The Problems and Challenges of High-Yield Bond Benchmarking

Abstract

High-yield bond benchmarks are often the major factor considered when evaluating the performance of high-yield bond managers. Levine, Drucker, and Rosenthal show that major indices are sometimes hard to beat and at other times easy to beat, and offer several reasons in support of their contention. The authors discuss the structural differences between the high-yield bond and equity markets as well as the properties of high-yield bond indices that make appropriate benchmarking in the high-yield bond market very challenging. The authors also provide a summary of the inclusion rules of several primary indices used as high-yield bond benchmarks. The conclusion reached by the authors is that the limitations of benchmarks, especially of high-yield benchmarks, should be kept in mind when a high-yield bond fund is compared to a high-yield bond index, and that high-yield bond fund performance is best judged within the context of the investor’s investment guidelines. Because plan sponsors often rely on benchmarks in compensating managers who “beat the benchmark,” in 2009 very few high-yield bond management professionals likely received bonuses despite great performance because they did not beat their benchmarks. In 2008, however, many managers received bonuses despite the high-yield bond market’s 26% loss, because the majority of funds outperformed their benchmarks. Something seems to be amiss. Beating major high-yield bond indices is sometimes difficult and sometimes easy, and plan sponsors should be aware of this phenomenon when compensating managers based upon their performance relative to their benchmarks.