Why did you feel you needed an alternative to market-cap indices?
When we started working on the GDP-weighted indices in 2007 the idea that sovereign creditworthiness was a concern was rather more theoretical than practical. With the global financial crisis, and in particular the sovereign debt crisis in Europe, a much broader variety of investors recognized the weakness that market-cap-weighted indices have in favouring highly indebted borrowers. These investors realized that it is not just a theoretical weakness, but it is very practical.
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| Ramin Toloui, global co-head of emerging markets, Pimco |
We introduced these GDP-weighted indices in 2009 with $3 million of seed capital; now we manage $18 billion. And in the last year, in particular, some large investors have embraced this GDP-weighted approach. What is the underlying risk exposure?
These are global indices. Many of the investors are moving from a general global government bond mandate to a GDP-weighted global government bond index. They are simply redefining global investment in GDP terms rather than in market-cap-weighted terms. The index we have is local currency and hard currency. We have some investors who are just investing in local currency – this is predominantly a local-currency debt phenomenon, although our aggregated index also includes the hard-currency bonds. But some of the largest allocations have been in local-currency GDP-weighted debt.
Which region has been most interested in GDP-weighting?
This has been a very broad-based phenomenon; the interest is global. In the early years the demand was most aggressive from the US, where we have had most interest in our retail products – the mutual funds that individuals can participate in among pension plans. Last year we saw a big expansion of interest, from Asia in particular, and that’s largely been from sovereign investors and pension plans. And in Europe interest is probably strongest in our mutual funds, but there is also some institutional demand.
Have you updated the 1989-2009 study that showed an annual 34 basis point outperformance of GDP-weighted indices?
What was appealing about that study was that we had theoretical propositions about weighting by GDP that we thought would hold true; it ended up that the empirical evidence bore those out pretty well, but no, we haven’t updated that study since 2009.
Do you think some of the demand for recent frontier transactions is index-led?
There might be some index demand but I definitely don’t think that could be attributed to GDP-weighted indices. I wouldn’t say it’s index choice per se that is driving the heavy demand, it’s more a function that lots of money is flowing into credit and people are looking for extra spread wherever they can find it.
If GDP-weighted indices became more popular, could it change valuations of countries with relatively little outstanding debt?
You probably have to see a much bigger embrace of these indices by the market generally to start to have that influence on valuations. I don’t think that has happened yet. We are very pleased with the fact that we are managing $18 billion against our GDP-weighted indices, but the size of those flows isn’t meaningfully changing valuations at the moment. I think that primarily the biggest kind of squeeze is taking place in credit, and that’s just a function of the flows rolling into credit generally.
How important is the differentiation that Global Advantage brings to Pimco?
When we introduced this it was something that was very new. Being the first to have introduced a GDP-weighted index, and to have been awarded a US patent last year that recognizes that innovation, is an illustration of how we are trying to think ahead and develop solutions that generate attractive, risk-adjusted returns for our clients.
What do you think about other potential new index compositions: fiscally weighted or trade-weighted?
This is a very fertile area for people to throw around different ideas, but we have to have some humility about how much you can embed in an index. There is definitely a risk of trying to over-engineer and over-promise what an index can deliver, as opposed to what always is going to form active management and an individual portfolio manager. Our philosophy in designing our indices was to present what we thought was a better benchmark and a better guide for directing a portfolio, but the idea was that would be a benchmark and we would still be actively managing the portfolios. If there are countries we don’t like we can avoid them entirely – not just underweight them.
Do you plan to launch any new indices?
We are always discussing internally about adequacy of benchmarks and how they can improve, but nothing new is imminent. We are pretty satisfied with the formula we have embraced for Global Advantage; we have applied the same parameters to different parts of the global bond market. So, for example, we have an inflation-indexed version, a government-bond-only-version – that’s where most of our development has been and probably will continue to be.
