Journal of Asset Management

, Volume 17, Issue 4, pp 280–294 | Cite as

A fundamental bond index including solvency criteria

  • Marielle de Jong
  • Lauren Stagnol
Original Article


Doubts are rising whether bond indices, in the way they are constructed, are effective in their role of representing the markets they are designed for. Since index constituents are defined on market shares – the larger the debt obligation, the larger the share in the index – it may be that certain risks related to a high level of indebtedness are being accentuated which are not necessarily representative for the market as a whole. Undue debt levels would in theory not arise in an information-efficient market, however, if prices are distorted and do not convey information efficiently, it makes sense to compensate for that and integrate elementary information on the debt issuers into the index construction process. We test how that works out on corporate bonds. We build an index that is based on firm accounting data rather than debt size, and give evidence that it serves as a market proxy.


fundamental indexing alternative corporate bond index solvency criteria market efficiency 



The authors would like to thank Valérie Mignon, Frédéric Lepetit, Valentine Ainouz and Bruce Phelps for their valuable suggestions.


  1. Al-Khazali, O.M. and Zoubi, T.A. (2011) Empirical testing of different alternative proxy measures for firm size. Journal of Applied Business Research 21 (3): 79–90.Google Scholar
  2. AlMahdhi, S. (2015) Smart beta portfolio optimization. Journal of Mathematical Finance 5 (2): 202.CrossRefGoogle Scholar
  3. Altman, E.I. (1968) Financial ratios, discriminant analysis, and the prediction of corporate bankruptcy. Journal of Finance 23 (4): 589–609.CrossRefGoogle Scholar
  4. Amenc, N., Goltz, F. and Lodh, A. (2012) Choose your betas: Benchmarking alternative equity index strategies. Journal of Portfolio Management 39 (1): 88–111.CrossRefGoogle Scholar
  5. Amenc, N., Goltz, F. and Martellini, L. (2013) Smart Beta 2.0. EDHEC-Risk Position Paper.Google Scholar
  6. Arnott, R., Hsu, J., Li, F. and Shepherd, S.D. (2010) Valuation-indifferent weighting for bonds. Journal of Portfolio Management 36 (3): 117–130.CrossRefGoogle Scholar
  7. Arnott, R.D., Hsu, J.C. and Moore, P. (2005) Fundamental indexation. Financial Analysts Journal 61 (2): 83–99.CrossRefGoogle Scholar
  8. Arnott, R.D. and Markowitz, H.M. (2008) Fundamentally flawed indexing: Comments. Financial Analysts Journal 64 (2): 12–14.CrossRefGoogle Scholar
  9. Asness, C. (2006) The value of fundamental indexation. Institutional Investor 40 (10): 94–99.Google Scholar
  10. Bakshi, G., Madan, D. and Zhang, F.X. (2006) Investigating the role of systematic and firm-specific factors in default risk: Lessons from empirically evaluating credit risk models. Journal of Business 79 (4): 1955–1987.CrossRefGoogle Scholar
  11. Balchunas, E. (2014) Smart beta: The investing buzzword that won’t – And needn’t – Die. Bloomberg News 27 August.Google Scholar
  12. Basu, A.K. and Forbes, B. (2013) Does fundamental indexation lead to better risk-adjusted returns? New evidence from Australian securities exchange. Accounting & Finance 53 (3): 1–30.Google Scholar
  13. Beaver, W. (1966) Financial ratios as predictors of failure. Journal of Accounting Research 4, 91–101.CrossRefGoogle Scholar
  14. Black, F. and Scholes, M. (1973) The pricing of options and corporate liabilities. Journal of Political Economy: 637–654.Google Scholar
