Buy-side financial institutions well understand that benchmarks are a key tool used to assess the performance of investments, which corporations cataloged through financial records management. Recently, two well-known industries launched a benchmark, of sorts, to help companies with investment risk management.
Banking conglomerate Citi and Research Affiliates, a fundamental indexing specialist, inaugurated RAFI World Corporate Investment-Grade Bond Index, Investment and Pensions Europe reported. The initiative was formulated in order to help advance smart-beta concepts for financial services firms.
According to the news source, there are two ways in which the index measures bonds – through long-term assets and cash flow. The former weighs assets that bondholders have a claim on, while the latter measures debt service capacity.
The value of these indices are then calculated by Citi through the indexing method that Research Affiliates helped formulate
It’s this methodology that sets this index apart from other methods. For example, Investment and Pensions Europe indicated that it substantially lowers the debt-to-equity ratio as it relates to the market capitalization that’s weighted by Merrill Lynch, moving from 0.8 percent to 0.7 percent. Meanwhile, the debt-to-cash flow ratio drops to just under 6.5 percent from approximately 8 percent.
“Traditional bond indices, which give the largest weights to the biggest debtors, are great tools for benchmarking performance,” Rob Arnott, CEO at Research Affiliates, told the online business and investment news resource. “But they are suboptimal as the basis for investment funds.”
Shane Shepherd, vice president and head of fixed income research for the Newport Beach, Calif.-based asset allocation firm, noted that companies that use the index will be pleased with it.
“This new index offers lower credit risk, lower volatility and better risk-adjusted returns over full market cycles than traditional market value-weighted indices,” said Shepherd.
Accurate benchmarks are crucial for strategic management, which is why the alleged manipulation of the London Interbank Offered Rate has gripped the financial services industry. In the latest developments, three former Barclays employees were charged on suspicions they may have been involved in the scandal.