A good index system
There is currently a bewildering choice of potential benchmarks proffered
by a large number of vendors. It is incumbent upon us to introduce
some criteria for benchmark selection particularly within the realms of
European credit, which in contrast to the US, has not quite evolved
towards an industry standard.
It is a common misconception among bond investors that any rule-
based index will display consistency of risk-return proﬁles for related
holding periods. This is certainly not the case and while volatility levels
will be in some accordance, the levels of return can be appreciably
different. The source of this discrepancy is usually the introduction of
proxy pricing for illiquid bonds incorporated as index constituents.
This may seem attractive until the considerations of actually trading
these bonds are entertained. By way of conclusion the portfolio man-
ager should perform diligence on an index and ensure it is a liquid
rule-based aggregate that is representative of the market.
There exist a large number of classical prescriptions as to what con-
stitutes a good benchmark. However it must be borne in mind, particu-
larly with regard to credit investing, of equal import to the quality of
design is the quality of the data. Together with the infrastructure sup-
porting the provision of the service.
Many vendors regard the provision of an index service as highly
proprietary, consequently constituent data and methodology are only
available on a commercial basis. Further a custom index creation
facility, allowing the user to tailor the benchmark according to their
risk/return appetites, may be sold as a differentiating capability. These
developments have been a hindrance to market progression in general.
Given the dramatic decrease in the cost of mediating information it is
now becoming viable to compete only on bespoke index services rather
74 Credit risk: from transaction to portfolio management
iBoxx pricing (real-time and historical)
iBoxx index family (real-time and historical)
return attribution etc.
Figure 1.41 The current and future of credit index. Source: Deustche Bank.