The case for Enhanced Indexing in credit

Firstly, passive credit strategies structurally lag their benchmark index returns and exhibit substantial tracking errors versus their benchmark. Secondly, passive strategies by definition do not integrate sustainability. We outline in this article how our Enhanced Indexing approach provides a smarter alternative to passive in credits.

The objective of Robeco’s enhanced indexing strategies is to deliver improved returns at market-like risk with better sustainability integration than passive strategies. The strategies are managed in a rules-based manner and offer transparent and consistent returns. In credits, we manage our Global Multi-Factor Credits strategy as an enhanced indexing strategy by ensuring that the portfolio’s risk profile remains aligned with that of the credit index.

In the selection of individual issuers and bonds, the strategy prefers bonds from financially healthier companies over bonds from weaker ones. Also, it prefers bonds with more attractive relative valuations. This is based on our long-standing multi-factor credit selection model. Furthermore, it prefers more sustainable companies over less sustainable ones. This approach has led to a relatively low tracking error while having delivered above-index returns with improved sustainability.

The success of this approach is evidenced by the strategy’s average relative return of 0.33% per annum (gross of management fees) after trading and implementation costs, compared to the Bloomberg Global Aggregate Corporates Index, since inception in July 2015 (see Figure). As a result of its risk-controlled portfolio construction, the strategy was able to track its index almost as closely as passive alternatives (tracking error of 0.64% versus 0.51%). However, instead of underperforming its benchmark, like passive strategies did over this period, it successfully outperformed its benchmark in nine out of ten calendar years, including the second half of 2015 and the first half of 2024.

Passive credit strategies face several challenges, including high turnover, transaction costs, and difficulty in fully replicating credit indices. These challenges result in structural underperformance, considerable tracking error, and limited possibilities for alpha generation or sustainability integration. Enhanced Indexing, as exemplified by Robeco’s Global Multi-Factor Credits strategy, offers a smarter alternative by delivering improved returns at market-like risk, with better sustainability integration. Enhanced Indexing strategies prefer healthier and more sustainable companies while keeping the portfolio's risk profile in line with the index. This offers investors a more attractive and responsible option for their core allocations to credits.