Market Update 29th July 2025

Fixed Index Mindset

As many are aware, throughout the investment industry, cost has become an increasingly prominent topic of discussion. There has been a general move towards passive solutions or enhanced passive products surrounded by satellite funds in a portfolio to reduce costs. I heard a crazy statistic from a conference that there are more tracker funds than there are underlying indexes.

Over the past few years concentration has come to the forefront due to the concentration of the S&P 500, which my colleague Robert touched upon in last week’s Innovation. As he mentioned the S&P is not the only index with this problem, there are lots of other regional equity indexes with similar issues and are evidently more concentrated, Indonesia and Denmark to name a few. Admittedly they are much smaller but still worth noting. The MSCI Indonesia’s largest constituent is 28.88% of the index, the second largest is 15.31%, making the top two over 44%. Denmark famously has Novo Nordisk at nearly 52% of the index.

Robert and I have spent time looking at passive options in all asset classes, including fixed income. Fixed income passives come with a few issues from my perspective: tracking error, cost, and liquidity. They aren’t all bad and many trackers do manage to track their underlying benchmark well. However, there is a fundamental flaw. When you buy an equity tracker you are buying the biggest companies by market cap. When you buy a fixed income tracker the largest constituents are companies with the most debt.

If you try to buy all the bonds in the index this will be very time consuming for the asset manager running the tracker fund and costly to the underlying client (high management fees) as the cost associated with trading frequently is high. If you consider how many bonds are in an index (thousands usually), then most trackers use a sampling approach. The most common is stratified which takes the overall allocation and risk of the index but without buying all the bonds.

Liquidity is another issue. It is much lower in the bond market compared to its equity equivalent. A bond issued has a limited size and does not “grow” as more people buy it. A company usually only has a few different types of shares in issue and more shares can be issued if there is demand for them.

There is also potential that if a bond were to fall out of the index, many tracker funds would be selling, leading to liquidity issues. Bonds can fall out of the index for a number of reasons, such as rating changes, or not meeting the index criteria for example trading volume or liquidity.

The fixed income market is $140.7 trillion globally as at the end of 2023. For comparison the global equity market was around $115 trillion at the end of 2023. (Although the bond market is larger in size, it is still less liquid than the equity market in terms of volume traded). Just under 40% of the fixed income market is in the US or $55.3 trillion. The next largest is the EU and is under half the size at 18.4% or $25.9 trillion. The UK is the sixth largest at around 4.2%. Although the size of the market has increased, issuance has come down by 0.1%.

A general issue with bond indexes is that they tend to be heavily weighted in financials. We recently spoke with a fund which said they feel the sterling short dated corporate bond index isn’t a good comparator for them as it’s about 40% in financials and 20% in subordinated debt. They use the euro index instead, which is closer to 30% in financials. This particular fund has no subordinated debt and has about 30% in financials.

There are plenty of fixed income opportunities outside of financials. These can be other sectors within corporates or within the asset backed securities (ABS) market, including mortgage-backed securities (MBS) and in floating rate notes. We’ve also looked at infrastructure bond funds which offer a diversified aspect to a portfolio.

For over a decade following the GFC there was little return available on government bonds in particular. This led to an increase in alternatives, such as infrastructure debt which offered a more attractive yield and diversification. But since bond yields have risen over the last few years, including government bonds, traditional fixed income has again become an important part of portfolios.

Apart from within government securities we’ve found it tricky to allocate to any index trackers/ passive fixed income funds. We are conscious of cost but right now there are some very good active managers, running active portfolios at very attractive prices. Just as an example one of our active managers has an OCF at 25bps.

Emily Cave – Research Analyst

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