Tag Archives: portfolio allocation

Should Bond Benchmarks Shift from Traditional to GDP-Weighted Indices?

Some prominent institutional bond investors are shifting their focus away from traditional benchmark indices that weight countries’ debt issues by market capitalization, toward GDP-weighted indices.   PIMCO (Pacific Investment Management Company, LLC, the world’s largest fixed-income investment firm) and the Government Pension Fund of Norway (one of the world’s largest Sovereign Wealth Funds), have both recently made moves in this direction.  

There is a danger that some investors will lose sight of the purpose of a benchmark index.   The benchmark exists to represent the views of the median investor dollar.  For many investors, going with the benchmark is a good guideline – especially those who recognize themselves to be relatively unsophisticated and also those who think they are sophisticated but really aren’t.   This is the implication of the Efficient Markets Hypothesis (EMH), for example.  

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Q: So What Should I Invest in? A: Munis

“What should I invest in?” We economists get asked this question all the time. Many members of the profession believe that Efficient Markets theory forbids us from giving an answer – beyond recommending “a well-diversified portfolio.” Perhaps a few of us won’t countenance a question that ends with a preposition. But the rest of us would like to be helpful. Even so, the past year has been a difficult time to give an answer.

One can no longer recommend euros or commodities, as the (somewhat predictable) appreciations there have already taken place, over the last five years. As for equities, corporate bonds, and housing, they have all been measurably overvalued for awhile. Even if one believed that the corrections in those three markets were now largely complete, it would be hard to predict that their rates of return on average over the next 25 years will be anywhere near as great as over the preceding 25 years. But, complains the investor, I have to hold something.

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