Construction Rules for the Morningstar Emerging Markets Bond Index Family
Morningstar Methodology Paper Version 1.4 – August 2013
©
2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc.
Reproduction or transcription by any means, in whole or in part, without the prior written consent of Morningstar, Inc., is prohibited.
Contents
Introduction Emerging Markets Index Characteristics Overview Inception Dates Rebalancing Trading, Settlement, and Transaction Costs Ex-Dividend Rules Assigning Countries to Emerging Markets Country Inclusion Criteria Country Rebalancing Assigning Bonds to the Emerging Markets Bond Indexes Morningstar Emerging Markets Composite Bond Index Morningstar Emerging Markets Sovereign Bond Index Morningstar Emerging Markets Corporate Bond Index Morningstar Emerging Markets High Yield Bond Index Index Calculations Overview Calculation and Dissemination of Index Values Return Calculations Index Weights Data Correction and Precision Index Data Corrections Computational and Reporting Precision Undocumented Events Market Events Duration Calculations Appendix A: Emerging Markets Country List
3 4 5 5 5 6 7 8
9 10 12 15
17 17 18 20
22 22 22 22 22 24
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Introduction
The Morningstar Emerging Markets Bond Index family was created to provide bond investors with accurate benchmarks for performance measurement and to offer discrete building blocks for portfolio construction. These indexes provide an accurate, broad depiction of the performance and fundamental characteristics of the emerging bond markets. There are four key features underlying the design and construction of the Morningstar Emerging Markets Bond Indexes:
× Transparent and objective rules. The construction of indexes is governed by a clear and transparent set of well-documented rules for security selection and exclusion, as well as reconstitution. × The right balance between comprehensive market coverage and investability. Indexes are broad and inclusive enough to incorporate the prominent characteristics of active managers’ portfolios and fulfill a market-monitoring function while still maintaining a focus on investability. × Nonoverlapping and hierarchical structure. Each subindex offers discrete exposure— without any overlap—to specific underlying bond sectors. This clear family-level organizational scheme affords the following benefits: o Distinct indexes serve as ideal tools for performance benchmarking and portfolio construction. o Well suited for accurate analysis and attribution of performance in active strategies. o Avoidance of overlap is critical in reducing concentration risk for users employing collections of subindexes to build customized portfolios. o Slicing the bond market into distinct pieces suits the needs of investors who are trying to match specific liabilities or manage specific risk exposures. × Open access to index-level data and metrics to all users. Morningstar makes its bond index data available to all users through our products and websites.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Emerging Markets Index Characteristics
Overview Emerging markets present some of the world’s most dynamic growth opportunities. As emerging-markets economies have experienced steady improvement in credit quality, much higher growth than developed economies, and more sustainable fiscal deficits, corporate and sovereign bonds of such nations have taken a more prominent role in fixed-income portfolios. In a world short of yield, emerging-markets debt has become a difficult asset class to ignore. Emerging-markets bonds allow investors to express a variety of investment themes, ultimately adding diversity and value to their fixed-income portfolios.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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The Morningstar Emerging Markets Bond Index family consists of four indexes, covering corporate and sovereign debt of the emerging markets.
× A broad composite index: Morningstar Emerging Markets Composite Index × Two sector indexes: Morningstar Emerging Markets Corporate Bond Index and Morningstar Emerging Markets Sovereign Bond Index × One subsector index: Morningstar Emerging Markets High Yield Bond Index
Inception Dates The following table provides the inception dates of the indexes. Index Morningstar Emerging Markets Composite Bond Index Morningstar Emerging Markets Sovereign Bond Index Morningstar Emerging Markets Corporate Bond Index* Morningstar Emerging Markets High Yield Bond Index
Inception Date Oct. 31, 2001 Dec. 31, 1998 Oct. 31, 2001 Oct. 31, 2001
*Methodology revised Dec. 22, 2011 Price and total return series are available from inception dates forward.
