The Benefits of Breaking Minimum Maturity Rules (Podcast)
Fixed-income index funds typically closely follow the construction rules of the indices they seek to replicate; in particular, bonds that violate an index’s minimum maturity rule will often be removed from funds that track that index. In an article in the May/June 2013 issue of the Financial Analysts Journal, “Minimum Maturity Rules: The Cost of Selling Bonds before Their Time,” Darrin DeCosta, CFA, and his coauthors Fei Leng, CFA, and Gregory Noronha, CFA, find that funds unnecessarily underperform when they follow their indices’ minimum maturity rules.
Rodney Sullivan, CFA, recently interviewed DeCosta, co-founder and head of product development at Accretive Asset Management LLC, about his research as part of our FAJ author interview series.
DeCosta says that he and his coauthors were concerned by the high level of turnover they observed in traditional fixed-income funds and the potential result of that turnover: underperformance and a subsequent negative effect on investor earnings. They wanted to find out what caused the high turnover rates as well as quantify the impact on investors.
They found that fixed-income index fund investors lose about 3.5 bps a year because fund managers who adhere to an index’s minimum maturity rule needlessly sell bonds before they mature. DeCosta says that a certain amount of close tracking of an index makes sense but that the minimum maturity rule “puts constraints on the portfolio managers and forces them to sell at inopportune times.”
“It’s important for practitioners to look at rules of index construction for index funds and really understand what those rules are going to do in terms of turnover and trading costs lost to the marketplace,” he says. To hear more of DeCosta’s thoughts on index construction and what managers can do to improve the performance of their funds, listen to the complete interview above or download the MP3.
CFA Institute members can access the full article on the CFA Publications website.
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.