Investors know little about the several bond market series because these bond series are relatively new and not widely published. Knowledge regarding these bond series is becoming more impor- tant because of the growth of fixed-income mutual funds and the consequent need to have a reli- able set of benchmarks to use in evaluating performance.9Also, because the performance of many fixed-income money managers has been unable to match that of the aggregate bond market, inter- est has been growing in bond index funds, which requires the development of an index to emulate.10 Notably, the creation and computation of bond market indexes is more difficult than a stock market series for several reasons. First, the universe of bonds is much broader than that of stocks, ranging from U.S. Treasury securities to bonds in default. Second, the universe of bonds is chang- ing constantly because of new issues, bond maturities, calls, and bond sinking funds. Third, the volatility of prices for individual bonds and bond portfolios changes because bond price volatility is affected by duration, which is likewise changing constantly because of changes in maturity, coupon, and market yield (see Chapter 19). Finally, significant problems can arise in correctly pric- ing the individual bond issues in an index (especially corporate and mortgage bonds) compared to the current and continuous transactions prices available for most stocks used in stock indexes.
The subsequent discussion is divided into three subsections: (1) U.S. investment-grade bond indexes, including Treasuries; (2) U.S. high-yield bond indexes; and (3) global government bond indexes. Notably, all of these indexes indicate total rates of return for the portfolio of bonds and most of the indexes are market-value weighted. Exhibit 5.13 contains a summary of the charac- teristics for the indexes available for these three segments of the bond market.
As shown in Exhibit 5.13, four investment firms have created and maintain indexes for Treasury bonds and other bonds considered investment grade; that is, the bonds are rated BBB or higher.
As demonstrated in Reilly and Wright and shown in Chapter 4, the relationship among the returns for these investment-grade bonds is strong (that is, the correlations among the returns average about 0.95), regardless of the segment of the market.
One of the fastest-growing segments of the U.S. bond market during the past 15 years has been the high-yield bond market, which includes bonds that are not investment grade—that is, they are rated BB, B, CCC, CC, and C. Because of this growth, four investment firms created indexes related to this market. A summary of the characteristics for these indexes is included in Exhibit 5.13. As shown in studies by Reilly and Wright, the relationship among the alternative high-yield bond indexes is weaker than among the investment-grade indexes, and this is especially true for the bonds rated CCC.11
Exhibit 5.14 contains the Bond Market Data Bank, which provides recent returns for a wide range of domestic bonds from Treasuries to high-yield and including municipal bonds.
High-Yield Bond Indexes Investment-Grade Bond Indexes
8The discussion in this section draws heavily from Frank K. Reilly and David J. Wright, “Bond Market Indexes,” The Handbook of Fixed-Income Securities, 6th ed., ed. Frank J. Fabozzi (New York: McGraw-Hill, 2001).
9For a discussion of benchmark selection, see Chris P. Dialynas, “The Active Decisions in the Selection of Passive Man- agement and Performance Bogeys,” in The Handbook of Fixed-Income Securities, 6th ed., ed. Frank J. Fabozzi (New York: McGraw-Hill, 2001).
10For a discussion of this phenomenon, see Kenneth E. Volpert, “Managing Indexed and Enhanced Indexed Bond Port- folios,” in The Handbook of Fixed-Income Securities, 6th ed., ed. Frank J. Fabozzi (New York: McGraw-Hill, 2001).
11Frank K. Reilly and David J. Wright, “An Analysis of High-Yield Bond Benchmarks,” Journal of Fixed Income 3, no. 4 (March 1994): 6–24. The uniqueness of CCC bonds is demonstrated in Frank K. Reilly and David J. Wright,
“The Unique Risk-Return Characteristics of High-Yield Bonds,” The Journal of Fixed Income 11, no. 2 (September 2001): 65–82.
SUMMARY OF BOND MARKET INDEXES NUMBERREINVESTMENT NAMEOFINDEXOFISSUESMATURITYSIZEOFISSUESWEIGHTINGPRICINGASSUMPTIONSUBINDEXESAVAILABLE U.S. Investment-Grade Bond Indexes Lehman Brothers5,000+Over 1 yearOver $100 millionMarket valueTrader priced and NoGovernment, model pricedgov./corp.,corporate, mortgage-backed, asset-backed Merrill Lynch5,000+Over 1 yearOver $50 millionMarket valueTrader priced and In specific bondsGovernment,gov./corp., model pricedcorporate,mortgage Ryan Treasury300+Over 1 yearAll TreasuryMarket value Market pricedIn specific bondsTreasury and equal Salomon Smith Barney5,000+Over 1 yearOver $50 millionMarket valueTrader pricedIn one-month Broad inv. grade,Treas.- T-billagency,corporate, mortgage U.S. High-Yield Bond Indexes C.S. First Boston423All maturitiesOver $75 millionMarket valueTrader pricedYesComposite and by rating Lehman Brothers624Over 1 yearOver $100 millionMarket valueTrader pricedNoComposite and by rating Merrill Lynch735Over 1 yearOver $25 millionMarket valueTrader pricedYesComposite and by rating Salomon Smith Barney299Over 7 yearsOver $50 millionMarket valueTrader pricedYesComposite and by rating Global Government Bond Indexes Lehman Brothers800Over 1 yearOver $200 millionMarket valueTrader pricedYesComposite and 13 countries, local and U.S. dollars Merrill Lynch9,736Over 1 yearOver $50 millionMarket valueTrader pricedYesComposite and 9 countries, local and U.S. dollars J.P. Morgan445Over 1 yearOver $100 millionMarket valueTrader pricedYes in indexComposite and 11 countries, local and U.S. dollars Salomon Smith Barney400Over 1 yearOver $250 millionMarket valueTrader pricedYes at local short-Composite and 14 countries, term ratelocal and U.S. dollars
EXHIBIT 5.13 Copyright 1992,Association for Investment Management and Research. Reproduced and republished from “Alternative Bond Market Indexes”in the May/June 1992 Financial Analysts Journalwith permission from the Association for Investment Management and Research. All Rights Reserved.
Merrill Lynch Convertible Securities Indexes In March 1988, Merrill Lynch intro- duced a convertible bond index with data beginning in January 1987. This index includes 600 issues in three major subgroups: U.S. domestic convertible bonds, Eurodollar convertible bonds issued by U.S. corporations, and U.S. domestic convertible preferred stocks. The issues included must be public U.S. corporate issues, have a minimum par value of $25 million, and have a min- imum maturity of one year.
BONDMARKETINDICATORSERIES 165 EXHIBIT 5.14 BOND MARKET DATA BANK
Source: The Wall Street Journal, 13 July 2001, C14. Reprinted with permission from The Wall Street Journal, Dow Jones Co., Inc.
12Frank K. Reilly and David J. Wright, “Global Bond Markets: Alternative Benchmarks and Risk-Return Performance,”
mimeo (June 2000).
Similar to the high-yield bond market, the global bond market has experienced significant growth in size and importance during the recent 10-year period. Unlike the high-yield bond mar- ket, this global segment is completely dominated by government bonds because few non-U.S.
countries have a corporate bond market. Once again, several major investment firms have cre- ated indexes that reflect the performance for the global bond market. As shown in Exhibit 5.13, the various indexes have several similar characteristics, such as measuring total rates of return, using market-value weighting, and using trader pricing. At the same time, the total sample sizes and the number of countries included differ.
An analysis of performance in this market indicates that the differences mentioned have caused some large differences in the long-term risk-return performance by the alternative indexes.12Also, the low correlation among the various countries is similar to stocks. Finally, there was a significant exchange rate effect on volatility and correlations.