Security Rebalancing
The bond list for each index is updated at the end of each month to ensure the index accurately reflects new issuance in the market. Updates to the bond-level composition are made on the first business day of each month. Changes to the portfolio reflect reopenings, buybacks, new issuance activity, exchanges, exercised options, or any rating changes. The new universe of bonds is simply last month’s composition taking into account the new additions and drops triggered by the inclusion criteria and liquidity assessments for the index. These characteristics stay constant throughout the month. All securities must settle before the last business day of the month in order to be eligible to be included in the rebalanced index for the following month. Preliminary rebalancing reports indicating expected changes to the composition of the index are available for each of the last four business days of the month along with the forecast portfolio of index securities. These reports and portfolios may differ from the actual rebalanced index.
Trading, Settlement, and Transaction Costs Trading and settlement of these securities follow local market conventions. The index does not take transaction costs (bid-offer spreads) or tax withholdings into account. Bid-side prices are used for the daily bond index calculations and offer-side for adding new bonds to the index. Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Ex-Dividend Rules Ex-dividend date refers to the last day an investor must hold the bond to be eligible to receive the next coupon payment. If a security is purchased after the ex-dividend date, the bond will trade at a discount to compensate the investor for the negative accrued interest.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Assigning Countries to Emerging Markets
The country selection and security selection are defined based on the criteria described in this section. The country selection and security selection are followed in the sequence shown below.
Country Inclusion Criteria Morningstar Indexes classifies countries as emerging for the purpose of defining the investable universe. To arrive at the initial selection of emerging-markets countries, Morningstar Indexes includes only countries with GDP per capita defined by the World Bank as low income, middle income, or upper middle income. High income is excluded. Certain additional criteria are then applied to each country to identify characteristics of development and economic freedom that may exclude a country from the final selection. Exclusion from final selection may occur when an otherwise emerging-markets country exhibits characteristics that demonstrate a developed bond market, or when an emerging-markets country's bond market is deemed uninvestable. Additional criteria used to classify emerging-markets status include the following: Market regulatory authority Legal infrastructure and recourse Foreign ownership Treatment of minority shareholders Repatriation (full/partial) of capital Foreign exchange market Custodian services Stock lending Competitive brokerage services and trading cost Adequate liquidity and free float Short sales Off-exchange transactions Visibility and timely trade reporting process Developed derivatives market Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Country Rebalancing Morningstar Indexes reviews and announces the list of eligible countries annually in September. The list is announced by Sept. 30 and takes effect in the end-of-October rebalancing that establishes the October portfolio of the same year. Country rebalancing is determined using the aforementioned criteria.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Assigning Bonds to the Emerging Markets Bond Indexes
Eligibility rules for each index are applied based on the criteria described in this section. Each criterion is applied only to the "survivors" of the criteria applied previously. Morningstar Emerging Markets Composite Bond Index The Morningstar Emerging Markets Composite Bond Index is a combination of the Emerging Markets Sovereign and Emerging Markets Corporate Bond indexes, whose rules for inclusion are described below. To qualify for inclusion in the Emerging Markets Composite Bond Index, a security must be in the Emerging Markets Sovereign Bond Index or the Emerging Markets Corporate Bond Index.
Composite Rating Assignment Methodology Sovereign bond ratings are the lower of Standard & Poor's and Moody's. Corporate bond ratings are the average of Standard & Poor's, Moody's, and Fitch. All bonds must have at least one rating for inclusion in the Emerging Markets Composite Bond Index.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Morningstar Emerging Markets Sovereign Bond Index
The Morningstar Emerging Markets Sovereign Bond Index is designed to provide diversified exposure to credit-sensitive, U.S. dollar-denominated sovereign debt through the most liquid issues in the market. The index methodology balances the need for adequate market coverage with easy replication and diversification. This is achieved through exclusion of smaller issues that are difficult to purchase and that impose heavier transaction costs. It is also achieved through country weighting constraints that are meant to ensure diversified exposure. The following eligibility rules are applied: × Only bonds issued by a country or its central bank (sovereign bonds) are included in the index.
