Skip to main content
SpringerLink
Log in

A fundamental bond index including solvency criteria

  • Original Article
  • Published:
Journal of Asset Management Aims and scope Submit manuscript

Abstract

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.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Figure 1
Figure 2
Figure 3
Figure 4

Similar content being viewed by others

Notes

  1. Calculations available from the authors upon request.

  2. We use an independent bond market index to avoid too high correlation levels between the DEF factor and the CW benchmark.

References

  • 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 

  • AlMahdhi, S. (2015) Smart beta portfolio optimization. Journal of Mathematical Finance 5 (2): 202.

    Article  Google Scholar 

  • Altman, E.I. (1968) Financial ratios, discriminant analysis, and the prediction of corporate bankruptcy. Journal of Finance 23 (4): 589–609.

    Article  Google Scholar 

  • Amenc, N., Goltz, F. and Lodh, A. (2012) Choose your betas: Benchmarking alternative equity index strategies. Journal of Portfolio Management 39 (1): 88–111.

    Article  Google Scholar 

  • Amenc, N., Goltz, F. and Martellini, L. (2013) Smart Beta 2.0. EDHEC-Risk Position Paper.

  • Arnott, R., Hsu, J., Li, F. and Shepherd, S.D. (2010) Valuation-indifferent weighting for bonds. Journal of Portfolio Management 36 (3): 117–130.

    Article  Google Scholar 

  • Arnott, R.D., Hsu, J.C. and Moore, P. (2005) Fundamental indexation. Financial Analysts Journal 61 (2): 83–99.

    Article  Google Scholar 

  • Arnott, R.D. and Markowitz, H.M. (2008) Fundamentally flawed indexing: Comments. Financial Analysts Journal 64 (2): 12–14.

    Article  Google Scholar 

  • Asness, C. (2006) The value of fundamental indexation. Institutional Investor 40 (10): 94–99.

    Google Scholar 

  • 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.

    Article  Google Scholar 

  • Balchunas, E. (2014) Smart beta: The investing buzzword that won’t – And needn’t – Die. Bloomberg News 27 August.

  • 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 

  • Beaver, W. (1966) Financial ratios as predictors of failure. Journal of Accounting Research 4, 91–101.

    Article  Google Scholar 

  • Black, F. and Scholes, M. (1973) The pricing of options and corporate liabilities. Journal of Political Economy: 637–654.

  • Blitz, D. and Swinkels, L. (2008) Fundamental indexation: An active value strategy in disguise. Journal of Asset Management 9 (4): 264–269.

    Article  Google Scholar 

  • 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 

  • Chen, C., Chen, R. and Bassett, G.W. (2007) Fundamental indexation via smoothed cap weights. Journal of Banking and Finance 31 (11): 3486–3502.

    Article  Google Scholar 

  • 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.

    Article  Google Scholar 

  • Collin-Dufresne, P., Goldstein, R.S. and Martin, J.S. (2001) The determinants of credit spread changes. Journal of Finance 56 (6): 2177–2208.

    Article  Google Scholar 

  • 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.

    Article  Google Scholar 

  • de Jong, M. and Wu, H. (2014) Fundamental indexation for bond markets. Journal of Risk Finance 15 (3): 264–274.

    Article  Google Scholar 

  • 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.

    Article  Google Scholar 

  • Dijkstra, T.K. (2015) On Perold’s ‘fundamentally flawed indexing’, http://www.researchgate.net/publication/238240589, accessed 20 October 2015.

  • 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.

    Article  Google Scholar 

  • Estrada, J. (2008) Fundamental indexation and international diversification. Journal of Portfolio Management 34 (3): 93–109.

    Article  Google Scholar 

  • 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.

  • Fama, E. (1970) Efficient capital markets: A review of theory and empirical work. Journal of Finance 25 (2): 383–417.

    Article  Google Scholar 

  • 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.

    Article  Google Scholar 

  • 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.

    Article  Google Scholar 

  • Hemminki, J. and Puttonen, V. (2008) Fundamental indexation in Europe. Journal of Asset Management 8 (6): 401–405.

