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At the recent ETF Ecosystem Unwrapped conference, ETF Stream editor Jamie Gordon interviewed VettaFi’s Head of Fixed Income Samarth Sanghavi. The two discussed fixed income innovation the power of equal weighting, how to deal with persistent turnover, and more.
The bond index world has changed over the past decades, but anyone looking to be a player in the fixed income space needs data. “VettaFi acquired the Credit Suisse bond indices last year,” Sanghavi said. “This first foray into fixed income already gives us a very good base of products that have extensive history, extensive live track record and a huge mine of the institutional client segment already looking at this market.” After sharing his personal connection to this suite from his former life at Credit Suisse, Sanghavi noted that this is an incredible starting place. “We ended up with a suite that gives us beta exposure to the entire fixed income space. That’s where we get started.”
The Credit Suisse indices predate ETFs. Sanghavi shared, “One of the things we want to focus on is creating a suite of products that has significantly better tradability and reflection of the market.”
Stressing that it is inherently neither good or bad, , Sanghavi noted that historic fixed income templates are market cap weighted. This means that fixed income portfolios are skewed towards the companies with the most debt without necessarily looking at the quality of that debt. “We want to rethink about diversification here. In today’s benchmark index, the top ten issuers account for 13% of the index. Is that really diversification at this point?” He stressed that VettaFi has created a suite of fixed income indices that have removed this overconcentration.
To make a more diverse fixed income index, VettaFi has deployed an equal weighting methodology based off a set of 200 bond issuers. “There is no bias as to which names you are holding,” he said. “The index should not decide what represents an issuer. That’s really the portfolio manager’s job. We want to give the issuer names, and then provide every single security available in these names for the portfolio manager to trade.”
Another issue that Sanghavi and VettaFi are solving is the persistent turnover problem. “If I was imagining fixed income from scratch today, I wouldn’t design something that forces me to buy and sell securities every month,” he said. “We created an index that’s balanced annually.”
This approach offers full visibility for who the index constituents will be over the course of the year. It also allows for monthly maintenance to account for securities that mature, or get downgraded, or have a change in rating. “But that core set is constant. And that already provides an enormous edge for a portfolio manager.”
Gordon noted that the calling card of active management for UCITS ETFs is taking advantage of risk premia. With 80% of UCITS fixed income ETFs going to active managers, he asked Sanghavi how rules-based approaches can reliably capture risk premia. Sanghavi replied, “Risk premia that can be wrapped up in an index format needs to have consistency and harvestability.” Idiosyncracy is going to be challenging for a passive approach.
Credit risk, however, is something that Sanghavi views as both consistent and harvestable, particularly in the investment-grade space. “Since 2006 in the US investment-grade market there has been one quarter where BBB spreads have been lower than A spreads,” Sanghavi said, noting that this makes sense given that investors should be paid for the risk they are taking. “But the way the market prices that risk is very different, and that is evident by default rates in the market.” According to Sanghavi, in the last 30 years, 0.5% of companies that have been rated BBB or higher have defaulted. “What that’s telling us is that the market is paying us to take on the risk premium, but the risk is not materializing.” This makes for a harvestable risk premium that can be embedded into passive strategies.
By dipping into BBB investment-grade bonds, VettaFi has created a product that consistently outperforms in the investment-grade space. Gordon asked what the risks are of the strategy during periods of extreme volatility. Sanghavi offered, “It will underperform when there are periods of persistent stress that continue for a prolonged period.” He pointed to the global financial crisis as an example, but even there, he noted that the enhanced yield index did not significantly underperform the benchmark. “If you take something like COVID where the markets shot down and then shot right back up, that is an amazing environment for this strategy.”
Sanghavi shared that backtesting to 2006 and running the strategy through all of the major modern financial crises has revealed that the strategy consistently overperforms.
ETF Stream is VettaFi's European-focused distribution capability.
At the recent ETF Ecosystem Unwrapped conference, ETF Stream editor Jamie Gordon interviewed VettaFi’s Head of Fixed Income Samarth Sanghavi. The two discussed fixed income innovation the power of equal weighting, how to deal with persistent turnover, and more.
The bond index world has changed over the past decades, but anyone looking to be a player in the fixed income space needs data. “VettaFi acquired the Credit Suisse bond indices last year,” Sanghavi said. “This first foray into fixed income already gives us a very good base of products that have extensive history, extensive live track record and a huge mine of the institutional client segment already looking at this market.” After sharing his personal connection to this suite from his former life at Credit Suisse, Sanghavi noted that this is an incredible starting place. “We ended up with a suite that gives us beta exposure to the entire fixed income space. That’s where we get started.”
The Credit Suisse indices predate ETFs. Sanghavi shared, “One of the things we want to focus on is creating a suite of products that has significantly better tradability and reflection of the market.”
Stressing that it is inherently neither good or bad, , Sanghavi noted that historic fixed income templates are market cap weighted. This means that fixed income portfolios are skewed towards the companies with the most debt without necessarily looking at the quality of that debt. “We want to rethink about diversification here. In today’s benchmark index, the top ten issuers account for 13% of the index. Is that really diversification at this point?” He stressed that VettaFi has created a suite of fixed income indices that have removed this overconcentration.
To make a more diverse fixed income index, VettaFi has deployed an equal weighting methodology based off a set of 200 bond issuers. “There is no bias as to which names you are holding,” he said. “The index should not decide what represents an issuer. That’s really the portfolio manager’s job. We want to give the issuer names, and then provide every single security available in these names for the portfolio manager to trade.”
Another issue that Sanghavi and VettaFi are solving is the persistent turnover problem. “If I was imagining fixed income from scratch today, I wouldn’t design something that forces me to buy and sell securities every month,” he said. “We created an index that’s balanced annually.”
This approach offers full visibility for who the index constituents will be over the course of the year. It also allows for monthly maintenance to account for securities that mature, or get downgraded, or have a change in rating. “But that core set is constant. And that already provides an enormous edge for a portfolio manager.”
Gordon noted that the calling card of active management for UCITS ETFs is taking advantage of risk premia. With 80% of UCITS fixed income ETFs going to active managers, he asked Sanghavi how rules-based approaches can reliably capture risk premia. Sanghavi replied, “Risk premia that can be wrapped up in an index format needs to have consistency and harvestability.” Idiosyncracy is going to be challenging for a passive approach.
Credit risk, however, is something that Sanghavi views as both consistent and harvestable, particularly in the investment-grade space. “Since 2006 in the US investment-grade market there has been one quarter where BBB spreads have been lower than A spreads,” Sanghavi said, noting that this makes sense given that investors should be paid for the risk they are taking. “But the way the market prices that risk is very different, and that is evident by default rates in the market.” According to Sanghavi, in the last 30 years, 0.5% of companies that have been rated BBB or higher have defaulted. “What that’s telling us is that the market is paying us to take on the risk premium, but the risk is not materializing.” This makes for a harvestable risk premium that can be embedded into passive strategies.
By dipping into BBB investment-grade bonds, VettaFi has created a product that consistently outperforms in the investment-grade space. Gordon asked what the risks are of the strategy during periods of extreme volatility. Sanghavi offered, “It will underperform when there are periods of persistent stress that continue for a prolonged period.” He pointed to the global financial crisis as an example, but even there, he noted that the enhanced yield index did not significantly underperform the benchmark. “If you take something like COVID where the markets shot down and then shot right back up, that is an amazing environment for this strategy.”
Sanghavi shared that backtesting to 2006 and running the strategy through all of the major modern financial crises has revealed that the strategy consistently overperforms.
ETF Stream is VettaFi's European-focused distribution capability.
