Types of Fixed-income Indexes

Purpose of fixed income Indexes

Fixed-income indexes are pivotal in tracking the broad risk and return of bond markets. They serve to evaluate market performance, benchmark the performance of investments and investment managers, and lay the foundation for indexed investment strategies.

Equity vs. Fixed-Income Indexes

While they share similarities in function with equity indexes in stock markets, fixed-income indexes have distinct characteristics that set them apart.

Distinguishing Features of Fixed-Income Indexes

1. Multiplicity of SecuritiesA unique aspect of the fixed-income market is that a single issuer can have multiple securities. This leads to fixed-income indexes having a larger number of constituents compared to equity indexes. In fact, certain indexes can have over 10,000 constituents.
2. High TurnoverThe inherent nature of bonds, with their finite maturity and the frequent introduction of new issuances, results in a higher turnover for fixed-income indexes. A common practice is the monthly rebalancing of these indexes to accommodate new issues and phase out those nearing maturity.
3. Weighting MechanismIn a manner similar to equity indexes, which are weighted by issuers’ market capitalization, bond indexes typically weigh constituents based on the market value of outstanding debt. This means that broad bond indexes can undergo changes over time, reflecting shifts in the bond market landscape, such as the balance between public and private issuer debt, changes in maturity lengths, and shifts in credit quality. A notable observation is the significant weightage of government debt in many broad bond indexes attributed to the substantial issuance volume by government entities.

Classifying Fixed-Income Indexes

1. Aggregate Indexes: Characterized by a vast array of constituents.
2. Narrower indexes: These are more refined, drawing criteria such as sector, credit quality, maturity duration, geographical focus, and ESG considerations.

It is imperative that the chosen index resonates with the investment strategy of the fund or manager in question.

Illustrative Examples

1. Bloomberg Barclays Global Aggregate IndexThe inclusion criteria is summarized below:
   1. Issuers: Fixed-rate bonds from various entities, including sovereign, government, corporate, and securitized issuers from both developed (DM) and emerging (EM) markets.
   2. Currencies: Encompasses 28 currencies from the Americas, EMEA, and Asia Pacific.
   3. Credit quality: Must have an investment-grade rating or its equivalent.
   4. Maturity: Bonds should have at least a year to final maturity or an average weighted maturity.
   5. Rebalancing: Done monthly, adjusting for new issues and removing bonds that no longer meet criteria.
2. J.P. Morgan Emerging Markets Bond Index Plus (EMBI+)The inclusion criteria is summarized below:
   1. Issuers: Focuses on emerging market sovereign entities issuing US dollar debt.
   2. Currencies: Only includes US dollar-denominated bonds.
   3. Credit quality: Bonds rated Baa1/BBB+/BBB+ or below by major rating agencies.
   4. Maturity: Considers bonds with at least 2.5 years to maturity, excluding those falling below a 12-month maturity in the upcoming month.
   5. Rebalancing: Done on the last US business day of each month.
   6. Characteristics: This index zeroes in on US dollar–denominated debt from sovereign governments with a specific credit quality, targeting higher returns than developed market sovereign bonds.
3. Bloomberg Barclays MSCI Euro Corporate Sustainable SRI IndexThe inclusion criteria is summarized below:
   1. Issuers: Corporate entities like industrial, utility, and financial institutions.
   2. Currencies: Only includes euro-denominated bonds.
   3. Credit quality: Bonds rated Baa3/BBB-/BBB- or above by major rating agencies.
   4. Maturity: Bonds with at least a year to final maturity are considered.
   5. Rebalancing: Done on the last US business day of each month.
   6. ESG rules: Bonds must have an MSCI ESG rating of BBB or higher and exclude issuers involved in certain business activities or controversies.

Incorporating ESG in Fixed-Income Indexes

ESG-focused bond indexes adopt a rigorous screening process to exclude issuers that don’t meet certain ESG benchmarks. This can involve filtering out issuers engaged in specific business activities or those that don’t achieve the required ESG ratings.

Question 1

Which feature best distinguishes fixed-income indexes from equity indexes?

1. Fixed-income indexes are weighted by issuers’ market capitalization.
2. A single issuer in the fixed-income market can have multiple securities.
3. Fixed-income indexes have fewer constituents than equity indexes.

Solution:

The correct answer is B: One unique aspect of the fixed-income market is that a single issuer can have multiple securities, leading to fixed-income indexes having potentially many constituents.

A is incorrect: Both equity and fixed-income indexes can be weighted by market capitalization or the market value of outstanding securities.

C is incorrect: Fixed-income indexes can have a larger number of constituents compared to equity indexes, with some having over 10,000 constituents

Question 2

Which index would most likely exclude issuers involved in the alcohol and tobacco industries due to ESG considerations?

1. Bloomberg Barclays Global Aggregate Index
2. J.P. Morgan Emerging Markets Bond Index Plus (EMBI+)
3. Bloomberg Barclays MSCI Euro Corporate Sustainable SRI Index

Solution:

The correct answer is C: The Bloomberg Barclays MSCI Euro Corporate Sustainable SRI Index has ESG rules that exclude issuers involved in certain business activities, including alcohol and tobacco.

A is incorrect: The Bloomberg Barclays Global Aggregate Index does not specifically mention excluding issuers based on ESG considerations related to alcohol and tobacco.

B is incorrect: The J.P. Morgan EMBI+ does not specifically mention ESG considerations in its criteria.