Macaulay duration bucket

A bond index cannot just be a list of bonds. A three-month treasury bill and a thirty-year government security behave nothing alike, so putting them in one index would measure nothing useful.

So index providers sort bonds by Macaulay duration — the weighted average time to receive a bond's cash flows — and build a separate index for each band.

Each band is a duration bucket. The NIFTY government securities family uses six of them. The shortest covers 3 to 6 months. The longest covers anything above 7 years.

Once the buckets exist, a fund can track exactly the interest-rate sensitivity it wants. A client who needs cash in a year buys the short bucket. One who can wait buys the long one.

The corporate bond indices do the same thing, and then split each bucket again by credit rating.

The government securities buckets (Chapter 12, section 12.6.1). NIFTY G-Sec Indices represent Government of India bonds across 6 distinct duration buckets:

The methodology that fills each bucket. Up to 3 liquid bonds within a duration bucket, chosen on the previous month's turnover, are eligible for the index. The bond's outstanding amount must be more than Rs 5,000 crore. Each bond is weighted on its amount outstanding, and the index is rebalanced and reconstituted monthly.

The corporate bond buckets (section 12.6.2). NIFTY AAA, AA+, AA, AA− and Banking & PSU Bond Indices measure corporate bond performance across 6 duration buckets and distinct rating segments, each index holding up to 14 issuers, each represented by its most liquid bonds. NIFTY AA Category Bond Indices aggregate the AA+, AA and AA− indices of the same duration bucket, again with up to 14 most liquid issuers from each rating sub-category.

A different bucket count for A-rated paper. NIFTY A Bond Indices use only 2 Macaulay duration buckets — Short (up to 3 years) and Long (more than 3 years) — and include all bonds with an issuance size greater than Rs 50 crore within the respective range. Issuers are selected on primary market issuances, weights are assigned on issuance size, and it is rebalanced and reconstituted monthly.

The workbook carries a second, different bucketing — and it is not the index one. Chapter 19, section 19.3.1, records the practice endorsed by SEBI while categorising fixed income mutual funds: bonds with a Macaulay duration of more than 7 years are Long Duration, between 3 and 7 years Mid Duration, and less than 3 years Short Duration. That is three buckets, not six, and its Short Duration band reaches to 3 years where the index family's Short Duration bucket stops at 3 years but has two shorter buckets beneath it. Both sets of figures are in the workbook; which one a question wants depends on whether it is asking about an index (Chapter 12, six buckets) or a mutual fund category (Chapter 19, three buckets).

Illustrative figures, applied to the workbook's bucket table. A treasury desk holds four government securities and wants to know which NIFTY G-Sec index each one belongs to.

Notice the second and third rows. A bond maturing in 2 years has a duration of 1.85 years, comfortably inside the 1-to-3-year bucket. A bond maturing in 6 years has a duration of only 4.90 years, because its coupons arrive along the way — so it lands in the 4-to-7 bucket, not a 6-year one. The bucket is set by duration, not by maturity.

Now the eligibility test. A fifth security, with a duration of 2.4 years but only Rs 3,800 crore outstanding, fails the more than Rs 5,000 crore condition and cannot enter the Short Duration index at all, however liquid it is.

And the concentration is deliberate. If only 3 bonds can represent the 1-to-3-year bucket, a Rs 500 crore index fund tracking it holds roughly Rs 167 crore in each — weighted, in fact, by amount outstanding, so the largest issue takes the biggest share.

Chapter 12 (Introduction to Indices), section 12.6.1, gives Table 12.8 with the six government securities duration buckets and the NIFTY G-Sec methodology; section 12.6.2 gives the corporate bond buckets, the 14-issuer cap and the two-bucket NIFTY A family.

This is a table-heavy section and therefore a favourite for precise recall: how many duration buckets the NIFTY G-Sec indices use (6), what duration range Short Duration covers (1 to 3 years), the minimum outstanding amount (more than Rs 5,000 crore), how many liquid bonds per bucket (up to 3), and the rebalancing frequency (monthly). Chapter 19's three-way SEBI mutual fund categorisation is examined separately and is easy to confuse with this.

• Six buckets for the index family, three for the SEBI mutual fund categorisation. Chapter 12 and Chapter 19 give different bucketings for different purposes, and both are in the workbook. Read which one the question is about.
• Duration, not maturity, decides the bucket. A 6-year bond can sit in the 4-to-7-year bucket because its coupons pull its duration below its maturity.
• NIFTY A Bond Indices use only 2 buckets, split at 3 years, with a Rs 50 crore issuance-size floor — different from the Rs 5,000 crore outstanding floor on the G-Sec side.
• Ultra-Short starts at 3 months, not at zero. The shortest bucket is 3 to 6 months; Low Duration is the 6-to-12-month band.
• Up to 3 bonds per bucket on the G-Sec side, up to 14 issuers on the corporate side. Two different caps for two different index families.
• The buckets are rebalanced and reconstituted monthly, so a bond's index membership changes as its duration shortens with time.