Lauren Ryan from Thinktank speaks to Laurence Parker-Brown for our IN60 series. The Inside Adviser
That consumers are influenced heavily by well known, trusted brands comes as no great surprise. What does, though, is that they rate life insurance as the least most important tool in ensuring financial security.
Fixed income bond indices prove problematic when assessing performance
When it comes to assessing the fixed income assets of a multi-asset portfolio against a standard benchmark, the process becomes quite problematic due to a fundamental flaw. As bond weightings are based on the size of the debt issuance, a bond index is often skewed towards larger bond issuers making it less representative of the opportunity set available.
In comparison to equity markets fixed income markets are much larger, with several asset types delivered by a diverse list of bond issuers. In an equity index, companies that exhibit a rising share price will see their equity weightings increase as a percentage of the market indices.
However, this is not the same with bond indices. Weightings increase in bond indices when bond debt issuances increase.
Equity indices can be market capital weighted or price weighted, giving preference to companies that have better earnings and share price performance.
Kevin Toohey, principal at Atchison Consultants, uses the Bloomberg AusBond Composite Index, which most fixed income asset managers are benchmarked against to gauge outperformance or underperformance.
“Whole categories of securities are excluded from the fixed income benchmarks, with relevance to the financial advice sector now that the Your Future Your Super has effectively pegged industry and My Super Australian debt exposures against the composite index universe”, Toohey tells The Inside Adviser.
Using the AusBond Composite Index, Toohey highlights the fact that the index “only includes eight sectors of the fixed income market including federal and state government and then into corporate and some fixed rate residential mortgage-backed securities”.
The index purposely omits floating rate residential mortgage-backed securities and sub-investment grade rated bonds to make way for the large debt issuers.
Toohey drew attention to the AusBond Composite Index limitation being able to only measure a “slice” of the debt market universe.
“Using the AusBond Composite benchmark to measure performance of debt markets is like only using the election result of Queensland to call the Federal election,” he explained.
One solution could be to base weightings on to the debt issuer’s ability to repay the debt or to construct the index with an attractive risk-adjusted expected return.
Toohey agrees, however, the current benchmarking of fixed income assets has its flaws and needs a rethink. “A more nuanced benchmarking of fixed income allocations is warranted, such as splitting this into fixed, floating and inflation-linked sleeves,” he says.
