Bond indices were never intended to form a basis for investment, but merely reflect a market. As a consequence they expose investors to unintended risks and are not a rational investment strategy.
Indices were never meant to drive investment strategy
Bond indices, like all market indices, aim to represent a segment of the investable universe. Although they are widely tracked by ETFs and other passive products, they were never really intended to represent an investment strategy but rather a set of common securities. As indices have become the measure for investment performance, managers are often incentivised to stay close to their benchmarks.
Creditworthiness not assessed
Creditworthiness is not assessed either. In fact, weightings are based on those with the greatest liabilities not the greatest capacity to pay. Index members with the most debt potentially pose more risk than those with less debt, so index tracking can contradict a rational investment strategy where weightings should be based on return for risk or at a minimum economic scale. As such, they are a suboptimal way of determining real investment value or gaining a representative economic exposure to any market segment.
Our funds are benchmark agnostic
Although we recognise that benchmarks offer a guide to the risk profile of a market (average credit rating and duration), the inherent flaws associated with the over-representation of debtors need to be mitigated by an actively-managed investment strategy. Avoiding risk associated with benchmark exposure is key to the management of our relative value bond funds.
Benchmarks are overly exposed to the most indebted countries
Top-down and bottom-up screening
There are two dimensions to this. First, geographic exposure is a major determinant of risk in fixed-income markets and using screens to assess fundamental strengths on this basis trumps benchmark-weighted strategies in our view. Second, all funds in the range use our bespoke bottom-up relative value model. This model helps us optimise credit selection for a given fixed-income asset-allocation framework and is based on top-down macro factors (such as the level of subordination, geography, duration and credit quality).
For more information on the relationship between duration and relative value, read our whitepaper A Theory of Relativity.