Why do bond indices have higher turnover than equity indices?

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AcadiFi · Accepted Answer

Bond index turnover arises from three structural sources largely absent in equity indices. First, bonds mature: fixed-maturity instruments exit the index automatically when they fall below the minimum residual maturity (typically 1 year), forcing a proportionate replacement. A 5-year-average-maturity index mechanically turns over roughly 20% annually from maturities alone.

Second, new issuance is continuous and substantial. Corporates, sovereigns, and agencies issue new bonds monthly; when issues meet inclusion criteria (size, rating, currency), they enter at month-end rebalance. Aggregate indices typically see 1-2% of market cap in new issuance per month that must be absorbed.

Third, credit migration causes entries and exits: a bond downgraded from BBB to BB moves from investment grade to high yield index and vice versa. Fallen angels and rising stars can represent 1-3% of index market value annually in normal cycles, spiking during stress (2020 saw $300B+ of fallen angels).

For Brintwick Core Bond Fund tracking a market-value-weighted aggregate, this high turnover means higher transaction costs versus equity passive strategies. Costs depend on bid-ask spreads (1-5 bps for on-the-run Treasuries, 30-50 bps for BBB corporates, 100+ bps for illiquid names). Funds mitigate through: patient trading around rebalance dates, crossing trades internally, holding bonds beyond index removal when cost-effective, and using Treasury or credit futures as synthetic exposure.

Tracking error budget for fixed income passive is typically 10-30 bps, higher than equity's 2-10 bps, reflecting these frictions.

Why do bond indices have higher turnover than equity indices?

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