Indices Should Use a Dryer Sheet
When credit spreads widen, premiums for lower-rated bonds have historically been higher on average, yet index bond funds often cannot adjust credit exposure dyn
Research shows that credit spreads, or yield differences between bonds of different credit quality, contain reliable information about future differences in returns. When the spread widens, the subsequent premium, or excess return for lower-rated bonds over higher-rated bonds, historically has been higher on average. Therefore, it makes sense to incorporate credit spreads as a continuous input when managing bond portfolios, allowing credit exposure to adjust dynamically.
Unfortunately, funds that track bond indices do not have this level of flexibility. Information conveyed by credit spreads is largely irrelevant to the rules governing an index’s emphasis on credit tiers over time. For example, the Bloomberg Global Aggregate Bond Index’s combined weight in A and BBB rated bonds has remained almost constant—between 45% and 48%—over the past six years, even as credit spreads fluctuated from 39 to 125 basis points (bps). Lack of flexibility to vary credit exposure in response to changes in credit spreads potentially leaves returns on the table for funds tracking bond indices.
The dry air that comes with winter weather constantly reminds me how much I dislike static electricity. Index bond fund investors might likewise appreciate having a little less static credit exposure.
EXHIBIT 1
Bloomberg Global Aggregate Bond Index Credit Exposure
November 2019–November 2025
Glossary
Basis point: One basis point equals 0.01%.
Yield: The return on a bond investment. Price and yield are inversely related, and as the price of a bond goes up, its yield goes down.
Disclosures
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