State Street Global Advisors is developing a high-yield index fund--the second such fund ever. Bruce Walbridge, high-yield portfolio manager at the Boston-based firm, says the idea for the fund was hatched in the spring. Since then, however, high-yield has been hit hard by market-wide concerns about corporate creditworthiness. As of August 23, high-yield mutual funds had seen 11 consecutive weeks of outflows, according to AMG Data Services. With many credits trading at spreads of 1,000 basis points over Treasuries and yields averaging 14%, Walbridge said investors are more open to the possibility of such a fund than they were in the spring, when spreads were at roughly 700 over. Walbridge says State Street is working with Lehman Brothers to develop a customized index on which to benchmark the fund. He says the index will be publicly released.
Tom Parker, portfolio manager at Barclays Global Investors in San Francisco, the first firm to create a high-yield index fund (BW, 6/5/00), says high-yield index funds are extremely difficult to create, because junk bonds are often illiquid, making it virtually impossible to match a broad-based benchmark index. Despite this, he argues that indexing will become a trend, reasoning that in a rising rate environment, it becomes more difficult to outperform an index. He says junk managers could, in past markets, outperform an index by over-weighting double-B credits, which are more sensitive to Treasuries. "There hasn't been appetite for high-yield index funds. That's going to change. Variance between managers is increasing, and old strategies don't work as well."
At any rate, several high-yield pros reason that the poor returns in high-yield are causing a number of investors to become "closet indexers." One salesman and a portfolio manager say Putnam Investments has gone to more of an indexing approach, where they look to match indices by sector. Steve Peacher, head of high-yield at Putnam, says his firm is not an indexer and looks at indices only as broad measures of market risk concentrations. "We are convinced that the high-yield market remains very security-specific," he says, noting that "if you indexed to the Merrill Lynch index when they put WorldCom in, you would have had 4% of your portfolio pegged to WorldCom and its headlines."
State Street's Walbridge says that a primary difference between the SSGA fund and Barclays' will be nature of the index tracked. He says SSGA's index will be "rules based," excluding, for example, companies that do not have at least $400 million in total debt outstanding, triple-C ratings and that are not outstanding for at least three months. Barclays' Parker says his firm places a premium on liquidity, so it benchmarks off a smaller, much more liquid index, the Morgan Stanley Core 250.