A second look at a fixed-income indexing concern

Investors with misgivings about how debt issuers are weighted may have less to fear than they thought

A second look at a fixed-income indexing concern

Fixed-income exposure has become more crucial to investors in 2019, with Canadians injecting over $1 billion in new assets into fixed-income ETFs in September. As a defensive attitude takes hold, more are relying on the investment vehicles’ ability to provide convenient exposure to the bond market.

Not everyone’s a fan, particularly when it comes to index-based exposure. One popular argument from detractors is that the approach leads the underlying portfolios to become overweight in the companies with the most debt. The result, they say, is that investors are left exposed to the riskiest companies.

“While this concern is understandable, it’s also easy to debunk,” said Matthew Bartolini, Head of SPDR Americas Research.

In a recent blog post, he pointed out that fixed-income ETF benchmarks follow rules designed to ensure investability through liquidity and diversification. Issuers can raise various types of debt, and certain issues may not qualify for inclusion in an index. That means bond ETFs are not necessarily exposed to a company’s entire debt.

To drive home the point, Bartolini examined the top 10 issuers in the Bloomberg Barclays U.S. Corporate Bond Index. “The ranking of the most indebted firms in the index is far different than the ranking of the firm’s overall short- and long-term debt,” he said.

For instance, while AT&T has the third-largest weighting in the Bloomberg index, the company ranks 25th out of all the member companies in the benchmark based on its total short- and long-term debt. Similarly, Apple is ranked 10th based on its debt included in the index, but it takes 34th place when one considers the total debt of all the portfolio companies in the index.

He also pointed out that the amount of debt a company holds does not reflect its inability to pay the debt. Firms with a high amount of debt, he said, likely were able to amass that much financing from the market because they have large asset bases and healthy revenue profiles.

Turning once again to the top 10 debt issuers within Bloomberg Barclays U.S. Corporate Bond Index, Bartolini said that they have garnered over US$1 trillion in sales over the past year. They also have a cumulative total of US$1 trillion in assets, as well as a combined equity-market value of US$2.7 trillion.

“Those figures represent 10%, 34% and 10% respectively of the entire S&P 500® Index’s figures,” he said.

Finally, he observed that firms with high debt levels do not necessarily carry more risk than those with less. That’s evident based on the lack of a linear relationship between debt issuance and credit ratings; by separating the Bloomberg index member firms into 10 deciles based on debt issued, he determined that the ones in the top decile — the largest debt issuers — had the highest average credit rating (A-), while the eighth decile had the lowest average rating (BBB).

“At the end of the day, focusing on the amount of debt an issuer has in an index is not a reflection of an ETF’s risk level,” he concluded.

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