market capitalization, market capitalization-weighted indexes are at a structural disadvantage as they have a bias to assign greater weights to highly indebted countries, even though the credit quality of those issuers may be eventually compromised by their debt load. In contrast, GLADI Government’s GDP-weighted approach bases allocation on national income (GDP), which embodies the capacity to repay debt. The income-orientated approach produces a government bond beta with an emphasis on countries with lower leverage, or lower levels of debt relative to their ability to service the debt, as illustrated in Figure 1.

 

2. Forward-Looking. Traditional patterns of global indebtedness are being reversed, as industrialized countries expand government debt issuance at an accelerated pace while many emerging economies have become large-scale creditors to the rest of the world. Once regarded as exotic, opportunities in the emerging markets are increasingly becoming an essential element of core fixed income portfolios. Market capitalizationweighted indexes fail to capture these changes because they are inherently backward-looking, reflecting past patterns of capital market development. Since rapid economic growth tends to precede the liberalization and deepening of capital markets, GLADI Government’s GDP weighting is designed to capture the opportunities that exist in the world’s most dynamic economies. By embedding a concept of where capital markets will be in the future – rather than where they have been in the past – GLADI Government helps investors position their portfolios to reap potential first-mover benefits.

 

3. Counter-Cyclical Rebalancing. Another well-known disadvantage of market capitalization-weighted indexes is that they assign progressively greater weight to securities as they go up in price, exactly the opposite of the investment maxim to “buy low, sell high.” GLADI Government not only is designed to avoid this pitfall of market capitalization weighting, but also has the potential to benefit from counter-cyclical rebalancing, since bond prices tend to move inversely to GDP growth over the business cycle, with bond prices rising as economic growth slows, and falling as economic growth accelerates. A GDP-weighted index that increases the relative weight of countries in the expansion phase of the business cycle (when bond prices are low) and reduces the relative weight of countries in the contraction phase (when bond prices are high) helps embed a “buy low, sell high” bias, as illustrated in Figure 2.

 

Methodology

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.

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 2012.

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 3 bonds are required for an industrialized country to become eligible; and a minimum number of 5 bonds are 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.

The list of 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.

A. Eligibility Criteria

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 bullet bonds or sinking funds issued by developed and emerging governments are eligible.

  • 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 currency.


B. Market Profile

The market profile process is applied to select countries of GLADI Government. The process involves three steps: (1) creating 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.

Index Attributes

The index methodology described in the prior pages produces an index that is broadly diversified across regions, currencies and maturities. Key attributes of GLADI Government and its sub-indexes are presented in the accompanying figures.

Re-weighting & Rebalancing

Target regional weights for GLADI Government will be revised in an annual review, with the new weights becoming effective on 31 October of each year. On occasion, the target country weights may also be changed at the monthly update to reflect the most up-to-date set of eligible countries following sovereign downgrades and upgrades.

The actual country weights of GLADI Government on a daily basis will deviate from their target weights, reflecting changes in the prices of the underlying instruments in the index. On a quarterly basis (31 October, 31 January, 30 April, 31 July), GLADI Government will be rebalanced to restore the actual country weights to their targeted levels.

On a monthly basis, countries that no longer meet eligibility requirements will be removed and securities within each country will be added and removed at month-end according to GLADI eligibility criteria.

Index Administration and Data

GLADI Government will be administered and calculated independently from PIMCO by Merrill Lynch, an unaffiliated leading global index provider. Merrill Lynch will be responsible for the ongoing application of the index methodology, identification of index constituents and all other technical matters connected to the calculation and provision of index data.

Additional information and access to data can be found at:
www.pimcoindex.com.

GLADI data is available on Bloomberg:



For more information, please email pimcoindex@pimco.com

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