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Bond of the Week: 7 February 2013

FTSE ORB Bond Index

    

An exciting development is taking place in the retail bond market. Earlier this month, the good old FTSE, assisted by the investment bank Investec, launched the first retail bond index in the UK, known as the FTSE ORB Bond Index. As you might expect, this bond index covers most of the sterling corporate bonds currently trading on the LSE ORB platform. As far as I know, this index is the first serious attempt to push this little corner of the bond market into a distinct sector within the investment universe.

Below are the brief details of the index, along with the constructed historic chart of the FTSE ORB Index (courtesy of Investec):

FTSE ORB Index
Index Launch Date: 31 January 2013
Number of constituents: 83
Notional Amount: £22.7 billion
Universe: Sterling Corporate Bonds
Currency: GBP
Base Value & Date: 100 (1 Oct 2010)
Nature: Total Return Index (price return plus coupons)
Calculation: Daily
Rebalancing Frequency: Monthly
Ticker: FTORB
Sub-indices: 4 – FTSE ORB Financials Index, FTSE Non-Financials Index, FTSE ORB Under 5Y Index, FTSE ORB Over 5Y Until Maturity Index

Since this is a bond index, as opposed to an equity index, its construction is somewhat different. First, the universe. According to the FTSE, this index has 83 constituents, with a notional value of about £22 billion. A good size sector, I think. But the following bonds are excluded from the index, for obvious reasons:

  • Hybrid bonds
  • Inflation-linked bonds
  • Callable, and Puttable bonds
  • Perpetual bonds
  • Contingent convertibale bonds

What’s in the index are sterling denominated corporate bonds with fixed coupon payments, with more than one year left to maturity.

Second, pricing. The basic data is sourced from Bloomberg, with the arithmetic mean between the bid and ask quotes used for the daily index calculation. When these quotes themselves are under suspect, FTSE may source the quotes from bond dealers directly.

Most useful to investors is the FTSE ORB Total Return Index, which computes the return with the price performance and interest payments of each bond within the universe, and the Gross Redemption Yield.

Source: Investec/FTSE, available from www.investec.co.uk/retailbonds

The efforts of Investec/FTSE to construct a bond index should merit recognition because, in time, this will serve in the interest of all retail bond investors.

First, it allows investors and readers to know, at a glance, the state of the market – just like FTSE 100 Index or FTSE All Share Index. Previously, we did not have that capability.

Second, it puts the market on the radar for the wider market, making comparison easy and standardised. Note that the index is calculated by the venerable index firm FTSE, which has a set of mature and transparent rules to compute the index daily (see here for a copy of the FTSE ORB Index) . Also handy are the yields of each index. Last I checked, the FTSE ORB Index fetches a Gross Redemption Yield of about 4%, 50bps higher than the FTSE All Share’s dividend yield of 3.55%.

Lastly, this set of indices could serve as a benchmark for investors and issuers alike. Interestingly, there are four sub-indices beneath the main FTSE ORB index (Financials, Non Financials, Less Than 5-Year Maturity, & More than 5-Year Maturity). One possible extension of this group is to create a sub-index that tracks retail bonds within a certain credit band.

View: The construction of a set of retail bond indices has all kinds of favourable implications. This is another step towards a more mature retail bond market. The downside, however, is that the index is not tradable at this point. Perhaps the index is still in its infancy and not widely recognised. I hope there could be a concerted effort to market this index and educate investors about the advantages of a benchmark index.

However, once the majority of market participants are aware of its existence, I suspect there could be sufficient demand to create an investment product layered on top of this index. A candidate could be an ETF (exchange traded fund). By investing in this one bond ETF, retail investors could achieve diversification pretty quickly.  The practical difficulties of setting up a product like this are price transparency and liquidity, but then, in a bull market, these issues are not insurmountable. Exciting times for investors indeed.

Dr Jackson Wong

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