What are bond indices?

iBoxx indices
What are bond Indices?

Today’s bond market

"Bonds play
The bond market is the largest securities market in the world. a vital role in
With $87.2tn outstanding, it far surpasses the more popular equities market, which enjoys a greater share of
the media spotlight.1 However, bonds play a vital role in the functioning of the global financial system. They link the functioning
lenders (investors) with borrowers. In buying a bond, an investor is essentially providing a loan to the bond issuer
who in return will pay back the full loan with periodic interest payments. How do investors connect with the bond
of the global
market to access investment opportunities globally? Enter bond indices and index investing. financial system."

What is an index?
An index is defined as a statistical measure, typically of a price or quantity,
calculated from a representative set of underlying data.2
Most commonly known for its role as a benchmark, an index can be described as the standard against which the
performance of a financial instrument can be measured. In this role, an index provides a way to measure the
performance of a specific segment of a financial market, i.e. comparisons within a region, industry sector or other
asset classes.

A bond index is used to measure the value of a section of the bond market. It can be defined by specific characteristics
such as maturity or credit rating to capture a narrower slice of the market.

How are indices used?

As a measure of performance, investors, central banks and regulators use
indices to gauge market developments. "Aside from
Aside from acting as a barometer of market temperament, indices also play a significant role in both active and
acting as a
passive fund management strategies. barometer
An actively managed fund (one that seeks to outperform the market) will use an index as a benchmark to measure of market
performance. Passively managed funds, also known as “passive indexing” or “index tracking” funds, use indices
to track a specific market (or asset class) as closely as possible in a bid to replicate the performance of the index. temperament,
Investors (active and passive alike) will invest in index funds that track specific bond indices that fulfill their indices also play
investment criteria. a significant role
iBoxx $ Liquid Investment Grade Index
in both active
Total return level and passive fund
300 management
strategies. "
250

200

150

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2002 2004 2006 2008 2010 2012 2014 2016 2018

1
Bank for International Settlements, Quarterly Report, June 2015
2
European Commission http://ec.europa.eu/index_en.htm

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What are bond Indices?

Fixed income complexities

The complex nature of the fixed income markets made the emergence
and initial adoption of the bond index much more gradual than its equity
index cousin.
Unlike equities where shares trade on an exchange with public prices, transactions for fixed income securities take
place bilaterally between two parties via a dealer network. Traded over-the-counter, transactions are off exchange.

Bonds can vary in many ways, including asset class, type (government, corporate or sovereign), tenor and coupon
rates. Equities are limited to two lines of stock such as ordinary and preference shares, yet there can be multiple
bonds for every issuer of debt. Bonds trade less frequently than shares, and the lengthy trade times between issues
can amount to a lack of liquidity in the bond market.

All of these factors contribute to reduced transparency of the asset class.

The role of bond indices

Bond indices provide a way to overcome the complexities of the
"Overall, the
bond market.
Since John Bogle, founder of Vanguard Group, launched the first bond index fund in the 1980s, bond indexing has
benefits of lower
evolved with indices now providing benchmarks for virtually any bond market exposure. costs, greater
Investing in an index fund that tracks a bond index removes the challenge of having to select individual bonds. risk control and
Bond indices provide broad exposure to segments of the bond market (taking into account the range of bond
characteristics).
diversification have
For instance, a bond index can offer investors an opportunity to invest in multiple liquid bonds in a single
led to mainstream
instrument. Bond indices also allow for greater risk control by affording investors the ability to tailor their potential acceptance of
exposure to risk and return.
passive indexing
An index’s return will closely track that of the market, with the most effective bond indices achieving close to
zero tracking error. This means that the divergence between the price behaviour of a position or a portfolio and the
and emphasised
price behaviour of a benchmark is as narrow as possible, reducing the risk of an unexpected profit or loss. the significance
of effective bond
Uptake of passive investment indices."
A shift from active to passive investment management over the past two
decades has further highlighted the importance of bond indices and the
vital role they play.
Although the beginnings of the shift can be traced back to the 1990s, the sustained low yield environment created
by the global financial crisis has accelerated the pace of change and provoked widespread acceptance of passive
investment.

Today’s investors are seeking low cost alternatives, and indices operate in a low cost environment. Lower
management fees result in lower expense ratios, while lower turnover ratios (rate at which securities are bought
and sold) generate lower short term capital gains.

Overall, the benefits of lower costs, greater risk control and diversification have led to mainstream acceptance of
passive indexing and emphasised the significance of effective bond indices

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What are bond Indices?

Conclusion

Ultimately, bond indices help investors manage the complexities of the

bond market and bring greater visibility to a historically opaque and illiquid
asset class.
Investors now demand a wide range of indices, and the industry will continue to adapt and evolve further to meet
the changing needs of its participants.

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