Global bond giant PIMCO, led by bond king Bill Gross, announced today that the firm was awarded a patent on a methodology for constructing investable fixed income indices.
The patent PIMCO just received pertains to the firm’s strategy of weighting the constituent securities of an index by measures like GDP, as opposed to most indices, which typically weight securities by market capitalization (a measure derived from the prices of financial assets).
So, if you invest in a PIMCO index constructed by this method, you’ll be getting more bonds from countries with bigger economies as opposed to more bonds from countries whose bonds just happen to currently be valued higher.
The fact that PIMCO was able to get a patent for its strategy caught us a bit off guard – it doesn’t really seem like the type of thing one would typically seek a patent for.
After all, this a big part of what PIMCO and many other firms do as investment managers – they construct indices comprised of various bonds (or other instruments) that give investors access to a range of securities in a single investment vehicle.
Nonetheless, they justify the patent by the fact that the methodology is considered intellectual property.
Below is more description of the methodology from PIMCO’s press release:
The methodology is designed to capture the ongoing transformations in global bond markets — in particular the shifting economic weight from developed countries to emerging markets — by assigning more appropriate portfolio weights rather than using a backward-looking, market-capitalization weighting common to most global bond indexes.
The GDP weighting approach is intended to help investors to gain a first-mover advantage by positioning portfolios in markets that are underrepresented in traditional indexes. GDP weighting also helps investors avoid the biases embedded in market capitalization-weighted indexes that concentrate large weights in the most highly indebted countries. In addition, GLADI makes fuller use of the global fixed income opportunity set, incorporating both nominal and inflation-linked securities.
A few other managers have been active in the patent space for similar reasons. One is Rob Arnott, who runs Research Affiliates, a fund with over $170 billion in assets under management. One of Arnott’s patents is for an indexing methodology based on various accounting metrics.
The Wall Street Journal’s Eleanor Laise covered Arnott’s patent award in 2009. At the time, she interviewed Arnott about the significance of obtaining it:
Research Affiliates sees the patent “as giving us the opportunity to license our ideas to a lot of folks,” Rob Arnott, chairman of Research Affiliates says. Companies licensing Research Affiliates’ fundamental indexes pay annual fees of 0.08% to 0.20%, depending on the amount of assets and the type of indexes being licensed, Mr. Arnott says. Firms like Charles Schwab Corp. and Allianz SE’s Pacific Investment Management Co. offer products based on these benchmarks.
Laise also received a few choice quotes from another manager that shed some light on the practice and how it is viewed in the industry:
Mr. Arnott isn’t alone in seeking to patent his indexing methodology. ETF provider RevenueShares Investor Services also has applied to patent its approach, which involves reweighting capitalization-weighted indexes like the S&P 500 by revenues. The fact that Research Affiliates was able to obtain a patent “is an encouraging sign,” says Sean O’Hara, RevenueShares’ president. “I don’t think anybody thought anybody would get a patent on any of this stuff,” he says. Yet “there’s a lot of folks investing a lot of money in this area and it makes sense to protect your intellectual property.”
Good investment ideas in the fixed income space seem harder to come by every day as investors chase decent yield returns to the ends of the earth. At least the managers will still be able to make their fees.
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