EDHEC-Risk Institute Survey Confirms Investor Dissatisfaction with Corporate Bond Indices

In a survey entitled ‘Reactions to “A Review of Corporate Bond Indices: Construction Principles, Return Heterogeneity, and Fluctuations in Risk Exposures”’ researchers at EDHEC-Risk Institute have analysed industry reactions to a previous EDHEC-Risk study on corporate bond indices and confirmed that investors are dissatisfied with the indices currently on offer.

Among the main findings of the survey:

 Only 41% of respondents are satisfied or very satisfied with corporate bond indices, a level which confirms that current corporate bond indices do not meet investor needs.

 The instability of corporate bond indices’ risk factor exposures was affirmed by the majority of respondents. Between 64% and 80% of respondents agree or strongly agree that the instability of interest rate risk exposure is problematic. 45% of respondents agree or strongly agree that bond issuers and investors have conflicting interests when it comes to the duration of corporate bonds. 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 indicate 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 is also identified as problematic by about two-thirds of respondents. In that case, only one-third of respondents say 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. We observe unfortunately that the new forms of corporate bond indices do not take this dimension into account.