Fund managers are currently sending out annual statements to their investors, including information on how their funds have performed. Typically, the fixed interest returns will be compared with something called the ‘UBS Composite Bond Index’.
However, many investors don’t know what that index actually means, or how it came to be the standard for comparing funds. During my years as a fixed interest fund manager, I was often asked to explain the nature and origin of this mysterious benchmark.
So who or what is ‘UBS’?
The history starts with the venerable merchant bank Dominguez Barry Samuel Montague (DBSM). The UBS indices are simply the modern version of the DBSM bond indices. Through the 1990s the firm changed its name many times, and so did the suite of bond indices that it maintained. Most of the names had SBC in them, which became UBS in 1998 when the Union Bank of Switzerland took over Swiss Bank Corporation.
A legitimate question is whether this gives UBS Asset Management any sort of unfair advantage in managing bond funds. The answer is definitely no. I can say this with confidence, having worked with them from 1993-96 and also from understanding how the bond index calculation process works. The indices have been maintained for many years now by the capital markets and broking side of the business, which deals with all fund managers in the market. UBS Asset Management has no influence over the valuations used for any of the bonds in the index or the performance of the index.
The meaning of composite unravelled
What about the use of the word ‘composite’ in the name of the index?
The index is made up of bonds in the market, not just an index of Commonwealth government securities (CGS). It includes debt issued by a wide variety of issuers, including state government authorities, local companies and foreign entities that choose to raise money in Australian dollars.
That’s the simple answer. But the more detailed explanation of why an index like this was produced needs a short history lesson in Commonwealth-state financial relations.
Prior to the mid-1980s the only bond market of any substance in Australia was for CGS. Apart from state government utilities like the NSW Electricity Commission, the Commonwealth undertook all borrowing on behalf of the states and on-lent the proceeds to them.
Then, at the Loan Council meeting in 1984, a package of measures was introduced to bring greater national control over the level of public sector borrowing. All borrowing by state entities was brought under the Loan Council oversight and limits for total annual borrowing by the states were determined. Under this global approach, the states would now borrow for themselves and on-lend to their own departments and agencies.
This led to the establishment of the state Treasury corporations to undertake the borrowing and to manage the internal lending to the various arms of government that needed funding. These institutions are what we now know as the semi-government authorities (or ‘semis’ for short).
At this point, Dominguez Barry entered the picture. Merchant bankers Jim Dominguez and Rob Barry saw the opportunity for their investment bank to help the semis get established, to originate and to market their debt securities and to encourage the development of this new bond market in Australia. (UBS is still a leading firm in the semi-government market.)
As part of the strategy they established a funds management business to invest in a portfolio that would include semis as well as CGS, and they needed a performance benchmark that was a composite of these two sectors.
As the market has evolved, with new issuers coming along, the index has also developed. It is now a composite of four sectors, each of which has its own index for performance and analysis purposes. The sectors are:
- UBS Treasury Index, which is CGS only
- UBS Semi-government Index
- UBS Credit Index, which includes investment grade corporate bonds
- UBS Supra/Sovereign index, which includes supranational issuers like World Bank and other Government guaranteed bonds.
Returns beat the benchmark
The fund manager statements that are now being sent out will show that the return from the UBS Composite Bond Index in 2013 was 1.99%. Individual fixed interest funds will be compared with this benchmark return and some explanation given for the relative performance.
Most fixed interest funds did quite well in 2013 and outperformed the Composite. This was mostly because almost all active managers were underweight in Commonwealth bonds and overweight in semis and corporates. The UBS semi-government index returned 2.52% in the year, and the UBS Credit index delivered 4.32%, compared with the Treasury index return of only 0.27%.
Another factor for managers who outperformed in 2013 is most likely a short duration strategy. Because this was a year in which yields rose, longer duration bond returns were reduced by the decline in capital value that goes with higher yields in the short term. Within the UBS Composite, the zero to three year maturity component returned 3.4%, but the 10 year and longer component was -2.7%.
Although it’s not the only index used by Australian fixed interest fund managers, the UBS Composite is the most popular. It is a comprehensive benchmark including the full range of investment grade securities available in the local market; it has a track record back to the mid-1980s; and information about its performance is readily available to all professional fund managers.
It is the fixed interest world’s equivalent to the All Ordinaries or S&P/ASX 200 that are used to benchmark share fund performance. And it comes with a fascinating history.
Warren Bird was Co-Head of Global Fixed Interest and Credit at Colonial First State Global Asset Management. His roles now include consulting, serving as an External Member of the GESB Board Investment Committee and writing on fixed interest.