  15. Blitz, D. and Swinkels, L. (2008) Fundamental indexation: An active value strategy in disguise. Journal of Asset Management 9 (4): 264–269.CrossRefGoogle Scholar
  16. Campbell, J.Y., Hilscher, J. and Szilagyi, J. (2011) Predicting financial distress and the performance of distressed stocks. Journal of Investment Management 9 (2): 14–34.Google Scholar
  17. Chen, C., Chen, R. and Bassett, G.W. (2007) Fundamental indexation via smoothed cap weights. Journal of Banking and Finance 31 (11): 3486–3502.CrossRefGoogle Scholar
  18. Chow, T.M., Hsu, J., Kalesnik, V. and Little, B. (2011) A Survey of Alternative Equity Index Strategies. Financial Analysts Journal 67 (5): 37–57.CrossRefGoogle Scholar
  19. Collin-Dufresne, P., Goldstein, R.S. and Martin, J.S. (2001) The determinants of credit spread changes. Journal of Finance 56 (6): 2177–2208.CrossRefGoogle Scholar
  20. Das, S., Kalimipalli, M. and Nayak, S. (2014) Did CDS trading improve the market for corporate bonds? Journal of Financial Economics 111 (2): 495–525.CrossRefGoogle Scholar
  21. de Jong, M. and Wu, H. (2014) Fundamental indexation for bond markets. Journal of Risk Finance 15 (3): 264–274.CrossRefGoogle Scholar
  22. DeMiguel, V., Garlappi, L. and Uppal, R. (2009) Optimal versus naive diversification: How inefficient is the 1/N portfolio strategy? Review of Financial Studies 22 (5): 1915–1953.CrossRefGoogle Scholar
  23. Dijkstra, T.K. (2015) On Perold’s ‘fundamentally flawed indexing’,, accessed 20 October 2015.
  24. Downing, C., Underwood, S. and Xing, Y. (2009) The relative informational efficiency of stocks and bonds: An intraday analysis. Journal of Financial and Quantitative Analysis 44 (5): 1081–1102.CrossRefGoogle Scholar
  25. Estrada, J. (2008) Fundamental indexation and international diversification. Journal of Portfolio Management 34 (3): 93–109.CrossRefGoogle Scholar
  26. Falcon, L.T. (2007) Logit Models to Assess Credit Risk. Credit Risk Assessment Revisited: Methodological Issues and Practical Implications, European Committee of Central Balance Sheet data Offices Working Group on Risk Assessment, pp. 95–118.Google Scholar
  27. Fama, E. (1970) Efficient capital markets: A review of theory and empirical work. Journal of Finance 25 (2): 383–417.CrossRefGoogle Scholar
  28. Fama, E.F. and French, K.R. (1993) Common risk factors in the returns on stocks and bonds. Journal of Financial Economics 33 (1): 3–56.CrossRefGoogle Scholar
  29. Gebhardt, W.R., Hvidkjaer, S. and Swaminathan, B. (2005) The cross-section of expected corporate bond returns: Betas or characteristics?. Journal of Financial Economics 75 (1): 85–114.CrossRefGoogle Scholar
  30. Hemminki, J. and Puttonen, V. (2008) Fundamental indexation in Europe. Journal of Asset Management 8 (6): 401–405.CrossRefGoogle Scholar
  31. Herfindahl, O. (1950) Concentration in the US steel industry, unpublished doctoral dissertation, Columbia University, New York.Google Scholar
  32. Houweling, P., Mentink, A. and Vorst, T. (2005) Comparing possible proxies of corporate bond liquidity. Journal of Banking and Finance 29 (6): 1331–1358.CrossRefGoogle Scholar
  33. Houwer, R. and Plantinga, A. (2009) Fundamental Indexing: An Analysis of the Returns, Risks and Costs of Applying the Strategy. SSRN.Google Scholar
  34. Hsu, J. (2006) Cap-weighted portfolios are sub-optimal portfolios. Journal of Investment Management 4 (3): 44–53.Google Scholar
  35. Hsu, J.C. and Campollo, C. (2006) An examination of fundamental indexation. New Frontiers in Index Investing. Journal of Indexes 58, 32–37.Google Scholar
