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By guest contributor, Brandywine Global
Stock indices are meritocracies. The biggest companies in the S&P 500 made money for investors, achieved profitability and growth and rose to positions of respect and prominence. Fixed-income indices are the opposite of meritocracies – the countries with the largest allocations in capitalisation weighted, global fixed-income benchmarks achieved that status by being the most indebted. They ran the biggest deficits and were the least disciplined in their control over costs relative to revenues.
Using fixed-income indices as a framework for taking risk simply does not make sense. Investing in an index-like strategy leads investors to hold positions in countries that issue significant debt without any consideration for the return potential of those securities. In the current environment, major developed countries are issuing massive amounts of debt at extremely low yields. We believe this represents a significant misalignment of interests between issuers and investors since issuers are seeking to minimise their interest costs while investors seek to maximise their return.
In our view, the current massive debt issuance in the developed world illustrates the flaws of index-relative investing in fixed income. Now, more than ever, the index conceals opportunities and exposes investors to risk by driving them towards newly issued sovereign debt, “crowding out” the world’s emerging powerhouses.