Lehman brothers corporate bond index: Meaning, Criticisms & Real-World Uses

What Is the Lehman Brothers Corporate Bond Index?

The Lehman Brothers Corporate Bond Index was a prominent benchmark used in the fixed income market to measure the performance of investment-grade corporate debt. It specifically tracked publicly issued, fixed-rate, nonconvertible, dollar-denominated, SEC-registered, investment-grade bond securities. As a bond index, it provided portfolio managers and investors with a standardized tool to evaluate the overall health and returns of a significant segment of the bond market. This index fell under the broader category of Fixed Income Investment Tools and Portfolio Theory.

History and Origin

The development of bond indices gained momentum in the 1970s, with total return bond indices, including those focused on U.S. investment-grade bonds, first emerging during this period. Lehman Brothers, a long-standing financial institution, played a significant role in the evolution of these tools, creating key benchmarks for the U.S. bond market. The firm established the Lehman Aggregate Bond Index in 1973, which eventually broadened to include various types of fixed income securities beyond just corporate bonds.¹⁰

A pivotal moment in the index's history came with the bankruptcy of Lehman Brothers on September 15, 2008, a landmark event during the subprime mortgage crisis. This historic collapse led to a restructuring of many of Lehman's assets. Shortly after the bankruptcy, Barclays acquired Lehman's North American investment banking and capital markets businesses, including its widely used family of bond indices. Consequently, the Lehman Brothers Corporate Bond Index, along with other Lehman benchmarks, was renamed under the Barclays Capital brand in November 2008.⁹ The index underwent another change in ownership when Bloomberg LP acquired Barclays' index business in 2016, leading to its current designation as part of the Bloomberg Barclays U.S. Aggregate Bond Index family.⁸

Key Takeaways

The Lehman Brothers Corporate Bond Index was a crucial benchmark for U.S. investment-grade corporate bonds.
It helped investors gauge the performance of the corporate bond market.
Its lineage traces through Barclays and now to Bloomberg, reflecting significant shifts in the financial industry.
The index's components adhered to specific criteria, including being publicly issued, fixed-rate, dollar-denominated, and having an investment-grade bond credit rating.
The index served as a foundational tool for both active and passive fixed income portfolio management.

Formula and Calculation

Bond indices, including the historical Lehman Brothers Corporate Bond Index, are calculated based on the change in market prices of their constituent bonds, as well as the interest payments received from these bonds. For a total return index, the calculation aims to represent the comprehensive return an investor would receive by holding all bonds within the index.

The total return ((TR)) of an index over a period can be generally expressed as:

TR = \frac{(P_1 - P_0) + I}{P_0}

Where:

(P_0) = Initial market price of the index's constituent bonds (or index value)
(P_1) = Ending market price of the index's constituent bonds (or index value)
(I) = Income generated from interest payments (coupon payments) over the period

The market-weighted methodology is typically used for such indices, where each bond's influence on the index's overall movement is proportional to its outstanding market value. This ensures that larger, more liquid bond issues have a greater impact on the index's performance.

Interpreting the Lehman Brothers Corporate Bond Index

Investors and analysts primarily used the Lehman Brothers Corporate Bond Index to understand the performance of the U.S. investment-grade bond market. An increase in the index value suggested that corporate bonds were appreciating in value, either due to rising prices (falling yields) or accumulated total return from coupon payments. Conversely, a decline indicated that the market segment was experiencing losses.

Portfolio managers would often compare their actively managed corporate bond portfolios against this index to assess their relative performance. If a portfolio consistently outperformed the index, it suggested effective security selection or strategic market timing. For passively managed portfolios, the goal was to replicate the index's performance as closely as possible. The index's characteristics, such as its overall duration, provided insights into its sensitivity to interest rate risk, allowing investors to gauge potential volatility.

Hypothetical Example

Imagine a portfolio manager in 2007, before the significant changes to the Lehman Brothers Corporate Bond Index. This manager holds a portfolio of U.S. investment-grade bonds from various corporations, aiming to outperform the index.

At the beginning of the year, the Lehman Brothers Corporate Bond Index had a value of, say, 1,200. Throughout the year, the corporate bond market experienced some fluctuations, with prices generally rising due to declining interest rates, and the bonds paid their regular coupons.

By the end of the year, the index value, factoring in both price changes and reinvested coupon payments, had risen to 1,260.
The calculation for the index's total return for the year would be:

TR = \frac{(1260 - 1200)}{1200} = \frac{60}{1200} = 0.05

This indicates a 5% total return for the Lehman Brothers Corporate Bond Index over the year. The portfolio manager could then compare their own portfolio's total return to this 5% to see if they achieved their objective of outperformance, taking into account transaction costs and management fees.

