NEW YORK - Broad market bond indexes are the most widely used benchmarks for fixed-income investors, but experts say a new Goldman Sachs index is a more nimble and meaningful representation of the corporate bond market.
Fixed-income market mainstays such as the Lehman Brothers Aggregate Bond, the Salomon Smith Barney U.S. Broad Investment Grade and the Merrill Lynch U.S. Domestic Master indexes have been the traditional measures for bond market investors much as the Standard & Poor's 500 and the Dow Jones Industrials have represented the stock market. But broad market indexes, which are supposed to be accurate and representative benchmarks, are giving way to smaller, more liquid indexes.
Goldman, Sachs & Co. has introduced a proxy for the high-grade corporate bond market that Goldman executives claim sets a new standard for relevance, liquidity, replication and real-time price transparency. Institutional bond managers and academics who have reviewed the index agree the GS InvesTop index is a valid real-time proxy for the high-grade corporate credit market.
Basket of bonds
The InvesTop index is a basket of 100 investment-grade corporate bonds, from primary industry groups, with maturities of between five and 30 years. This, Goldman officials say, provides a more balanced representation of the U.S. dollar corporate bond market.
"The idea was to give investors in bonds an alternative to broad market indexes," said Fernando Cunha, head of Goldman's credit index group. "In the fixed-income markets you can see most of the successful indexes are clustered around the macro end."
But, Mr. Cunha said it is nearly impossible for investors to buy all of the issues in a broad market index like the Lehman Aggregate, which means it cannot be fully replicated because of the lack of liquidity and unavailability of some securities in the index.
The Lehman Aggregate contains more than 4,000 securities from about 800 issuers, of which only about 25% are available for trading at any one time, according to industry experts.
For investors seeking to replicate the index, "that creates a mismatch or risk in the position that you have vs. what you would like to have," he said, "generating tracking error." Investors using a broad market index must use a form of sampling to duplicate the index, he said. "If you do sampling, all the benefits of diversification that you are looking for are essentially gone," he said.
The Goldman index is rebalanced monthly and priced throughout the day in real time.
"We designed the index to be representative of the broad investment-grade market by applying a 4x3 matrix of cells to the larger market. We wanted to identify the most liquid bonds to represent the cells. The cells include four industry sectors - consumer, finance, telecommunications and technology, and industrials and utilities," he said.
Mr. Cunha the index is most suitable for active bond managers. "If you buy and hold you may be better off by going with a diversified broad market index. If you are more active it may be more appropriate to use something more efficient and that can be replicated ... anyone who likes to have information in real time. If you are marking to market and want to improve on the macro view of the bond market, this makes sense."
John Reilly, professor of finance at the University of Notre Dame, South Bend, Ind., has studied the use of appropriate indexes by institutional investors. He said the Goldman index "is a very valid index with some unique characteristics because of its specific measures of liquidity."
Mr. Reilly said the daily valuation of the index is important, along with the overall liquidity of the bonds in the index, which can be replicated by the investor.
"It's a good index," said John B. Sprow, executive vice president at Smith Breeden Associates Inc., Chapel Hill, N.C.
"When it comes to the credit market, no index is perfect. ... "I like to use it internally; it gives me a better handle on how I'm doing against the market," he said.
"It's a better performance yardstick for an active money manager."