Defining exactly what the investible universe (or benchmark) is when it comes to bonds is not easy. Defining the benchmark is important because there is not much point measuring return against the wrong benchmark.
Bond ETF’s are in many ways a more complex beast than equity ETF’s, there are many more bond securities than equities, the diversity of bond issues is staggering, pricing of bonds is not transparent and fixed income markets are global making distinguishing bonds based on geography difficult (refer to Bond ETF’s compared to Equity ETF’s for further information)
To top it off most countries around the world are suffering from excessive debt and governments are printing money (read quantitative easing) to keep the wolves at bay, which is distorting the risk/return equation for all investors.
Bond Index Benchmark
Given this background, it is crucial that investors know the benchmark and select a benchmark based on their desired risk/return profile. Specific criteria investors need to know and understand include the following :-
- Interest rate duration
- Credit spread duration
- Average or minimum credit quality
- Desired diversification (correlation) both within fixed income and between fixed income and other asset classes
- Investors other requirements such as income needs, prohibited securities<
- Currency exposure
To paraphrase from Socrates, bond fund investors more than any other index investor should ‘Know thy [benchmark]’ and whether or not the benchmark does in fact represent their desired risk return profile.