Government debt sustainability

Key takeaways:

• The FTSE Debt Capacity World Government Bond Index (DCWGBI) captures relative differences in sovereign debt/GDP ratios and debt/service costs by index constituents, and adjusts sovereign weights accordingly, giving investors protection against deteriorating debt dynamics and sustainability
• The DCWGBI has consistently outperformed the WGBI, during its first 10 yrs, and particularly since Covid in 2020, reflecting US sovereign spread widening, and the US underweight, and superior credit quality in the DCWGBI
• If investor concerns about debt sustainability deepen, this may drive further outperformance by the DCWGBI, given its relative weights

Points of differentiation:

• Sovereign fiscal factors used in DCWGBI are refreshed annually to reflect changes in debt sustainability
• The index works symmetrically - if debt sustainability metrics improve, the index has the capacity to increase a sovereign weighting accordingly, reducing the risk of underperformance, as well as to reduce weightings if debt sustainability deteriorates
• Sovereign weights are calculated using a non-linear function, which differentiates the fiscally healthier economies from the less healthy ones while not significantly discriminating against the various countries within each cluster
• The Research paper also looks at the reasons behind the deterioration in US debt sustainability, and the changing relationship more generally between monetary and fiscal policy

What does our research mean for investors?

• Investors are able to make better informed asset allocation decisions about debt sustainability
• Investors are able to assess how relative debt metrics between countries have changed