× Development banks and sovereign-owned companies (quasi-sovereign) are not included in the index. × Only U.S. dollar-denominated bonds are included in the index. × Only fixed-rate coupon bonds are included in the index. × The index includes bonds domiciled in Latin America, Eastern Europe, the Middle East, Africa, and Asia (ex-Japan) whose credit ratings are A+ or below, based on the lower of Standard & Poor’s and Moody's. × A minimum of $500 million remaining face amount outstanding for the issue is required for a bond to be included in the index. × A minimum of $1 billion remaining face amount outstanding for the issuer is required for a bond to be included in the index. × All bonds must be issued under U.S. or U.K. jurisdiction. × All securities must have a minimum of 13 months remaining to maturity. × All securities must have a minimum of 36 months' maturity or greater at time of issuance. × Bonds with embedded options, such as calls and puts, are included. × Bonds with sinking funds are included.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Exclusion/Removal × Sovereign issues in default are excluded from initial inclusion in the index, but are not removed if the default occurs after inclusion, provided that no additional inclusion or exclusion criteria are violated.
× × × × × ×
Loans, supranational, and perpetual bonds are excluded. Sukuk (commonly referred to as Islamic bonds) are excluded. PIKs (payment-in-kind bonds) are excluded. Subordinated debt is excluded. No domestic debt is included. Fixed-to-floating-rate bonds will be removed at the next rebalancing, subsequent to the last fixed payment.
× Illiquid bonds are excluded or eliminated from the index. A bond is deemed illiquid when pricing on a consistent basis is unavailable or becomes unavailable. Bonds with limited liquidity may be removed at the discretion of the Index Committee.
Private Placements × If a bond is issued under Regulation S only, the bond will be included in the index at the next rebalance following a 40-day seasoning period.
× If a bond is issued under Rule 144A only, the bond will be included in the index at the next rebalancing. × If there exists a bond issued under both Regulation S and Rule 144A for the same issuer, only the Regulation S version of the bond will be included in the index at the next rebalancing following a 40-day seasoning period.
Country Weighting Constraint The index is constrained so that no one country has a par amount greater than 15% of the par amount of the overall index. This constraint avoids high index allocation as a result of increased issuance, yet it allows a specific country’s share of the index to increase if it is the result of capital appreciation. This helps the index avoid excessive exposure to highly indebted issuers and promotes diversification. Each month, all sovereigns are capped at 15%, and the excess weight is redistributed on a par-weighted basis to the other issuers in the index.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Introduction to the Emerging Markets Corporate Bond Index
The Morningstar Emerging Markets Corporate Bond Index provides a benchmark for Emerging-markets corporate debt that represents the characteristics, pricing, and total return performance of the U.S. dollar-denominated emerging-markets corporate universe. All bonds in the MEMCBI are selected according to a fully transparent set of rule-based inclusion criteria regarding issue size, bond type, maturity, and liquidity. The index includes bonds issued by corporations in Latin America, Eastern Europe, Middle East/Africa, and Asia (excluding Japan). Individual securities have a minimum outstanding face value of $500 million or more, and eligible issuers for the index must have aggregate outstanding debt of $1 billion or more. All securities in the index are fixed rate and must have a remaining maturity of 13 months or more and an original maturity of 3 years or more. The index is market capitalization weighted with a 5% capping of issuers and a pro rata distribution of any excess weight across the remaining issuers in the index. Corporate issuers within the same “issuer family” are aggregated as a single issuer for this purpose.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Morningstar Emerging Markets Corporate Bond Index
The Morningstar Emerging Markets Corporate Bond Index is designed to provide diversified exposure to U.S. dollar-denominated corporate debt domiciled in emerging markets. Bonds in the index are selected using a two-step process that involves country selection and security selection. The index methodology balances the need for adequate market coverage with that for easy replication and diversification. This is achieved through exclusion of smaller issues that are difficult to purchase and impose heavier transaction costs. To qualify for inclusion in the Emerging Markets Corporate Bond Index, a security must meet the following criteria: Bonds issued by corporate and quasi-sovereign issuers are eligible for inclusion. "Quasisovereign" is defined as a corporation with more than 50% government ownership. No Treasury or sovereign issues are included in the index. × Only U.S. dollar-denominated bonds are included in the index.
