The world economy grows, and shrinks, capital markets change, technology improves, crises rock the equilibrium and investors carry on adapting, fast. It has been well documented how the introduction of the euro would, at a stroke, create a huge new market that would provide a new melting pot for the European capital markets. The Euro-zone bond market became, on January 1, 1999, the second largest bond market in the world.
Everyone agrees there have been many big changes to the world of fixed income investing in recent months and years, perhaps the most significant being the emergence of a viable credit market outside the US. Investing in non-government/ credit bonds has been part of the culture in domestic US fixed income for over 20 years and the market there is huge, with great diversity, depth and liquidity. The situation in Europe is at present far behind, but is catching up surprisingly fast.
An interesting paper investigating the arguments for and against credit bonds, published by ABN Amro Asset Management*, in August last year, concluded that “a compelling case can be made to include investment grade bonds and/or high yield bonds in the strategic benchmarks of most investors. It adds that market timing has to be carefully examined as it can take many years for the deleterious effects of ‘bad years’ to be evened out by the good ones. The authors are careful to highlight that the situation for emerging market bonds is considerably more ambiguous and advise “defensive investors should not have a significant strategic allocation towards emerging market bonds, but may of course want to allocate tactically”.
There is fierce competition between the index providers, with Lehman Brothers and Merrill Lynch leading the charge into providing broader and, some would argue, more useful – both to investors and their clients – benchmarks. Lehman Brothers has been hugely successful in the US and, according to an Institutional Investor survey, 90% of all US fixed income investors use Lehman Brothers’ family of indices. Explaining why Allianz Asset Management had chosen the Lehman family of indices, Anja Mikus, managing director of Allianz PIMCO Asset Management, points to Lehman’s success in the US and adds, “The Lehman indices provide us with what we need – an index that reflects the broad range of different security types, like governments, corporates, etc.”
According to Lehman Brothers the evolution of the global capital markets has been accelerating since 1986, and it is still doing so. Lehman Brothers’ Neil Wardley describes how initially the interest in broader indices within Europe was minimal, but has grown substantially over the past two years. He goes on, “We have done lots of presentations to many very interested investors, and we are sure that interest will carry on increasing. We are seeing a trend out of government-only benchmarks and into benchmakrks with credit exposure.”

Investors throughout Europe have been quick to move with the trends and most are at the very least reviewing their old government-only benchmarks. Many have already made the switch into the broader indices. Allianz quickly changes many of its portfolio benchmarks, says Mikus, who is in charge of fixed income. She goes on, “After the introduction of the euro, it was obvious to us that corporate credit would become an increasingly important part of our domain. We have chosen the Lehman indices for our master portfolios as benchmarks because we felt that their families of indices most accurately reflected our growing global goals. However, there are some clients who for special and valied reasons are sticking to their own benchmarks,and of course we are prepared to accommodate them.”
Persuading clients to change benchmarks from the perceived ‘safety’ of government-only indices is not going to happen overnight, but it is greatly aided by careful guidance up the learning curve.
Jean Pierre Grimaud is head of fixed income at HSBC Asset Management Europe in Paris, which was until the end of January this year known as CCF Asset Management. He explains that some clients have found it quite easy to make that leap. “We have gone to many of our clients and have described to them projected developments in an index such as the Salomon Smith Barney World Government Bond Index over the next few years. By that time the share of the Japanese government bond market will have grown to about 30–35% of the index. It is then not so hard for clients to agree they do not want to have so much Japanese debt, especially with such low rates and a fast deteriorating credit quality, and that other indices which include credit markets might be much more suitable.”
Grimaud points out that virtually any benchmark that includes credit will have a higher US content because of the size of the non-government market there. Using figures from the Lehman Brothers Global Family of indices as of January 2000, which included high yield market figures not used in the more common Aggregate Indices, the total size is some $14.2trn. US governments account for approximately 15%, pan-European 23%, while US corporates including the high yield market make up almost 14%, dwarfing the 3.9% share of its pan-European equivalent.
He argues that including credit is logical for global investors because it gives a more realistic reflection of what is readily available to investors in the ‘real’ world. “Ten years ago investing within the Euro-zone meant investing in government and quasi-government debt. But the market is of course changing quite fast now. The supply of government paper is diminishing as governments seek to reduce both budget deficits and overall levels of public debt.”
Grimaud agrees that it may be more difficult for governments to be cutting deficits when economies are weak, but argues that, according to his group’s economic forecasts, this slowdown is not going to be that severe anyway.

Even for those companies whose clients have not yet fully adopted the new world of broad benchmarks, Europe’s investment management companies are changing. CDC Ixis Asset Management has recently completed the $2.2bn (E2.3bn) acquisition of Nvest, a US investment manager specialising in high yield, credit and equity investing. Roland Lescure says, “We certainly have many plans to develop more credit analysis. At the moment we are either managing monies benchmarked to government bond indices but with allowances to go into credit, or we can now offer a global range of products including US credit funds. We do know that our clients here in France and across Europe are interested, but at the moment they are tending to stick with government bonds in Europe but are happy to take on US credit. So the appetite for risk is there.”
That the pace of change in global capital markets is still increasing is not in question. Wardley from Lehman Brothers points out, “What has surprised us has been the early interest in macro indices, ie, those that encompass government, credit and importantly the high yield markets too. We thought we would see a move to the globalisation, or unification, of indices over the course of the next two to three years. What we have actually seen is that demand happening already.”
* Credit Bonds as an Asset Class – Is there a role for credit risk in the benchmarks of traditionally diversified investors?” ABN Amro Asset Management Global Consulting Group, August 2000, page 9