desirable on a risk-adjusted return basis; iii. Changes in the composition of benchmarks themselves.

This third driver—benchmark composition changes—is important. Inclusion or exclusion in widelyfollowed bond indices can have a major impact on global investors’ asset allocations, and hence on net foreign flows. The announcement that South Africa would be included in Citigroup’s World Government Bond index (WGBI), against which it is estimated that about US$2 trillion in AUM are benchmarked, provides a recent example.<sup>13</sup> Citigroup announced that South Africa’s inclusion was being considered in April 2012 and the final announcement was made in June 2012.

While this was just one factor influencing the South African bond market over this period, the announcement does appear to have triggered a discernible upturn in net foreign purchases of domestic currency bonds, including the biggest daily net inflow seen in recent years just after the initial announcement (Figure 8); yields also fell. Contemporary estimates of the value of fresh inflows into South African bonds due to purchases by WGBI-benchmarked funds were US$5-9 billion, or up to about 10% of total market capitalization.<sup>14</sup> In 2010, when Mexico was added to the WGBI, foreign purchases of its domestic bonds surged by US$11 billion over the year, resulting in a 7 percentage point rise in the proportion of bonds held by foreigners, to 31%.<sup>15</sup> It is less easy to quantify the indirect, but generally positive, impacts of the increased visibility that high profile index inclusion brings.

South Africa brings to four the number of EMs currently included in Citibank’s WGBI (along with Malaysia, Mexico and Poland). These countries are constituents both of EM-only bond indices, and of very widelyfollowed global bond indices comprising both “developed” and “emerging” markets. This exemplifies the blurring of the traditional lines between asset classes, a trend, which the explosion in public debt in advanced economies since the financial crisis, has surely accelerated.

The convergence of EM debt ratings with those of developed markets provides a clear illustration of how traditional asset class definitions are being challenged. EM local and hard currency sovereign debt ratings upgrades have significantly outweighed downgrades since the global financial crisis, while the opposite is true for developed market debt. This trend reflects the increased macroeconomic and balance sheet strength of many developing countries. Although less easily quantifiable, improvements in policymaking environments in EMs is another factor driving improvements in EM sovereign ratings and increasing asset allocations to these markets. Interested readers are referred to Public Debt Management in Emerging Market Economies: Has This Time Been Different?, Anderson et al (2010), which provides an overview of how these factors, along with improved debt management practices, helped minimize the impact of the global financial crisis on EMs.

> 13 Reuters, _South African bond rush_ (Rao, S., 10 May 2012)

> 14 Reuters, _S.Africa to join Citi world bond index in October_ (11 June 2012)

> 15 Reuters, _South African bond rush_ (Rao, S., 10 May 2012)

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