What if fixed income indices were comprised of securities that were tradable?

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One of the more widely followed US investment grade corporate bond indices is comprised of more than 6,500 securities and a popular broad US. high yield corporate bond index includes almost 2,000 securities. Even “liquid” investment grade and high yield indices can include around 2,000 and 1,000 bonds, respectively. The issue is that these indices were generally created for use by active managers that weren’t necessarily focused on the liquidity of the constituents and therefore the tradability of the bonds themselves. After all, active management entails the selection of a subset of a universe, not investment across the entire universe.

With the consistent growth of the fixed income ETF market and the expansion of electronic trading, “beta” trading has become more prevalent in the fixed income market. However, the issue with trading existing credit indices and products is that the illiquid tails of the indices present difficulties in pricing, sourcing and hedging, which leads to greater costs and less efficient markets. These investment challenges are also prevalent for newer investment strategies, like smart beta or those based around ESG and green bonds. Smart or alternative beta models can identify a subset of securities as attractive or inefficiently priced when lack of liquidity is the predominant issue. This further highlights the need for accurate data to ensure that the securities identified by these newer strategies are actually available to trade when needed most.

So how can MarketAxess help? While we can’t make bonds magically appear on bid lists, we can help better define benchmarks and expectations.

Because of our unique position within credit markets, MarketAxess has greater insight into the tradability of individual securities and the construction of accessible betas or indices. For example, greater than 20% of the daily TRACE-reported trading volume in US investment grade corporate bonds occurs on MarketAxess. Unlike other market participants that have access to TRACE-supplied details for these trades (price, size, dealer or client direction) MarketAxess has additional data points including whether the trade was offer-wanted or bid wanted, number of responses and prices for each response. Potentially more powerful is the access to similar data for inquiries that DNT’d (did not trade) on our platform as TRACE provides no visibility. We have incorporated this data into unique products (Composite+™, Relative Liquidity Scores) which are the backbone of our index construction process and lead to our advantage in constructing tradeable indices.

Credit markets are evolving with smarter trading protocols and more defined investment strategies. Index construction needs to evolve as well.

For questions or follow-up, get in touch with John at jkeller@marketaxess.com

This is the first in a series of blogs that will dive into the rapidly changing fixed income index market and the issues that will need to be addressed to improve efficiencies in that market. John Keller, ETF Product Manager, utilizes his extensive industry experience to highlight areas of opportunity in Fixed Income indexation. Be on the lookout for the following topics that will be published as part of this “What if” blog series:

  • What if, fixed income index constituents were accurately priced in real-time?
  • What if, fixed income index constituents traded on live order books with visible depth of markets?
  • What if, fixed income ETF baskets could mimic the index with accurate real-time NAVs and premiums and discounts?