× Only fixed-rate coupon bonds are included in the index. × Only bonds issued by corporations based in Latin America, Eastern Europe, the Middle
East, Africa, and Asia (excluding Japan) are included in the index and all bonds must be issued under the jurisdiction of a country on the Emerging Markets Sovereign Issuers’ List. × There are no ratings restrictions on either the corporate bonds or the country of risk. However, all corporate issuers must have at least one rating from Standard & Poor’s, Moody’s, or Fitch. × A minimum of $500 million remaining face amount outstanding for the issue is required for a bond to be included in the index.
× A minimum of $1 billion remaining face amount outstanding for the issuer is required for a bond to be included in the index.
× × × ×
All securities must have a minimum of 13 months remaining to maturity. All securities must have a minimum of 36 months to maturity or greater at time of issuance. Bonds with embedded options, such as calls and puts, are included. Bonds with sinking funds are included.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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× Bonds issued under Regulation S will be included in the index only after an appropriate seasoning period. Similar guidelines will be followed if there are obstacles that prevent a broad investor base from participating in a new bond offering.
Exclusion/Removal × Corporate issues in default will be removed at the next rebalancing. Bonds are considered × × × × ×
in default for failure to make a scheduled coupon and/or principal payment. A company filing bankruptcy papers—or the local market equivalent—is considered to be in default. Loans, supranational, and perpetual bonds are excluded. Sukuk (commonly referred to as Islamic bonds) are excluded. PIKs (payment-in-kind bonds) are excluded. Fixed-to-floating-rate bonds will be removed at the next rebalancing subsequent to the last fixed payment. Illiquid bonds are excluded or eliminated from the index. A bond is deemed illiquid when pricing on a consistent basis is unavailable or becomes unavailable. Bonds with limited liquidity may be removed at the discretion of the index committee.
Private Placements × If a bond is issued under Regulation S only, the bond will be included in the index at the next rebalance following a 40-day seasoning period.
× If a bond is issued under Rule144A only, the bond will be included in the index at the next rebalancing. × If there exists a bond issued under both Regulation S and Rule 144A for the same issuer, only the Regulation S version of the bond will be included in the index at the next rebalancing following a 40-day seasoning period.
Issuer Constraint The index is constrained so that no one issuer has a par amount greater than 5% of the par amount of the overall index. Each month, all corporate and quasi-sovereign issuers are capped at 5%, and the excess weight is redistributed on a par-weighted basis to the other issuers in the index. Corporate issuers within the same “issuer family” are aggregated as a single issuer for this purpose.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Introduction to the Emerging Markets High Yield Bond Index
The Morningstar Emerging Markets High Yield Bond Index provides a benchmark for below-investment-grade emerging-markets sovereign and corporate debt that represents the characteristics, pricing, and total return performance of the U.S. dollar-denominated emergingmarkets universe. All bonds in the MEMHYBI are selected according to a fully transparent set of rule-based inclusion criteria regarding issue size, bond type, maturity, and liquidity. The index includes bonds issued by corporations and sovereignties based in Latin America, Eastern Europe, Middle East/Africa, and Asia (excluding Japan).
Morningstar Emerging Markets High Yield Bond Index The Morningstar Emerging Markets High Yield Bond Index is a combination of the Emerging Markets Sovereign and Emerging Markets Corporate Bond indexes (described earlier), with an additional credit rating restriction to isolate below-investment-grade debt. To qualify for inclusion in the Emerging Markets High Yield Bond Index, a security must be in the Emerging Markets Sovereign or Emerging Markets Corporate Index and meet the following criteria: × Corporate bonds must have at least one rating of BB+ (Ba1) or lower from Standard & Poor’s, Moody’s, or Fitch to be included. × Sovereign bonds must have at least one rating of BB+ (Ba1) or lower from Standard & Poor’s, or Moody’s to be included.
