Euro Crisis Causes Shift in Use of Bond Indexes

Credit downgrades last week of France, Austria and other European countries throw a spotlight on a dilemma investors have been wrestling with for months: how best to build a safe portfolio of European government bonds.

Big investors such as pension funds and insurance companies are increasingly looking for alternatives to widely used indexes that have long been the road map for how most institutional portfolios are constructed.

“Investors are beginning to question, quite rightly, the integrity of some of the sovereign issuers in the composition of European and the global benchmarks,” says Bill Street, a senior managing director for global fixed income at State Street Global Advisors in London.

This shift has important implications beyond the world of index developers and pension funds. These kinds of changes in how pension funds and other large, long-term investors such as insurance companies invest means a shrinking of the investor base for countries such as Italy and Spain at a time when they desperately need to tap bond markets. And this kind of trend isn’t one that is likely to be quickly reversed. Pension funds, in particular, tend to move slowly when it comes to such fundamental aspects of their investment strategies.

The weightings of debt from different countries within these benchmarks provide the starting point for how institutional investors allocate their money as well as a guidepost against which they measure their performance.

But for investors in European government bonds, sticking with established indexes—such as those typically created by banks like Barclays and J.P. Morgan Chase—would mean continuing to funnel money designated for safe investments into debt from countries that have turned out to be more volatile and much riskier than had been thought.

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