Salient to Investors:

The world’s biggest investors are moving away from allocating money to government bond markets based on their amount of debt – a preference that has favored the largest borrowers for three decades. Allocations of bond funds based on GDP are still a small part of the total. Indexes based on GDP are doing better than those based on debt outstanding.

Norway’s sovereign-wealth fund and Pimco are shifting to indexes that favor less-indebted nations with growing GDP, such as Brazil and South Korea. Pimco increased Mexican allocations and decreased US allocations. BlackRock has $3 billion tied credit-worthiness rather than capitalization.

G-7 bonds underperformed global government debt in 2012 by the most on record.

Saumil Parikh at Pimco sees evidence of the reallocation, and says the tyranny of market-cap indexing is going to reverse.

Chris Redmond at Towers Watson said investors can’t always get bonds of countries with the highest growth rates, such as China and India, because of restrictions on foreign ownership.

Chris Orndorff at Western Asset Mgmt said the full evolution may take a decade to be realized.

The median economist expects US GDP growth to slow to 2 percent in 2013 and Japan to slow to 0.7 percent in 2013.

Jeffrey Frankel at Harvard said the move away from cap-based bond benchmarks may cause higher borrowing costs for countries with elevated debt to GDP over the next few years.

Thomas Christiansen at BlackRock Investment Institute said market-cap weightings essentially reward failures, so longer-term some of these countries might now become more fiscally responsible.

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