Fixed-income indices have gained in popularity over the past decade, boosted in part by the growth of the smart beta market. These indices usually include corporate bonds and sovereign debt. Depending on the type of fixed-income index, risk and return profiles can vary greatly.
Fixed-income indices are regularly used as non-investable benchmarks. Benchmarking in the fixed-income space is a contested topic: while equity benchmark indices are weighted by the size of their constituents, fixed-income benchmarks are weighted by levels of indebtedness. This creates biases towards countries, companies and sectors which tend to be high issuers.
Smart beta providers have begun to target the inefficiencies of usual benchmark indices by offering custom indices with weightings towards GDP, for example.
But the fixed-income market is a relatively difficult one for smart beta providers to infiltrate, partly because of liquidity constraints and the need to keep smart beta indices strictly rules-based.
Replicating indices is more challenging than it is with equities, as the underlying instruments can be more difficult to access.
While the low interest rate environment has helped spur the rise of customized fixed-income indices, interest rates are expected to increase in coming years. As such, investors will need to ensure healthy diversification of their fixed-income portfolios as the market gradually alters.
But as demand for passive investing continues to swell, so too will the demand for fixed-income indices. Given the size of the global fixed-income market, the opportunity for index providers is not insignificant.