By Jayni Kosoff, managing director, head of fixed income ETF strategy & business development, FTSE Russell
Cartography, a fancy word to describe the design of maps, is similar to methodology, another fancy word that describes the design of indexes. As I participated in our recent panel discussion at Inside ETFs 2019 – "Fixed Income ETFs: Analyzing the Growing Demand" – it struck me that these two fancy terms can be quite complementary, and practical, for today’s fixed income investor.
From a market standpoint, fixed income has grown increasingly more complex and challenging. Bond investors today must contend with the dual challenge of still historically low yields with renewed market volatility. This is against a backdrop of tightening global monetary policy and interest rate increases that were precipitated by the global financial crisis that began more than a decade ago.
From a demand standpoint, fixed income ETFs are exploding in popularity, with investors looking more and more to fixed income ETFs as tools for portfolio construction and tactical allocation. In fact, according to a recent ETP Landscape report from BlackRock published in January, global fixed income ETPs gathered $23.5 billion in December alone, outpacing flows into US, global developed and emerging markets equities. Within fixed income, flows reflected investor concern for rising rates with more than half going into short maturity ETFs.
Yet from a product capability standpoint, we often find that fixed income follows equity trends. Our fixed income cartography skills for the ETF market are leveraging some of the equity indexing capabilities over time, but we can pick up the pace if we think in a multi-asset way. In other words, we can take lessons learned from the equity market indexes and apply these to address the emerging needs of our fixed income clients.
Let’s first discuss home country bias, or the tendency of bond investors to favor their own market over international diversification. Similar to equities 30 years ago, much of the home country bias issue can be attributed to lack of awareness of the nuances and differences between global markets. Major index providers like FTSE Russell have detailed, transparent and robust frameworks in place for global equity market country classification, which ETF investors rely on to make better informed portfolio market choices. This concept can and should be applied to global fixed income markets. For example, FTSE Russell recently codified its fixed income country classification framework for its FTSE World Government Bond Index (WGBI.) This process borrows key tenets from FTSE Russell’s equity market classification framework and leverages our global market insight already in place to enable fixed income investors to better evaluate global bond markets. This newly codified framework is very useful for evaluating emerging countries such as China, where investors are trying to better understand levels of market access and readiness for investment.
Let’s next address portfolio needs for managing market volatility, generating alpha, and enhancing risk-adjusted return. Fixed income indexes are beginning to map insights from the equity markets into the bond market. At FTSE Russell, we’ve developed variations on our broad fixed income indexes, like the WGBI using issuer country fundamentals of debt and debt service, to help fixed income investors meet a more varied set of portfolio objectives with greater precision.
These solutions also include development of tactical indexes such as a time-weighted fallen angels index that tracks bonds downgraded to high yield and “smarter” treasury and corporate indexes that are weighted based on issuer fundamentals. As a multi-asset index provider, our equity and fixed income teams collaborate to identify more opportunities to apply approaches and data sets that have worked on the equity side of the house to fixed income. Most recently, we adapted equity market style factors such as value, quality, momentum, volatility, carry and size. These fixed income factors can be used for creating fixed income indexes and portfolio construction.
Finally, let’s consider ESG for the fixed income market. Many of the same ESG factors that influence issuer performance in the equity market can be adapted for use to determine bond market performance. By mapping issuer ESG data into our fixed income analysis, we can develop fixed income-oriented ESG indexes to benefit our clients.
While the fixed income markets are inherently different from the equity markets, applying the equity market and index learnings and approaches to fixed income indexes can help us design better tools and solutions for clients. Global multi-asset index providers like FTSE Russell, with well-developed equity map making capabilities, already have a good head start in fixed income index cartography. I enjoyed furthering this important discussion in the current market environment with my industry colleagues at Inside ETFs 2019.
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