Now that you know all about the bond market, let’s dive into bond indices: the different types and how they’re weighted.
What is a Bond Index?
A bond index is a method of measuring the value of a specific section of the bond market. It is calculated from the prices of selected bonds. A bond index is a tool used by many investors to describe the market. Investors and financial managers also use it to compare the return on specific investments.
Different Types of Indices
Bond indices are typically categorized based on their broad characteristics, such as whether they’re composed of government bonds, municipal bonds, corporate bonds, high-yield bonds, etc. They can also be classified based on their credit rating or maturity.
Bond indices tend to be total rate-of-return indices. The main use for bond indices is to look at past performance of a market over time. They also tend to have yield, duration, and convexity, which are aggregated up from individual bonds.
Bond indices generally include more individual securities than do stock market indices. The indices are broader and tend to be more rule-based. This allows portfolio managers to predict which type of issues will be eligible for the index.
Bond Index Funds
An index is not something to be invested in directly. Think of it more as a mathematical construct. Many mutual funds and exchange-traded funds attempt to track an index, and those funds that do not may be judged against those that do.
There’s a lot to know about bond indices. Due to the large number of issues, they’re harder to replicate than stock market indices. Portfolio managers will typically define suitable benchmarks for their portfolios and use an already existing index. They’ll then purchase a subset of the issues available in their benchmark, and use the index as a measure of the market portfolio's return. They do this in order to have something against which to compare their own portfolio's performance.
Although it tends to get less media attention compared to the stock market, there’s still a whole lot of money to be earned in the bond market. To learn more about bonds, check out our free course Investing in Different Markets!