    Article  Google Scholar 

  • Herfindahl, O. (1950) Concentration in the US steel industry, unpublished doctoral dissertation, Columbia University, New York.

  • Houweling, P., Mentink, A. and Vorst, T. (2005) Comparing possible proxies of corporate bond liquidity. Journal of Banking and Finance 29 (6): 1331–1358.

    Article  Google Scholar 

  • Houwer, R. and Plantinga, A. (2009) Fundamental Indexing: An Analysis of the Returns, Risks and Costs of Applying the Strategy. SSRN.

  • Hsu, J. (2006) Cap-weighted portfolios are sub-optimal portfolios. Journal of Investment Management 4 (3): 44–53.

    Google Scholar 

  • 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 

  • Hsu, J.C., Kalesnik, V. and Xie, S. (2011) What makes fundamental index methodology work? Working Paper, Newport Beach, CA: Research Affiliates.

  • 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.

    Article  Google Scholar 

  • Jacobs, B.I. and Levy, K.N. (2014) Smart beta versus smart alpha. The Journal of Portfolio Management 40 (4): 4–7.

    Article  Google Scholar 

  • 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 

  • Kaplan, P. and Arnott, R. (2008) in Kaplan, P. (2012) Frontiers of Modern Asset Allocation. Chapter 4, Wiley Online Library, http://www.etf.com/publications/journalofindices/joi-articles/5139-the-fundamental-debate.html?nopaging=1.

  • Kwan, S.H. (1996) Firm specific information and the correlation between individual stocks and bonds. Journal of Financial Economics 40 (1): 63–80.

    Article  Google Scholar 

  • Malkiel, B.G. (2014) Is smart beta really smart? The Journal of Portfolio Management 40 (5): 127.

    Article  Google Scholar 

  • 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 

  • 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 

  • Moles, P., Parrino, R. and Kidwell, D. (2011) Fundamentals of Corporate Finance. Hoboken, NJ: Wiley.

    Google Scholar 

  • Ohlson, J.A. (1980) Financial ratios and the probabilistic prediction of bankruptcy. Journal of Accounting Research 18: 109–131.

    Article  Google Scholar 

  • Perold, A.F. (2007) Fundamentally flawed indexing. Financial Analysts Journal 63 (6): 31–37.

    Article  Google Scholar 

  • Perold, A.F. (2008) Fundamentally flawed indexation: Author response. Financial Analysts Journal 64 (2): 14–17.

    Article  Google Scholar 

  • Roncalli, T. (2013) Introduction to Risk Parity and Budgeting. Chapman & Hall, CRC Financial Mathematics Series.

    Google Scholar 

  • 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 

  • Shepherd, S. (2015) Smart Beta For Corporate Bonds. Research Affiliates White Paper (February).

  • Siegel, L.B. (2003) Benchmarks and Investment Management. Charlottesville, VA: CFA Institute.

    Google Scholar 

  • 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.

    Article  Google Scholar 

  • 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 

  • Treynor, J. (2008) Fundamentally flawed indices: Comments. Financial Analysts Journal 64 (2): 14–14.

    Article  Google Scholar 

  • Walkshusl, C. and Lobe, S. (2010) Fundamental indexing around the world. Review of Financial Economics 19 (3): 117–127.

    Article  Google Scholar 

  • 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.

Download references

Acknowledgements

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

Author information

Authors and Affiliations

  1. University of Paris Ouest Nanterre La Défense, 200 avenue de la République, 92000, Nanterre

    Lauren Stagnol

Authors
  1. Marielle de Jong
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Lauren Stagnol
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Lauren Stagnol.

Additional information

The views expressed in this article are those of the authors and do not necessarily reflect those of Amundi.

APPENDIX

APPENDIX

Table A1

Table A1 Definition of the solvency scores
Full size table

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

de Jong, M., Stagnol, L. A fundamental bond index including solvency criteria. J Asset Manag 17, 280–294 (2016). https://doi.org/10.1057/jam.2016.15

Download citation

  • Received:

  • Revised:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1057/jam.2016.15

Keywords

Search

Navigation