Bond fund benchmarks and indices

Just like equity funds, bond funds, whether active or passive, are managed against a benchmark, usually in the form of an index. However, unlike equity indices such as the FTSE 100, the diverse nature of bond types and durations means that bond indices can appear a bit baffling at first.

Bond indices explained

The names of bond indices can include any or all of the following items:

- Index provider 

- Bond type: government, corporate, inflation linked 

- Average maturity target or limit: as in ‘long’, or in terms of a number, such as 15+ years 

- Credit quality: Investment grade, high yield 

- Geography: emerging market, UK, Eurozone etc. 

- Whether or not it’s hedged (for bonds in foreign currencies) – an unhedged index is 
exposed to currency movements at the individual bond level 

- Special features or rules: float adjustment 

Understanding ‘the float’ 

‘Float adjusted’ refers to an index that has been adjusted to reflect the fact that not all
the bonds that fall within the index selection criteria are traded on the open market. For example, several types of government bonds have been purchased by the government and effectively taken out of circulation. Although they technically still exist, they can’t be bought by investors. Adjusting bond indices this way gives fund managers the ability to use an index that reflects the actual investable market, rather than a theoretical one. 

Putting it all together

Theoretically you could have a bond index like the one below, but often some of these traits are listed in the description of the index rather than its name.

XYZ (provider) UK corporate short-dated investment grade floated-adjusted bond index

Bond indices tend to include more individual securities than equity indices and are often based on a series of rules as to which type of bonds make up the index. This is a bit different than an equity index that has the 100 largest equities by market cap. The rules allow fund managers to have clarity on which bonds qualify for the index.

An example of a real index name and description:

The Barclays Capital Global Aggregate Float Adjusted Bond Index

This market-weighted index is designed to reflect the total universe of the major investment-grade and government bond markets with maturities greater than one year.

Fund types and categories

Fund names usually reflect exactly what the funds invest in. Some, however, may require some explanation. For example, a bond fund called a UK Government Bond Fund is fairly self-explanatory. But if it’s UK Long-Duration Government Bond Fund, you will need to look further to find out how the manager defines ‘long duration’.

Likewise, a fund called Global Income Select fund, could be either bonds, equities or both. Bond funds with ‘strategic’ in their name offer a particular challenge to advisers as they often have a wide remit. The prospectus of each fund will give the details of a fund’s investment universe and process and deserves a close read, especially for vaguely named funds or those with flexible or unconstrained remits.

- UK gilts
 - Invests mainly in bonds issued by the UK government. Depending on their prospectus, they might invest in some other instruments in small quantities.

- UK index linked - These should invest mainly in bonds linked to inflation. These will normally be issued by the UK government, but might also include a small percentage of foreign government inflation-linked bonds.

- Sterling corporate bond - Normally hold mainly corporate bonds that fall into the ‘investment grade’ category. Keep an eye on the prospectuses, but only rarely would they invest in lower credit quality bonds. Some may have the potential to invest in a certain percentage of government bonds.  

- Sterling high yield - Normally invest at least half their assets in below-investment-grade bonds. These offer a much higher yield, as pointed out elsewhere in this guide, but at a higher level of potential risk.

- Global bonds
 - Predominantly invests in global bond markets, which could be government, investment grade or non-investment grade corporate. These are often the most diverse indices.

- Strategic bonds - Funds in this category are the hardest to pin down and it’s extremely diverse. They invest across the other categories in search of returns, income and/or volatility dampening. It’s worth taking a very close look at any fund in this category to ensure you fully understand its investment universe and process.

- Multi-asset - Bonds appear in a variety of different multi-asset funds in combination with other asset types, which can include equities, property and cash in any number of different weights.