International investors are dissatisfied with the various corporate bond indices currently on offer, according to a report issued by EDHEC-Risk Institute.
In its survey, entitled ‘Reactions to “A Review of Corporate Bond Indices: Construction Principles, Return Heterogeneity, and Fluctuations in Risk Exposures”’ researchers at the Institute analyse industry reactions to a previous EDHEC-Risk study on corporate bond indices. Among the main findings of the survey:
- Only 41% of respondents were satisfied or very satisfied with corporate bond indices, confirming that current versions do not meet investor needs.
- Most respondents saw instability in corporate bond indices’ risk factor exposures; between 64% and 80% agreed or strongly agreed that the instability of interest rate risk exposure is problematic, while 45% agreed or strongly agreed that bond issuers and investors have conflicting interests when it comes to the duration of corporate bonds. The Institute comments that using derivative instruments may appear to be a solution to interest rate risk instability, as in principle one can create an overlay strategy that neutralises the fluctuation of risk exposures in the underlying index, but only 57% of respondents indicated that they can use derivatives for such purposes, leaving almost half of them with no tools to manage the instability problem.
- The instability of exposure to credit risk was also identified as problematic by about two in three respondents, leaving a minority who said that they would have the ability to use derivatives products to manage instability.
- Nearly half of the respondents recognise that there is a direct trade-off between an index’s risk factor stability and its investability, which will probably present obstacles to index providers who wish to provide indices created to be the foundation of an investment vehicle. The various issues identified for corporate bond indices may be one of the reasons for the current relative unpopularity of passive investing in the corporate bond market.
- As corporate bond indices should allow investors to achieve specific objectives, particularly in managing defined risk factors, it will be increasingly important for index providers to construct indices using methods that account for the stability of these risk factors. According to the Institute the new forms of corporate bond indices fail to take this dimension into account.
EDHEC-Risk Institute has campuses in Singapore, established at the invitation of the Monetary Authority of Singapore (MAS); the City of London in the UK; Nice and Paris in France; and New York in the US.