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Adjustments to closely tracked corporate bond indices have “clear” trading and pricing impacts, a new study from credit rating agency Fitch showed on Thursday.
The US rating agency found that changes to the Bloomberg Barclays US Aggregate Index earlier this year resulted in “dramatic increases” in trading volumes for bonds set to be dropped from the index and that prices for those bonds underperformed larger credits.
Bloomberg announced in January that it would increase the minimum requirement for a bond to gain inclusion in the index to $300m from $250m previously. More than $170bn worth of debt from 866 issues fell out of the index with the change.
The index is tracked by $1.2tn of mutual funds and exchange traded funds, according to Morningstar.
Fitch said it looked at nearly 700 bonds, split between those worth between $250m and $299m and were directly affected by the change, and bonds worth more than $300m.
Prices of the smaller bonds began to trail the larger credits in the days leading up to the start of the second quarter, when the adjustment to the index went into effect. The larger bonds had outperformed their smaller counterparts by 18 basis points on March 27. By March 31, the day before the change, price gains on the larger bonds outpaced the smaller cohort by 54 bps.
“The fact that even small changes in bond-index composition can trigger market responses of this kind suggests that larger changes in the index, including large-scale downgrades, could impact pricing and liquidity in a meaningful way,” says Robert Grossman, an analyst at Fitch.
As a result of the new minimum threshold, a number of small- and mid-sized companies increased the size of their bond offerings, including asset manager Eaton Vance, real estate investment trust CubeSmart and specialty chemicals group RPM International.
Many passive bond ETFs only buy bonds that are in the index.