Indexing in Fixed Income Portfolio Management

Investment firms often use indexing as a strategy for managing fixed income portfolios, particularly in liability-driven investment approaches. Indexing in this context involves constructing a portfolio that aims to replicate the performance of a bond market index. This strategy can align a portfolio’s cash flows with the liabilities it needs to meet, thereby reducing interest rate risk and achieving desired return characteristics.

Discuss the advantages and disadvantages of using an indexing strategy in fixed income portfolio management, especially when aligned with specific liabilities. Include examples of how indexing can provide benefits in terms of risk management and cost efficiency.