Valuation-Indifferent Weighting for Bonds

Abstract:     
In historical testing, valuation-indifferent weighting as applied to U.S. and global equities has produced statistically significant and economically large outperformance when compared with traditional capitalization-weighted benchmarks. In this paper, we apply the method to U.S. investment-grade corporate bonds, U.S. high-yield bonds, and hard-currency emerging market bonds. We find that fixed-income portfolios constructed using valuation-indifferent weighting outperform the corresponding cap-weighted benchmarks.

We also find that the outperformance is higher for markets in which we might typically expect more inefficiencies and greater volatilities. Both findings are consistent with the empirical evidence found in the equity applications of valuation-indifferent weighting, as well as the proposed noise-in-price theoretical rationale for these results.

Number of Pages in PDF File: 25

Keywords: Fundamental Index, Valuation-Indifferent Index, Bond Index

JEL Classification: G12, G14

working papers series