High yield indices don’t make good benchmarks
Speed read
- High yield portfolio managers face costs not reflected in the index return
- A high yield index therefore does not make a good benchmark
- Instead, high yield funds should be compared with one another
High yields come at a cost
High yield corporate bonds offer several attractive investment features, such as coupon rates and returns that are higher than that of investment grade assets. This comes at a cost, of course. This sector of the credit market also presents challenges for investors, such as limited liquidity, defaults, rating migrations and bonds that are callable before maturity. These characteristics imply a variety of costs that are not reflected in the index returns. The underperformance of passively managed ETFs, for instance, illustrates the difficulties of generating index-like returns in the high yield market.
As long as indices do not contain all the costs that accrue in practice, high yield indices are not a fair reflection of the potential returns from a high yield credit portfolio. This means that they are not suitable as benchmarks for evaluating fund manager performance.
What would be a better performance yardstick?
A different take on relative performance
Our recommendation for investors in high yield funds is to compare portfolio performances with one another, rather than with an index.
For managers who use the same index, a solution would be to compare performance amongst the managers. Where different indices are used, a solution could be to determine the relative performance of each manager – relative to the specific index used – and then to compare the outperformance amongst managers.
Our recommendation for investors in high yield funds is to compare portfolio performances with one another, rather than with an index
It is quite possible in this context that outperformance will be mainly negative for both active and passive managers. As our research shows, this does not automatically mean that all managers have performed badly, but it does make a clear statement about the use of indices as benchmarks.
