The sovereign debt crisis among developed economies and the loss of America's AAA credit rating by Standard & Poor's has forced real-money investors to reassess the way they analyse risks in government bonds.

Northern Trust Global Investments (NTGI) argues that sovereign debt should be assessed more like corporate debt. It has developed an internal methodology that separates developed-market debt into three buckets: core/prime, investment grade and high yield, says Wayne Bowers, London-based CEO.

This approach is designed to help investors get past passive allocations to traditional, market-cap weighted bond indices. Such benchmarks are inherently biased toward the biggest issuers, such as Japan and the US, which also suffer from debt burdens and yet, as liquid safe havens, perversely offer negative real yields on their bonds.

Risks among developed-market debt vary, which is reflected in a variety of spread levels. This is good in that it gives investors diversification and trading opportunities. But too many investors rely on credit-rating agencies for determining their idea about risk and asset allocation.

In an era where investors are putting a premium on transparency, understanding what's in their portfolio and de-risking, they should do more of their own analysis on government bonds, just as they would on corporate ones, Bowers says: "If you take such a view, you can actively asset-allocate against the benchmark."

Based on the firm's client portfolios, Bowers argues that traditional benchmarks leave clients overexposed to 'core/prime' and to 'high-yield' government debt, and not enough to 'investment grade'.

Examples of investment grade in Northern Trust's view include Italy and Spain, at least at the shorter end of their yield curves. "They are currently priced as though they were high yield, but their fundamentals do meet investment-grade standards," Bowers says. This analysis includes assumptions about revenues, tax rates, geopolitics and current account balances.

Much of this under-investment in investment-grade sovereigns is due to their relative lack of issuance, compared with the likes of America and Japan. One way around this is for investors to allocate equal weightings among G8 countries, or by GDP weights. Institutions in Scandinavia and the Middle East have taken both approaches, Bowers says. "There are different ways to create a passive allocation, all of which challenge the traditional index," he says.

Within these 'credit' buckets for sovereigns, investors can also find pair trades and other ways to exploit anomalies. For example, Northern Trust considers the US, the United Kingdom, Japan and Scandinavian countries as all 'core/prime', but factors such as politics mean they shouldn't be priced the same. Bowers declined to comment on what those price differentials should be.

Bowers says this credit-analysis-type approach to developed country debt is not yet applicable to emerging markets, even those with better fundamentals. They lack sufficient liquidity or have imposed capital controls. Over time, some emerging markets will qualify for such a framework, but for now remain a different kind of risk asset, in the firm's view.