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Stratton Street: Question bond index weightings

Bond investors who have allocated money based on the major global bond indices are missing out on better bond opportunities, according to Andy Seaman, Stratton Street Capital’s London-based partner and chief investment officer.

“Bond indices are constructed to give the biggest weight to the most heavily indebted countries and companies, as well as countries where populations are shrinking dramatically,” Seaman told FSA.

To determine heavily indebted countries, Seaman uses data on net foreign assets (NFA) – the value of the assets that country owns abroad, minus the value of the domestic assets owned by foreigners (chart below).

NFA is expressed in terms of percent. A negative NFA percentage measures the extent of a country’s indebtedness and he limits portfolio exposure to countries with an NFA that is better than minus 50%.

Examples of countries with a negative NFA, as measured by the firm, are Portugal, Greece and Spain. In addition, the working population in these economies is expected to drop 30% by 2050.

On the flipside, there are countries that are wealthier and have rapidly growing populations above the world average. Examples of such countries are in the Middle East, such as Saudi Arabia, Qatar and the United Arab Emirates, Seaman said.

The firm’s Next Generation Bond Fund invests in these wealthy countries. For example, large allocations are to Qatar (19.5% of the portfolio) and Abu Dhabi (10.88%), according to the fund factsheet.

The fund is also invested in indebted countries (up to -50% NFA). For example, the portfolio has nearly an 8% allocation to Mexico, which has an NFA position of -40%. However, it is expected that its working population will increase 30% by 2050, he noted.

NFA and defaults

For investors who are concerned about bond defaults, he said that countries that usually default are those that are heavily indebted.

Because of the NFA limit of -50%, Seaman claims that his firm has never had a default in any of its strategies since 2000.

Another firm product, the NFA Global Bond Fund, also allocates to the wealthier countries with growing populations. 

The global bond product is a pure investment grade fund and the currencies are always 100% hedged back into US dollars for the dollar class or in sterling for the sterling class, he said. 

The difference between the two funds is the investment strategy: The next generation fund is set up to have a minimum of 80% exposure to governments and quasi-governments, 80% to investment grade bonds, and can have up to 25% exposure to non-US dollar currencies.

It won’t always be the case that both funds have similar country allocations. “It just so happens at the moment that’s where the opportunities lie in both funds,” he said.

Diversifying bonds 

Investing in countries that are not on the global bond indices helps investors further diversify their investments, Seaman believes.

“If you’ve got six emerging market bond managers in your portfolio and they’re all invested in the same assets, the benefit of diversification is actually zero,” Seaman said. 

He acknowledged, however, that some investors feel uncomfortable taking exposure to countries not included on the main bond indices. Home bias prevails in any region.



Net foreign assets 

 Source: Stratton Street Capital



Part of the Mark Allen Group.