Research Affiliates Fundamental Index®: Bonds

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The Fundamental Index® approach works for bonds as well as stocks. In 2010, research published in Journal of Portfolio Management showed that applying the RAFI methodology to U.S. high-yield bonds would have generated more than 2% per annum in added value for the 23-year period ended December 2009. U.S. investment-grade bonds would have generated 0.43% in excess return, while local currency emerging market debt would have provided 1.27% in return above a traditional index.

RAFI Bonds Outperform Traditional Indices
	Return	Standard Deviation	Sharpe Ratio	Average Credit Rating	Duration	Excess Return
High-Yield Bonds
Composite¹	8.79	12.24	0.46	BB3	4.87	2.54
Benchmark²	7.06	8.88	0.43	BB3/B1	4.58	0.81
BofA Merrill Lynch US High Yield Index	6.25	9.19	0.33
Investment-Grade Bonds
Composite¹	6.76	5.49	0.65	A2	5.94	0.43
Benchmark²	6.52	5.66	0.59	A2/A3	5.95	0.18
BofA Merrill Lynch US Corporate Index	6.33	5.81	0.54
Emerging Market Debt
Composite³	12.07	11.45	0.77	BB1	5.17	1.27
Benchmark²	11.06	13.98	0.56	BB2/BB3	5.79	0.26
BofA Merrill Lynch US Dollar Emerging Markets Sovereign Plus Index	10.80	13.87	0.55
¹Composite includes assets, dividends, cash flow, and sales. ²Benchmark is a customized cap-weighted benchmark. ³Composite includes population, area, GDP, and energy consumption.
Source: Research Affiliates based on data from Bloomberg.

The RAFI® methodology for fixed income selects and weights securities using fundamental measures of issuer size rather than market value of debt outstanding. For corporate bonds, cash flow, sales, book value of assets and dividends are used. This approach breaks the link between portfolio weight and any over- or undervaluation, resulting in a more efficient portfolio.

Different factors reflecting the important of countries in the global economy are used for sovereign developed and emerging market bonds. (Traditional account measures, such as sales or profits, or not available.) Instead, the RAFI methodology uses total population, gross domestic product, square root of land areas (as a proxy for resources), and energy consumption (also a proxy for resources). As with equities, Fundamental Index fixed-income portfolios preserve the original benefits of traditional cap-weighted indexes, including broad diversification, economic representation, liquidity, scalability, low turnover, and tax efficiency.

The RAFI Fundamental Bond indices are calculated in conjunction with Ryan ALM, Inc. The Citi RAFI Bond Index Series are calculated by Citi.

More information on RAFI Bonds can be found on these pages:

Fact sheets for the RAFI Investment Grade Bond Index and the RAFI High Yield Bond Index provide performance and ticker information.
Detailed construction rules for the investment-grade corporate and high yield corporate bond indices explain the methodology.
Additional questions are addressed in the RAFI FAQ.

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