As investor preferences shift towards a total risk and return framework, it’s becoming increasingly important to understand the part optimisation of anchoring benchmarks play in achieving ideal portfolio risk and excess return, Manroop Singh, AMP Capital’s Global Fixed Income portfolio analyst, explains.

Singh describes the inefficiencies of traditional benchmarks and explores the need for an optimal benchmark alternative credit allocation. 

Singh uses Mean Variance Optimisation analysis to demonstrate the benefit of shifting to a Credit Reference Portfolio using outlined constraints, at the recent AMP Capital bi-annual Global Fixed Income Research Forum.

Singh’s analysis shows that a CRP (Credit Reference Portfolio) for both the US and Australia overcome the inefficiencies inherent in benchmark construction, offering a superior risk adjusted return and creating a more favourable allocation to the Credit Risk Premium. 

Indeed, the credit risk premium is an integral component of Fixed Income markets and a source of excess return that can be accessed both actively and passively via a benchmark, Singh highlights. 

“While actively managing a portfolio to the benchmark implicitly assumes that the benchmark is efficient and ideal, traditional benchmarks are simply market value weighted aggregations of bonds, selected for inclusion by features such as rating, tenor, currency, and issue size,” Singh explains. 

The construction of a traditional benchmark is agnostic of market factors such as liquidity and therefore unlikely to be the best risk adjusted outcome at any given point in time, he says.

Singh outlines a method to construct a benchmark alternative to illustrates the benefits of adopting this approach using data to assess Australian and US investment grade credit markets dating back to 2005.

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