PIMCO avoids UK, U.S. printing presses

July 20, 2009

REUTERS— Margaret Doyle is a Reuters columnist. The views expressed are her own —

One of the challenges for bond investors over the coming years is how to deal with the enormous ballooning of government debt that is happening as a result of the credit crisis.

Traditionally, investors allocate funds between asset classes and require managers to manage to a benchmark. However, most indexes are based on market capitalisation: the securities with the biggest value in aggregate have the largest share of the index.

This is less than ideal in equity markets, where indexing can lead to herding by forcing investors to buy overvalued shares. But it is particularly perverse for bond investors. The countries with the largest weightings in the indices are those that have issued the most debt.

At present those are the countries with the most colossal deficits to finance. So, traditional index-tracking bond funds are being obliged to allocate more money to precisely those countries whose creditworthiness is decreasing fastest.

PIMCO, the world’s biggest bond investment manager, has come up with a new index — the Global Advantage Bond Index (“Gladi”) — that tries to get around this problem.

Gladi, which is being administered by Markit, a global index provider, is weighted by national income rather than by historic debt issuance. When initially launched, after 2 years of research, earlier this year, it was pitched as a way of “building in a tilt toward these countries that are developing rapidly but their capital markets and market capitalization haven’t caught up yet.”

However, now it is being marketed as a way for pension fund trustees and other investment managers to avoid increasing their exposure to the debt of countries like the United States and the UK, which are planning to issue trillions of dollars worth of bonds over the next few years to pay for their bank bailouts and to stimulate the economy.

Indeed, PIMCO reports that some clients want to avoid government bonds — which account for around 50 percent of traditional bond indexes (the remainder is roughly split 50/50 between corporate bonds and various mortgage-backed securities), altogether.

In the past, governments have found cunning ways of increasing demand for their bonds, whether patriotism, to flog war bonds, or requiring insurers to hold more “safe” gilts as a hedge against long-term liabilities. Now regulators are going to require banks to hold more capital, and more of it in the form of liquid instruments, i.e., government bonds.

However, they will also need to persuade non-bank investors to buy their bonds if the interest burden is not to spiral out of control. And unfortunately for the deficit-hit governments, investors seem to have seen them coming.

(Editing by David Evans)

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