Issuer Constraint The index is constrained so that no one issuer has a par amount greater than 15% of the index portfolio, and the sum of all issuers over 5% is capped at 48%. Issuers under 5% are capped at 4.7%. In instances where an issuer exceeds the capping threshold, the weight is modified and allocated on a pro rata basis to the remaining constituents. Sovereign and quasi-sovereign issuers controlled by the same government are aggregated as a single issuer for this purpose. Corporate issuers with the same “ultimate parent” are also aggregated as a single issuer for this purpose. Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Additional Inclusion/Exclusion Criteria Securities entering or leaving the index as a result of credit rating changes are subject to a threemonth phase-in or phase-out if the current or expected weight in the index is greater than or equal to 9%. Sovereign and quasi-sovereign issuers controlled by the same government are aggregated as a single issuer for this purpose. Corporate issuers with the same “ultimate parent” are also aggregated as a single issuer for this purpose. The changes will be implemented by taking a pro rata share (one third) of each affected security in each “adjustment” month.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Index Calculations
Overview Morningstar partners with a third-party calculation agent to calculate the Morningstar Emerging Markets Bond Index family. This agent calculates the actual change in all measured characteristics of the respective indexes on a daily basis. All of the index measures are calculated for all levels of the aggregate indexes, including the individual bonds that make up the indexes. Market capitalization weighting is used for all index characteristics, excluding average price and average coupon, where "principal outstanding" is used. The weightings are fixed as of the last business day of each month. Indicative bid-side prices are used for all index calculations and are provided by outside pricing sources on a daily basis. Updates to the bond-level composition are made on the first business day of each month. Indicative offer-side prices are used when securities are added to an index. Transaction costs and tax consequences are ignored.
Index Publication Daily and monthly price and total return index values can be accessed in the following ways: (1) Morningstar's corporate website: http://www.morningstar.com (2) The Morningstar Indexes website: http://indexes.morningstar.com (3) Bloomberg: Page is the directory page for all Morningstar Indexes and their closing levels. Bloomberg identifiers for the Morningstar Emerging Markets Bond Index Family: Morningstar Emerging Markets Composite Index MSBIECTR Morningstar Emerging Markets Sovereign Index MSBIESTR Morningstar Emerging Markets Corporate Index MSBIERTR Morningstar Emerging Markets High Yield Index MSBEIHTR
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Return Calculations There are three basic equations for calculating returns on individual bonds and on the indexes themselves: total return, price return, and interest return. Total return is the sum of the other two returns. If daily returns are known, users can calculate returns for any given period. In what follows, a "clean price" is a quoted price that does not include accrued interest. A "dirty price" includes accrued interest. The formulas for the three types of return are as follows: The total return from date 0 to date t is defined as: (1)
TR( 0,t )
Where: Pc(0) Pc(t) Pd(0) AI(0) AI(t) IC(0,t)
= = = = = =
Pc (t ) Pc ( 0) AI (t ) AI ( 0) IC( 0,t ) Pd ( 0)
clean price on date 0 clean price on date t dirty price on date 0 accrued interest on date 0 accrued interest on date t cash received between date 0 and date t including coupon reinvestment
Then, the one-day total percentage return between dates t-1 and date t is given by: (2)
TR 1 TR(t 1,t) (0,t) 1 * 100 TR(0,t 1) 1
The price return is based on the clean price appreciation over the dirty price. From (1), the price return (between date 0 and date t) component can be separated as:
(3)
PR(0,t)
Pc ( t) Pc (0) Pd(0)
The interest return is given by: (4)
IR(0,t)
AI( t) AI(0) IC (0,t) Pd(0)
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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There are two components to the interest return calculation: accrued interest appreciation and the reinvestment of the coupon during the period. The time between coupon payments on a bond is referred to as the coupon period. At any time during a given coupon period, the seller of the bond is entitled to that portion of the next coupon payment, known as accrued interest, that is proportionate to the time elapsed since the prior payment. The reinvestment rate is based on the relevant currency's one-month Libor rate as of the last business date of the previous month. This rate is applied to the cash received during date 0 and date t. If there is no coupon payment during the period, the IC component is set to 0. The IC component between date 0 and date t is calculated as: (5)
IC (0,t) CF(0,t) *(1 DCT(0,t) *
Rt ) 360
