Impact of inclusion of government bonds to global indices

Abstract

In the recent past, we have seen paradigm shifts in investment strategies with passive investing gaining significant traction across the class of investors. Passive investing relies upon market efficiency as more and more investors/traders realize how difficult it is to outperform the market significantly and consistently. This exponential growth in passive investing has also been fuelled by advances in financial theory and technological innovations. This shift towards passive investing is more pronounced in fixed-income securities than any other asset class. The reliance on bond indices has surged amongst investors looking to diversify their portfolios across geographies while relying on cost-effective and transparent instruments. As these funds have gained immense prominence in the past decade, the quantum of capital flows that a country can access is hugely impacted by the composition and rebalancing of some prominent indices. On the upside, inclusion in a prominent bond index increases and diversifies the pool of external financing. But on the flipside, it increases the sensitivity of external flows to global factors. This research paper tries to elicit the impact of bond inclusion/exclusion from major bond indices on an economy’s overall well-being. For the purpose of this research, we have predominantly relied upon JP Morgan’s GBI-EM set of indices.