  36. Hsu, J.C., Kalesnik, V. and Xie, S. (2011) What makes fundamental index methodology work? Working Paper, Newport Beach, CA: Research Affiliates.Google Scholar
  37. Huang, J. and Huang, M. (2003) How much of the corporate-treasury yield spread is due to credit risk? Review of Asset Pricing Studies 2 (2): 153–202.CrossRefGoogle Scholar
  38. Jacobs, B.I. and Levy, K.N. (2014) Smart beta versus smart alpha. The Journal of Portfolio Management 40 (4): 4–7.CrossRefGoogle Scholar
  39. Jacobs, B.I. and Levy, K.N. (2015) Smart beta: Too good to be true? The Journal of Financial Perspectives 3 (2): 1–9.Google Scholar
  40. Kaplan, P. and Arnott, R. (2008) in Kaplan, P. (2012) Frontiers of Modern Asset Allocation. Chapter 4, Wiley Online Library,
  41. Kwan, S.H. (1996) Firm specific information and the correlation between individual stocks and bonds. Journal of Financial Economics 40 (1): 63–80.CrossRefGoogle Scholar
  42. Malkiel, B.G. (2014) Is smart beta really smart? The Journal of Portfolio Management 40 (5): 127.CrossRefGoogle Scholar
  43. Merton, R.C. (1974) On the pricing of corporate debt: The risk structure of interest rates. Journal of Finance 29 (2): 449–470.Google Scholar
  44. Modigliani, F. and Miller, M. (1958) The cost of capital, corporation finance and the theory of investment. The American Economic Review 48 (3): 261–297.Google Scholar
  45. Moles, P., Parrino, R. and Kidwell, D. (2011) Fundamentals of Corporate Finance. Hoboken, NJ: Wiley.Google Scholar
  46. Ohlson, J.A. (1980) Financial ratios and the probabilistic prediction of bankruptcy. Journal of Accounting Research 18: 109–131.CrossRefGoogle Scholar
  47. Perold, A.F. (2007) Fundamentally flawed indexing. Financial Analysts Journal 63 (6): 31–37.CrossRefGoogle Scholar
  48. Perold, A.F. (2008) Fundamentally flawed indexation: Author response. Financial Analysts Journal 64 (2): 14–17.CrossRefGoogle Scholar
  49. Roncalli, T. (2013) Introduction to Risk Parity and Budgeting. Chapman & Hall, CRC Financial Mathematics Series.Google Scholar
  50. Sharpe, W.F. (1964) Capital asset prices: A theory of market equilibrium under conditions of risk. Journal of Finance 19 (3): 425–442.Google Scholar
  51. Shepherd, S. (2015) Smart Beta For Corporate Bonds. Research Affiliates White Paper (February).Google Scholar
  52. Siegel, L.B. (2003) Benchmarks and Investment Management. Charlottesville, VA: CFA Institute.Google Scholar
  53. Staal, A., Corsi, M., Shores, S. and Woida, C. (2015) A factor approach to smart beta development in fixed income. The Journal of Index Investing 6 (1): 98–110.CrossRefGoogle Scholar
  54. Tamura, H. and Shimizu, Y. (2005) Fundamental indices: Do they outperform market-cap weighted indices on a global basis? Security Analysts Journal 43 (10): 32–46.Google Scholar
  55. Treynor, J. (2008) Fundamentally flawed indices: Comments. Financial Analysts Journal 64 (2): 14–14.CrossRefGoogle Scholar
  56. Walkshusl, C. and Lobe, S. (2010) Fundamental indexing around the world. Review of Financial Economics 19 (3): 117–127.CrossRefGoogle Scholar
  57. Whalen, G. and Thomson, J.B. (1988) Using financial data to identify changes in bank condition. Economic Review 24. Federal Reserve Bank of Cleveland, 17–26.Google Scholar

Copyright information

© Palgrave Macmillan, a division of Macmillan Publishers Ltd 2016

Authors and Affiliations

  1. 1.University of Paris Ouest Nanterre La DéfenseNanterre

Personalised recommendations