A More Thoughtful Approach to Global Inflation-Linked 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. Profound changes crucial to the global ILB market include the divergence in monetary policies and inflation regimes across regions, an explosion of public debt levels in industrialized countries, and a structural shift in consumption patterns in developing countries. Traditional global inflation-linked bond indexes – by virtue of their market capitalization weighting methodology – are beholden to ILB issuance patterns around the world and turn a blind eye to desirable factors for investing in global inflation-linked bonds. As concerns about sovereign creditworthiness become increasingly critical to asset allocation, and as growth patterns and inflation realities diverge across regions, there is greater urgency for an alternative to traditional indexing approaches.
Through its unique construction methodology, GLADI ILB recognizes the need for investors to better position their global inflation-linked bond portfolios within this evolving global environment. Several core features distinguish GLADI ILB from traditional global inflation-linked bond indexes, including:
- An innovative GDP-weighting methodology that is designed to avoid the disadvantages of traditional indexes based solely on market capitalization weighting
- A continuum in coverage from developed to emerging markets, capturing the fuller set of global investment-grade opportunities and avoiding a bias in weighting toward developed markets
- 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 ILB weights constituent countries based on gross domestic product (GDP) as an alternative to the market capitalization weights used by most existing global inflation-linked bond indexes. GDP weighting offers a number of relative potential benefits:
1. Better alignment of investors’ bond exposures with countries’ capacity to pay.
Traditional ILB indexes use a market capitalization weighting approach, which aligns the investors’ country exposure with the arbitrary metric of national ILB issuance. By contrast, GLADI ILB’s GDP-weighted approach bases country allocation on national income (GDP), which should better reflect the capacity to repay debt.
2. More comprehensive inflation protection.
GLADI ILB’s GDP-weighted methodology gives investors exposure to countries based on their global economic significance. This includes exposure to leading developing economies, where inflation rates tend to be higher and more sensitive to key inflation drivers such as commodity prices. In addition, the GLADI ILB GDP-weighted approach incorporates a broader currency allocation concentrated in countries that are greater contributors to global growth. This may enhance overall inflation protection by capturing 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 ILB helps investors position their portfolios to reap potential first-mover benefits.
3. Favoring higher real yielding economies.
GLADI ILB’s GDP-weighted methodology emphasizes countries that contribute a larger share of global GDP, favoring higher growth countries over comparably sized lower growth countries. In addition, the inclusion of emerging market inflation-linked bonds may contribute to an elevated overall real yield, as these countries tend to exhibit higher growth rates with additional risk premium requirements. As emerging markets continue to develop, real yield convergence toward developed market levels represents the potential for further total return opportunities.