Asset flows – Investors have shown strong interest in ETFs and other
passive, index-replicating bond strategies, as evidenced by asset flows.

Benchmark inefficiencies – There are numerous complexities and
benchmark inefficiencies associated with passive holdings in fixed income
that have a bearing on the risk-return profile of these investments.

Index composition and liquidity – Factors for consideration include the
nature of the over-the-counter (OTC) bond market and issuer-weighted
indices, which often means that investors seeking to replicate the index will
be investing most heavily in bonds issued by the most indebted companies
and countries.

Interest rate sensitivity – Passive investors have been taking on more
interest rate risk than they were during the global financial crisis as a result
of the rise in the interest rate sensitivity (duration) that has followed the fall
in yields in the benchmark indices.

Benchmark-aware approach – We advocate a “benchmark-aware”
active approach that allows a manager to incorporate the style discipline
benchmarks provide, while maintaining the flexibility to make investment
decisions that may help avoid the pitfalls of passively tracking the benchmark.

More fixed income insights from MFS experts at