Thursday 28th August 2025
Why fixed income benchmarks are built for issuers, not investors
It's a bugbear for investors that in the fixed income world, benchmarks are very different to what they represent in the equities world. In FI, departing from the index is virtually essential, argues Allspring's Michael Schueller.
Fixed income investors often treat benchmarks as neutral arbiters of market performance. Michael Schueller, senior portfolio manager at Allspring Global Investments, argues they are anything but. Speaking to advisers and asset allocators at The Inside Network’s Income & Defensive Symposium, he described most cap-weighted bond indices as “the issuer’s portfolio, not the investor’s,” structurally tilted to serve the needs of borrowers and laden with exposures that can work directly against investors’ interests.
Schueller (pictured) began by contrasting equity and bond markets. In equities, cap-weighting can be seen as a meritocracy: companies that grow revenues, expand margins and innovate are rewarded with a larger index weight. “The interests of the investors and managers are generally aligned,” he said. In fixed income, the relationship is inherently adversarial. Borrowers want to lock in low coupons for as long as possible, while lenders want higher coupons repaid sooner.
He illustrated the point with an extreme case: the cruise lines in 2020. Royal Caribbean and Carnival, desperate for liquidity, issued debt with coupons as high as 11 and 12 per cent, secured by prime collateral. “As an investor, I would have loved to lock that in for at least 10 years,” Schueller said. Instead, maturities were set at five years, with early call options that issuers swiftly exercised once conditions improved.
Cap-weighted indices, he argued, embed these issuer-friendly outcomes. When yields fall, borrowers rush to issue long-dated debt, extending the index’s duration. When yields rise, they shorten maturities, leaving investors stuck with the longer-dated paper issued in easier times. Investors rarely push back, Schueller said, because of a “classic prisoner’s dilemma” – any one investor demanding better terms risks losing the allocation to peers willing to accept the issuer’s conditions.
The structural bias runs deeper. Cap-weighted indices give the largest weights to the most indebted issuers. In the Bloomberg Global Aggregate Bond Index, two-thirds of the weight comes from just 30 sovereign and agency issuers, led by the US government. That concentration, once seen as a safe anchor, looks different in an era of rising fiscal stress worldwide.
Schueller noted that these issuer-driven shifts can meaningfully alter benchmark characteristics. Before the global financial crisis, a surge in US mortgage-backed securities (MBS) drove the securitised allocation of the Global Aggregate to its peak, leaving passive investors heavily exposed to the asset class just as the housing bubble burst. More recently, corporate issuance has boomed while credit quality has eroded: the share of BBB-rated bonds in the corporate segment has grown from 26 per cent to 47 per cent since 2008.
Duration risk is another silent consequence. The Global Aggregate’s duration rose from five to seven-and-a-half years in the decade after the crisis, peaking just before the worst bond bear market in history. The result was a negative total return of more than 15 per cent in 2022 for the index, a direct outcome of index composition dictated by issuer behaviour.
For Schueller, these examples are not abstract criticisms but evidence that passively tracking cap-weighted fixed income indices has delivered “return-free risk” in recent years. Over the past five years, both the US and Global Aggregate indices have produced negative annualised returns, with volatility between 6.5 and 8 per cent. By contrast, the average manager in the eVestment Global Multi-Sector Fixed Income universe delivered roughly 400 basis points more per year, with comparable or lower volatility.
His prescription is active, multi-sector investing that deliberately constructs an “investor’s portfolio” rather than inheriting the issuer’s. Global fixed income markets, he said, are “highly segmented, fragmented and full of inefficiencies” that skilled managers can exploit. Diversifying across sectors, adjusting duration and credit exposure actively, and resisting the embedded biases of benchmarks, can deliver better risk-adjusted outcomes.
Schueller’s critique challenges the default use of benchmarks in portfolio construction. For advisers and CIOs, it is a reminder that index exposures in fixed income are not neutral market snapshots but products of supply decisions by borrowers. Those decisions are driven by the issuers’ cost of capital, not the investor’s return needs.
The takeaway is clear. In a market where debt issuance patterns, fiscal conditions and credit quality are in flux, investors who outsource portfolio design to cap-weighted indices risk owning the wrong assets at the wrong time. Building a portfolio for investors means actively deciding what not to own – and being willing to depart from the benchmark when the benchmark itself is part of the problem.
Laurence Parker-Brown is head of content at The Inside Network and managing editor of The Inside Adviser and Investor Strategy News.
