What is CMBX exactly?

If you search for information on this index, you will see that it is used a great deal on the web but I have not found a simple explanation for what it actually is and the precise role that if plays in finance. Here's what I have been able to piece together.

The CMBX is an index published by a company called Markit . It is simply an index that tracks performance of several baskets of bonds. The CMBX AAA index tracks the yield on a group of triple A bonds that are backed by real estate loans.

So, first we need a quick explanation of yield. Current Yield is the ratio of the annual interest payment and the bond's current price. If a bond costs $100 dollars and has an annual coupon Interest payment) of $10 the yield is 10%. If the price falls to $80, then the yield increases to 13%. The value of the bond would fall if the market believed that the bond became more risky. Riskier investments have a higher yield to compensate the holder for the risk of default.

To make things more confusing, the CMBX does not track the bond yields directly. The index is expressed as a 'spread'. In this case this is the difference (spread) between the yield of the bonds being tracked and the current yield offered by government bonds (commonly called the 'risk-free' rate).
The result is that when the bond prices fall, the spread increases and the index goes up. A high index value means that the financial community sees these bonds as being at a higher risk of defaulting. We can see from this chart that the spread for triple A rated bonds has increased from less than 0.5% in October to over 2% in February.

And how is the CMBX used? It is not a product you can buy directly. See CORRECTION in comments. This index is used as a benchmark for pricing other financial products: Credit Default Swaps. A CDS acts like an insurance policy on a bond. The seller of the product will assume the default risk of a bond. If the bond defaults, the seller will pay the buyer the value of the bond. For this insurance, the buyer pays the seller a periodic premium that is related to the riskiness of the bond. And how do they agree on the riskiness of the bond? The use the CBMX index!

You don't have to own the bond in question to buy a CDS against it. If you want to, you can bet against the commercial real estate industry. When real estate companies default, you will collect a windfall!

CMBX Index

A recent Wall Street Journal article discusses the CMBX index and it's use in predicting the default risk of commercial real estate. Even though there are very few current defaults, this index now suggests that there is trouble to come.

This is a derivative index that is based on the pricing of bonds backed by commercial real estate. In simple terms it represents to cost of insurance against default - which is a good measure of risk.

The alarming thing is that this index has been going up of late which would seem to indicate a stormy future for commercial real estate.

This chart shows the index for AAA rated commercial real estate bonds:

Tech Note: I could not find this index on popular finance sites. The above chart is published through an iframe that is fed from Markit.com, the creator of the index.

Long Tail Evidence

The 'Long Tail' is a popular term these days. It is the idea that the aggregate of all the little niche markets is bigger than the mainstream markets. The total number of book sales for obscure books (less than 1,000 copies) is greater than the sales of the top ten list of books that sell over a million copies.

The internet and the power of search mean that we are now opening up all of these small, obscure niche markets. Buyers and sellers can now find each other. For example, today you can have an active market for salt shakers on Ebay that was not possible before.

The market for information is no less affected. Look at this example of news media. Not only are niche web publishers creating new content, they are also taking market share from the big players. Here we see a chart that displays the percent of total page views for a selection of information sources. You can see that Wikipedia and Blogger which are published by many individuals have grown exponentially in popularity. At the same time the commercial news media - published by editors - has been loosing market share since 2006.

Factoid: The term "Long Tail' was coined by Chris Anderson who is the editor of WIRED magazine. He now has a book called "The Long Tail: Why the Future of Business Is Selling Less of More"

ISO Re-Registration

To maintain ISO registration we are required to conduct ongoing internal and external audits throughout the year. Every three years we must submit our management system to a full re-registration audit. We are very pleased that we have successfully passed this audit without any non-conformance issues, and we will now retain our registration for another three years.

At this point it is worthwhile to consider what we have learned over the three years that we have run the system. There are three significant points:

Error tracking is a valuable input for system improvement.

When we first set up our processes, we determined the best practices for every activity and set these as standard procedures. We identified key control points and created checking and review steps to manage these procedures. We also instituted a fairly rigorous quality control process at the end of projects, and we established a central repository to record all of our 'non-conformances'. We used this list to investigate the root cause of problems. Was there a problem with training? Methodology? Or were there extra steps that could be taken to reduce the chance of errors? All of the problems that we have encountered during the three years that the system has been in place have contributed to the improvement of the system. We have tweaked the system not in a random or hap-hazard manner but in response to problems and opportunities for improvement that we have discovered through the course of running our systems. You can learn from your mistakes - but only if you have method to catch and analyze them in the first place.

ISO management processes can - and should - be applied beyond the scope of registration.

We originally set up ISO processes to improve the quality of products and services we provide to clients. This is still the scope of the registration. But, as we have been running our system, we have started to expand the management system to other areas. At first we applied it to IT, security and network management. These are routine, yet critical processes that support and protect our organization. We found that we could best manage them with documented procedures and controls very similar to our product and service control systems. We are now expanding these management concepts to more loosely defined activities such as sales. And this is also quite successful. The main lesson here is that an ISO registered management system is not designed just to satisfy ISO auditors - it is built to run a real business. It is not just the ISO management system, it is OUR management system.

An ISO registered management system is not just about quality control.

We have found that our ISO system has improved quality, but it has also given us additional, valuable insight into our business. A very basic quality control system would simply involve inspection. One would look at a product at the end of the process. Errors would be caught and fixed and rework would be done. ISO requires more than this. It mandates that we design processes to reduce or eliminate errors when the work is done. This makes a lot of sense. It costs less to prevent errors than to fix them. A stitch in time saves nine! By documenting our processes we get a much deeper understanding of our business. By recording data and setting measurable objectives, we get a clear sense of what is working and what is not. Besides improving quality, our management system has made our business more efficient, much easier to scale and easier to manage.