Where: CF(0,t) = coupon cash flow between date 0 and date t DCT(0,t) = days between coupon date and date t where coupon date is between date 0 and date t Rt = one-month LIBOR rate as of the last business date of the previous month
Coupon Reinvestment Coupons are assumed to be received in full, not accounting for withholding taxes. Cash received intramonth due to a coupon payment is held in a cash account. Because of restrictions in local markets on short-term investments, cash is not reinvested. The cash received is reinvested in the index at the beginning of the following month.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Index Weights All index-level (or portfolio-level) statistics aggregate bond-level measures by each bond’s market weights. For return-related statistics, the bonds' weights are fixed on the last business date of the previous month (since the indexes rebalance on the last business date of each month). For all other statistics, a bond's weight is defined as daily market weight with monthly fixed par amounts. Thus, the market value for the i'th bond is given by:
wi ( pricei accruedInteresti ) * parAmounti Then, an index' total weight is calculated as: n
W wi i 1
Where: n
=
total number of bonds in the index
Then the i'th bond in the given index has a weight given by:
i
wi W
Thus, for example, a given index's modified duration is calculated as: n
D i * mi i 1
Where: mi
=
modified duration of the i'th bond
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Data Correction and Precision
Index Data Corrections Commercially reasonable efforts are made to ensure the correctness of data used in index calculations. If incorrect data are detected, corrections are made as soon as is feasible. Incorrect pricing and corporate action data for individual issues in the database will be corrected upon detection.
Computational and Reporting Precision All calculated and adjusted data are stored in real numbers. For reporting purposes, index values are rounded to two decimal places. Morningstar publishes a Preliminary Report and a Final Monthly Adds and Drops Report on the indexes to reflect upcoming changes.
Undocumented Events Any matter arising from undocumented events will be resolved at the discretion of an index committee to be established by Morningstar.
Market Events In case of a significant market event (default, delayed payment, debt restructuring), any affected securities will not be removed until the next rebalancing date. Market prices and the index team's best estimate of how to treat the securities in question will be used to compute index returns.
Duration Calculations Duration can be described as the weighted average time to receipt of the future cash flows (or coupon payments), with weighting determined by the portion of the bond’s overall present value that is represented by the present value of those future cash flows. Duration shows that for small changes in the bond’s yield, the percentage change in the bond’s price approximates the negative of its duration multiplied by the change in yield. In other words, for small parallel shifts Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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in the yield curve, the ratio of two bonds’ price changes will be the same as the ratio of their durations. Duration is also a concept commonly used to describe the effective life of bonds. It is a method of assessing the risk profiles of different bonds regardless of differences in term to expiration, coupon rate, and yield to maturity. It is an important concept in the use of interest rate futures for hedging. The duration of a bond is a measure of how long, on average, the holder of the bond has to wait before receiving cash payments. Duration calculation using the conventional yield is often referred to as Macaulay duration and is represented mathematically as:
MacDur Where: freq P n ti CFi y =
1 1 n1 y ti (1 ) t i CF i freq P i 1 freq
= = = = = yield
frequency of cash flows bond price number of cash flows time to maturity at the i'th coupon payment date i'th cash flow
Macaulay duration divided by 1 plus the conventional yield is often referred to as modified duration. Modified duration can be used like continuously compounded duration to calculate the percentage change in bond price for small changes in yield.
ModDur
MacDur 1 P y P y 1 freq
Mathematically, modified duration represents the slope of the tangent line, at a particular yield level, to the price-yield curve of the bond. At different yield levels, the slope of this tangent line will vary. Modified duration can then be used to measure the price sensitivity of a bond. Modified duration always assumes instantaneous and small yield changes and parallel shifts in the yield curve.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Effective Duration Prepayments can alter future cash flows and thereby affect the duration of a mortgage pool. Therefore, the more appropriate measure for mortgage securities is effective duration, which takes into account the sensitivity of prepayments to interest rate changes. Effective duration is calculated in the following steps.
