Sovereign debt market has seen rate convergence due to factors such as:

• European Monetary Union

This has seen the convergence of rates between the eleven (now twelve) European countries in Euroland. For example, eight years ago the difference between the German and Italian ten year bond rates was 5.5 percentage points, today the difference is 0.4 percentage points

• A tendency towards centre-rights economics and a convergence of economic indicators has seen a convergence of interest rates globally.

Sovereign debt insurance is in the decline on a relative and an absolute basis due to fiscal surpluses being used to repay government debt and the rising of funds through the sale of state owned enterprises. The new entities may issue debt in their own name but this new debt is no longer sovereign debt.

In a qualitative sense it is not very difficult to explain why global bonds may have converged and return opportunities declined. The reasoning revolves around improvements in access, technology and communication.

• Access to individual country markets has become easier. Offshore investors are able to gain ready access to markets which previously were difficult to invest in and even more difficult to exit. Settlement processes are not the barrier they once were and many previously illiquid markets are now readily accessed. greater activity in the emerging markets is testimony to this improved access.
• Global industry standards have seen investors more willing to invest in previously more uncertain markets. For example, Standard and Poor's country credit ratings provide investors with an added level of comfort when taking an exposure to an emerging market.
• Technology has significantly reduced the information arbitrage. The speed of processing information and dissemination has made markets more efficient. processing speed has allowed investors to dissect performance components more accurately and to quickly identify and take advantage of opportunities when they occur. management and processes have adjusted accordingly. Processing speed has enhanced the use of synthetics which in themselves have also made for quicker market responses resulting in reduction in the size and frequency of opportunities.
• Improved communications has not only made for more efficient markets but it has meant that where previously investment management reams were localised and isolated. Today technology has allowed global investment management teams to be virtually in real time contact.

On the probability of default basis investors in non-government debt are more than adequately compensated. A ten year Standard and Poor's rated BB (speculative) security as at the end of July yielded 10.81%. BB securities have historically over the fifteen years to 1997 had a cumulative default rate of 15%. Using 15% as the probability of default gives an expected return of 7.57% for the debt security which compares well with the ten year Treasury bill which yielded 6.11% at the time.

From a portfolio optimisation point of view the inclusion of non-sovereign debt may enhance the risk/return relationship due to the added diversification value available from increasing the universe of available securities.

The Lehman Global Aggregate Index

Credit rating moves down a couple of notches from the Salomon Smith Barney World Government Bond Index (WGBI) S&P ratings of AAA to the LGA rating of AA. The existing mandate requires securities to be of AA-rating or better the proposed mandate requires a duration weighted average rating for the portfolio of AA- or better. The key difference is that it is a weighted average rating hence high yield debt would be permitted in portfolio.

Lehman Global Aggregate as at 31st July, 2000

Conclusion

Managers restircted to purely sovereign debt will need to take fewer but greater positions to achieve returns seen in the past. Moving to the Lehman Global Aggregate index benchmark/mandate should see a more efficient product offering to clients, indeed the change of benchmark is becoming an industry trend amongst global bond managers.