The problem with credit indices
The UK institutional client base is reliant on fixed income securities to meet its long-term requirement for stable, long term, income-generating assets. Often, that reliance extends to securities of traditional fixed income indices. This brings a series of risks into play.
Indices are not perfectly constructed, relying on periodic rebalancing rules which leave them open to concentration risk – across issuers, sectors and countries. For long-term investors, who require diversified sources of cashflows to aim for portfolio stability and seek to protect against potential impairments, this can be a major problem.
Falling credit quality
Recent years have seen a decrease in the average credit quality of indices; the ultra-low interest rate environment since 2015 likely provided corporate treasurers with a strong incentive to increase the overall level of indebtedness in capital structures. This has resulted in a drop in the average credit quality of issuers, driving a large increase in the BBB component of credit indices. The COVID-19 crisis has served to accelerate that trend. In the most liquid markets, BBBs now typically account for more than 50% of the investable universe in investment grade (IG) credit indices:
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