3 Things to Know About Using Fixed Income Indexes to Gauge Performance
Recently, we published an article on the differences in Equity Indexes. While surprising how different some of these Equity Indexes can be (and by extension the Index Funds that follow them), the Fixed Income Indexes are a completely different universe. If the Equity Index and the Index Fund do not match, there will be differences in performance. However, this is all shades of gray compared to Fixed Income Indexes, and the funds that follow them.
According to a recent Morningstar search, there are 861 unique Open Ended Fixed Income mutual funds in the United States. This count ignores all the various share classes that funds can be purchased in. It also is segregated from Global Bond, and High Yield Bond funds. Of these 861 funds, the chart shown below lists the top ten indexes used as benchmarks listed in the prospectuses. Notice anything? The most widely used benchmark, the BBGBARC US Aggregate, is used by fund managers more than the next nine most popular benchmarks combined. (The BBGBARC US Aggregate was known as the Barclays US Aggregate previously. Bloomberg recently renamed it due to the completed purchase of Barclays Indices.) It is also important to keep in mind that the bond market is estimated to be 3-4 times as large as the stock market from a capital standpoint. This 3-4 times measurement is purely in dollar size, never mind the myriad of different issuers, lengths of issue, differing points of the capital structure, and covenants attached to each issue.
|Top 10 Prospectus Benchmarks|
for 861 US Fixed Income Funds
|# of Funds Following|
|BBgBarc US Agg Bond TR USD||284|
|BBgBarc US Govt/Credit 1-3 Yr TR USD||42|
|BBgBarc US Govt/Credit Interm TR USD||33|
|BBgBarc US MBS TR USD||24|
|S&P/LSTA Leveraged Loan TR||20|
|Credit Suisse Leveraged Loan USD||19|
|BBgBarc US Credit TR USD||17|
|BofAML US Treasuries 1-3 Yr TR USD||16|
|BBgBarc GNMA TR USD||15|
|BofAML US Corp&Govt 1-3 Yr TR USD||15|
|Total Top 10||485|
Even though the Fixed Income universe is larger and more diverse than the stock market, there is one main index used as a benchmark. This presents a real problem for investors trying to compare returns, or trying to understand the performance difference in their portfolio and the index.
Knowing this is a problem, there are a few things you should understand when trying to comprehend the performance differences of your Fixed Income investments.
- Know what is in the index that is being used and what is in your investment fund.
A good example to look at is the BBgBarc US Aggregate index and the lack of Foreign or High Yield Fixed Income in the index. There are several funds that follow this index AND include Foreign and High Yield in their lineup. These usually are called Total Return funds, or Plus funds. However, these differences in holdings between the fund and the index can lead to significant out or under performance. Nothing feels worse than thinking you are getting great returns because the bond market is up, only to check your account and see that you are down because of something that happened overseas. The point here is to look into both the investment fund you hold and the index it is being measured against to make sure that the comparison is relevant.
- Understand that the named prospectus benchmark is not always the benchmark the manager is “really” using to compare the performance.
I have seen several funds that name the BBgBarc US Aggregate as the primary benchmark, but they really compare themselves to a blended benchmark. (A blended benchmark is a benchmark made of several slices of different indexes). Conservative asset allocation funds can fall into this bucket. For example, a fund lists the BBgBarc US Aggregate as a primary benchmark, but the “real” benchmark it uses is a blend of 14% Dow Jones US Total Stock Market Index, 50% BBgBarc US Aggregate, 6% MSCI ACWI Index ex USA, and 30% Barclays US 3 Month Treasury Bellwether Index. The moral here is that you need to understand what the fund is really comparing itself to, and that may take a little more digging than a simple glance at a prospectus, or your favorite financial website.
- Realize indexes are hard to beat.
This leads to temptation to take extra risk to get extra return and beat the index. There are going to be periods of outperformance for a fund versus an index, and periods of underperformance. It is intriguing that funds will outperform by taking on more risk than the index by investing outside of the index, but then tout that they outperformed the index. This is akin to me comparing my home run power to a professional because I can hit home runs on a Little League field; it makes no sense. This is important to understand when working with a financial professional, and they tell you how well a fund has performed versus an index. I hear things such as, “It has beat its index 4 out of the last 5 years!” But then upon closer inspection, the fund was taking risk that the benchmark was not taking. This doesn’t mean that it is a bad fund, but just may not be appropriate for your style of investing, or the risk you are willing to take.
When looking at funds and indexes, it is always important to look under the hood, and see what makes up both the fund and index. This helps you to understand the risk and returns you should expect by investing in the fund, and how it measures up to the appropriate index. This is even more important in the Fixed Income universe as the differences in holdings between a fund and the benchmark index can be as different as black and white, not just shades of gray.
To learn more about selecting the right Fixed Income index, contact Pension Consultants’ Investment Services or RetireAdvisers® or call 417.889.4918. Our performance-driven retirement plan management services can help you determine if your fund is top performing.
*Capital markets are markets for buying and selling equity and debt instruments. Investopedia.
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