GLOBAL - Corporate bond indices expose investors to an ever-increasing amount of risk the more investible they are, EDHEC Risk Institute has argued in new research.
Examining eight indices for investment-grade fixed income - four denominated in US dollars and four based on euro-denominated issuances - the report also found that US-denominated indices showed a higher credit risk, and that the difference between investing in the US or the euro-zone was not simply a matter of determining a preferred currency exposure.
For US-denominated indices, EDHEC examined the Citigroup US Broad Investment Grade Corporate Bond, the Bank of America Merrill Lynch US Corporate Bond, the Barclays US Corporate & Investment Grade - formerly called the Lehman Brothers US Corporate & Investment Grade - and the Dow Jones Corporate Bond.
For the euro-zone, it looked at two iBoxx indices, as well as an index from Citigroup and another from Bank of America.
The report concludes that both credit and interest-rate risk exposure were "fairly unstable" across all eight indices.
The report adds: "This instability has major implications for investors: even if a particular index matches an investor's desired risk exposures today, there is no guarantee it will do so tomorrow.
"The fluctuations in risk exposures are incompatible with investors' requirements that these exposures be relatively stable so allocation decisions are not compromised by such fluctuations."
The authors note that those indices based on a smaller number of bonds, numbering fewer than 100 corporate issuances, saw heightened instability.
"In addition, the average index rating of the euro indices is slightly higher than that of the US indices - in other words, the euro indices are less exposed to credit risk," the report said.
It also found that the duration and maturity of euro-zone fixed income products was shorter, meaning currency risk was not the only consideration when switching, but also credit and interest rate risk.
The report said: "The difficulty of finding the desired index may be one of the reasons for the relative unpopularity of passive investing in the corporate bond market.
"Given its broad popularity in equity markets, passive investing will gain ground only if bond index providers begin to develop better methods of constructing indices."