× Shift the current yield, typically by 25 or 50 basis points. × Use a prepayment model (a statistical model that predicts changes in prepayment rates as interest rates change) to calculate the prepayment rate at the new, shifted yield level. × Calculate the new cash flow of the mortgage pool, based on the prepayment assumption derived in the above step. × Price the security as the present value of the cash flow obtained in the previous step. These steps produce the following values needed for calculating effective duration: Ys Px(Down) Px(Up) Px(Base)
= = = =
Yield shift (typically 25 or 50 basis points) Price of mortgage security when the yield shifts down Price of mortgage security when the yield shifts up Price of mortgage security if yield stays constant
Effective duration is then given by:
EffectiveD ur
Px ( Down) Px (Up) *100 2 * Px ( Base) * Ys
Effective duration is thus the expected percentage change in price for a small change in yield.
Convexity When moderate or large changes in interest rates are considered, a measure known as convexity is sometimes important. Convexity is a measure of the speed with which a bond’s duration changes as its yield changes. Therefore, the duration of a bond with high convexity will get longer as yields fall faster than it will get shorter as yields rise. This is a desired feature for a security: It means that for parallel yield shifts of equal size, the price gain on a downward move in yield is larger than the price loss on an upward move. By contrast, a security with poor or negative convexity may present the opposite profile, performing poorly when market yields rise, but also failing to perform as well as a positively convex security when yields fall. This is a hallmark trait of securities bearing certain kinds of call options, such as mortgages, in particular. Mathematically, it is the second derivative of price with respect to yield.
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Appendix A
Emerging-markets countries eligible for inclusion.
Country Argentina Bahrain Bangladesh Belarus Bosnia and Herzegovina Brazil Bulgaria Chile China Colombia Costa Rica Croatia Czech Republic Dominican Republic Ecuador Egypt El Salvador Estonia Georgia Guatemala Hong Kong, SAR, China Hungary Iceland India Indonesia
Code
Region
ARG BHR BGD BYS BIH BRA BGR CHL CHN COL CRI HRV CZE DOM ECU EGY SLV EST GEO GTM HKG HUN ISL IND IDN
LAC MNA SAS ECA ECA LAC ECA LAC EAP LAC LAC ECA ECA LAC LAC MNA LAC ECA ECA LAC EAP ECA ECA SAS EAP
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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Islamic Republic of Iran Israel Jamaica Jordan Kazakhstan Kuwait Latvia Lebanon Lithuania Malaysia Mauritania Mexico Morocco Nigeria Oman Pakistan Panama Peru Philippines Poland Qatar Romania Russian Federation Saudi Arabia Serbia Singapore Slovakia Slovenia South Africa South Korea (Republic of) Sri Lanka Taiwan Thailand Trinidad and Tobago Turkey Ukraine
IRN ISR JAM JOR KZN KWT LVA LBN LTU MYS MRT MEX MAR NGA OMN PAK PAN PER PHL POL QAT ROM RUR SAU SRB SGP SVK SVN ZAF KOR LKA TWN THA TTO TUR UKR
MNA MNA LAC MNA ECA MNA ECA MNA ECA EAP SSA LAC MNA SSA MNA SAS LAC LAC EAP ECA MNA ECA ECA MNA ECA EAP ECA ECA SSA EAP SAS EAP EAP LAC ECA ECA
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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United Arab Emirates Uruguay Venezuela Vietnam
Region East Asia and Pacific Europe and Central Asia Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa
ARE URY VEN VNM
MNA LAC LAC EAP
Code EAP ECA LAC MNA SAS SSA
Construction Rules for the Morningstar Emerging Markets Bond Index Family | August 2013 © 2013 Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or part, without the prior written consent of Morningstar, Inc., is prohibited.
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