Adapting to the market’s evolution

How can investors adapt as the bond-market evolution continues and perhaps accelerates? I think one of the most important steps an investor can take is to take a close look at their fixed-income portfolio’s benchmark.

The bond-market indices that most investors use as portfolio benchmarks are weighted by market capitalisation, which means countries that borrow the most also have the largest weighting in the index. As a result, developed markets can account for more than 80 per cent of a standard global treasury index. Not surprisingly, many investors I have talked to have expressed concern about this approach.

The course I recommend is to adopt a benchmark that uses GDP growth rather than market capitalisation to determine weightings. In my view, GDP- weighted indices have two key advantages over traditional cap-weighted indices.

First, they moderate exposure to highly indebted countries that continue to trade at a premium based on their traditional designation as safe assets.

Second, GDP-weighted indices increase exposure to growth and emerging countries, and thus better reflect both the current state of evolution in the bond market as well as the future growth opportunities in the global fixed-income markets.

For example, two of the biggest effects of GDP-weighting are a sharp decline in developed market weightings (about 23 percentage points) and a sharp increase in the weighting of growth economies (about 20 percentage points).

Evolve or perish

Being early in identifying market trends typically brings great investment rewards. The rise of growth and emerging markets is clear from an economic perspective, yet investors still seem reluctant to embrace the notion. I believe that investors who are willing to accept the evolutionary process and increase their weighting to emerging and growth markets will be rewarded with better risk-adjusted returns.

History clearly demonstrates what happens to those who are not able to evolve. I think it is time to reconsider bond allocation.

Andrew Wilson is co-head of global fixed income at Goldman Sachs Asset Management