Old bond benchmarks boost default risk, VettaFi says

TMX VettaFi says traditional fixed-income benchmarks that weight bonds by outstanding debt give the largest allocations to the most indebted issuers and increase default risk. The firm is developing equal-issue-weighted and smart-beta indices that prioritize credit quality over issuance volume.

The market-cap method dates to the first total-return U.S. government and investment-grade corporate bond indexes in the early 1970s and has remained the standard. Samarth Sanghavi, head of fixed income index product at TMX VettaFi, argued that in bond indexes market-cap weighting has effectively become debt-weighting, so issuers that borrow most automatically receive the biggest index weights. Sanghavi added: “Debt weighting is not an investment thesis.”

Sanghavi contrasted bond indexing with equity indexing, noting that equity size often reflects market value and investor sentiment, while bond investors typically focus on preserving capital. Brian Coco, head of index products at TMX VettaFi, described the bond mindset as: “In fixed income, you win by not losing.”

Current macro conditions have made credit exposure more relevant. Higher-for-longer interest rates have raised borrowing costs and increased the chance that firms with heavy debt loads could face liquidity pressure. Under market-cap-weighted benchmarks, those firms would hold larger shares of an index, increasing credit exposure for passive bond portfolios when servicing debt is more expensive.

TMX VettaFi’s alternative indexes apply issuer-level limits and credit filters to reduce concentration in the largest borrowers and raise representation for smaller, higher-rated issuers. The designs can include sector, duration and rating screens and use technology that allows index creators and ETF issuers to set rules filtering holdings by those attributes.

Sanghavi called conventional fixed-income benchmarks “broken” and said the objective is not to exclude large issuers but to prevent issuance volume from becoming the main determinant of portfolio weight.