Practical Applications

The Lehman Brothers Corporate Bond Index, and its successors, found widespread practical applications across the financial industry:

Performance Benchmarking: It served as a standard benchmark for fixed income funds, particularly those specializing in corporate debt. Fund managers were often evaluated on their ability to match or exceed the index's total return.
Asset Allocation Decisions: Investors and financial advisors used the index's historical performance and current characteristics to inform asset allocation strategies, determining the appropriate weighting of corporate bonds within diversified portfolios.⁷
Risk Management: By analyzing the index's composition and changes, investors could gain insights into the prevailing credit risk and interest rate risk within the corporate bond market, aiding in overall risk management.
Index Fund Creation: The existence of a robust, well-defined index like the Lehman Brothers Corporate Bond Index facilitated the creation of passive investment vehicles such as index funds and exchange-traded funds (ETFs) designed to track its performance.

Limitations and Criticisms

While highly influential, the Lehman Brothers Corporate Bond Index, and aggregate bond indices in general, faced certain limitations and criticisms:

Market-Weighting Bias: The market-weighted approach meant that the index naturally gave higher weighting to issuers with more outstanding debt. This could lead to a concentration in certain large issuers or sectors, potentially exposing index-tracking portfolios to higher idiosyncratic risk if those large issuers encountered financial difficulties.
Exclusion of High-Yield Bonds: The index strictly focused on investment-grade bonds, meaning it excluded the substantial and often higher-returning high-yield bond market. This limited its comprehensiveness in representing the entire corporate debt landscape.⁶
Limited Exposure to International Markets: The index primarily covered U.S. dollar-denominated corporate debt, offering limited direct exposure to global corporate bond markets, which could be a drawback for investors seeking broader international diversification.⁵
Sensitivity to Interest Rate Fluctuations: As a fixed income index, its performance was significantly influenced by changes in interest rates. Rapid increases in rates could lead to price depreciation across the index's components, affecting its total return.

Lehman Brothers Corporate Bond Index vs. Bloomberg Barclays U.S. Aggregate Bond Index

The Lehman Brothers Corporate Bond Index was a component of the broader family of indices managed by Lehman Brothers. After its acquisitions, its spirit and methodology were largely integrated into what became the Bloomberg Barclays U.S. Aggregate Bond Index.

The primary distinction is that the original Lehman Brothers Corporate Bond Index specifically tracked investment-grade corporate debt. In contrast, the Bloomberg Barclays U.S. Aggregate Bond Index, often referred to simply as "the Agg," is a much broader benchmark. The Agg includes a wider array of fixed income securities, such as U.S. Treasury bonds, U.S. agency securities, mortgage-backed securities, asset-backed securities, and investment-grade corporate bonds.⁴

The confusion often arises because the corporate bond portion of the Agg continues the lineage of the former Lehman corporate bond benchmarks. However, the Agg provides a more comprehensive snapshot of the overall U.S. investment-grade bond market, making it a more encompassing benchmark for diversified bond portfolios, whereas the Lehman Brothers Corporate Bond Index was narrower in its scope.

FAQs

What was the main purpose of the Lehman Brothers Corporate Bond Index?

Its main purpose was to serve as a benchmark for the performance of publicly issued, investment-grade bonds from corporations in the U.S. fixed income market. It allowed investors and analysts to track and evaluate how this specific segment of the bond market was performing over time.

Why is it no longer called the Lehman Brothers Corporate Bond Index?

The name changed due to corporate acquisitions following the bankruptcy of Lehman Brothers in 2008. Barclays acquired the index business, renaming it. Later, Bloomberg acquired the business from Barclays, leading to its current designation as part of the Bloomberg Barclays U.S. Aggregate Bond Index family.³

What types of bonds were included in the index?

The Lehman Brothers Corporate Bond Index focused exclusively on U.S. dollar-denominated, fixed-rate, nonconvertible, publicly issued corporate bonds that had an investment-grade bond credit rating from recognized agencies. It did not include government bonds, municipal bonds, or high-yield bonds.²,¹

How did the index help investors?

The index helped investors in several ways: by providing a benchmark to measure the total return of their corporate bond portfolios, by offering insights into the overall trends and yield levels in the corporate bond market, and by serving as a basis for creating passive investment vehicles like index funds. It was a vital tool for asset allocation and understanding market sentiment.