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Passive perspective: How to handle the govvies and gilt complex

Passive perspective: How to handle the govvies and gilt complex

The constituents of global government bond indices should worry investors and excite those marketing active funds.

Deep in debt

The Bloomberg Barclays Global Aggregate index, for example, has a 40% weighting to the US, where serving the national debt is a political bargaining chip. The index’s next three largest allocations are to Japan, Germany and France, where sovereign yields are negative to around the five-year point.

Just as equities indices feature the largest companies, so bond yardsticks are bloated by the biggest debtors. But this does not seem to bother fund buyers. In the past year, a net £8.6 billion has gone into global bond exchange-traded funds (ETFs) worldwide, according to data provider TrackInsight.

Flows into actively managed global bond funds in the UK have been positive too, with the sector attracting a net £2.3 billion in the past year. But active managers must wonder why they are not taking much more of the money allocated to the sector.

Negative performance

Part of the reason is performance. In the past three years, the average active global government bond manager has failed to deliver positive risk-adjusted returns, with the average manager information ratio in the sector -0.184 on an equal-weighted basis.

Moreover, the average investor in the sector has undershot even that. Indeed, funds with negative risk-adjusted returns for the period represent 57% of the global bond category by market share. In this sub-segment, the average information ratio has been -0.44 over the past three years.

Active global government bond managers look a lot better over the past year, with an average information ratio of 0.99, indicating they have comfortably beaten the index. The damage may nevertheless have already been done to active managers’ reputation here.

A world of choice

So, what are the options for those wanting to invest passively in global bonds? The cheapest and broadest vehicles are tracker funds, with the Vanguard Global Bond Index, available for 0.15% (plus a 0.2% initial charge), and the narrower iShares Overseas Government Bond Index, for 0.11%.

On the ETF side, the least expensive London-listed equivalent is the dollar-denominated iShares Global Government Bond Ucits ETF, with ongoing charges of 0.2%. Deutsche Bank’s db x-trackers Global Government Bond Ucits ETF also carries a 0.2% all-in fee, but only for the unhedged version (hedged varieties come in at 0.25%).

Deutsche also offers the db x-trackers Barclays Global Aggregate Bond Ucits ETF. This has a 0.3% fee, but has a far broader portfolio that includes corporate debt.

An underlying alternative

For a smarter beta alternative, one of the few global bond products is the ETFS Lombard Odier Global Government Bond Fundamental GO Ucits ETF. This does not weight its index by the amount of debt issued by a country. Instead, it allocates according to a combination of an issuer’s current indebtedness, its revenues, and its social and political stability.

It is thus more active than those weighted by issuers’ gross domestic product and is also rebalanced every month. This process inevitably results in a very different portfolio. Here, the US drops down to a 12% weighting, and there are higher allocations to the Czech Republic and Mexico than to the UK.

The characteristics of the underlying bonds differ more subtly from traditional indices. The average coupon in the Lombard Odier ETF is 3.5% and the average maturity 8.4 years. This compares with equivalent figures of 2.5% and 8.6 years for the Vanguard Global Bond Index.

The emphasis on fundamentals seems to have been rewarded. The Lombard Odier ETF, which has a 0.25% fee, is up 12% so far this year, while the broader Vanguard index gained just 2.1%.

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