Total bond funds may invest in bonds of a similar maturity, class and rating to replicate an issue that is not available for purchase by the fund. These restrictions exist because of the diversity and relative illiquidity of the bond markets compared to equities markets. It is important for a total bond fund to have a similar interest rate and maturity to the base index.
Total bond fund portfolios actually have a bit more freedom in their security selection than a total stock fund does. Because individual bond issues have less liquidity than stocks, some funds have to bypass certain issues that are in the benchmark index while choosing other bonds that aren’t in the index.
Many total bond funds have a small allocation, around 20% of assets, from which bonds can be chosen at the discretion of the managers and held in assets outside the Lehman Index, such as international bonds, derivatives and lower-rated corporate paper. This allows fund managers a chance to invest in some non-correlated assets while keeping the overall risk profile of the fund within the same range as the Lehman Index.
The most important risk metrics to keep close to the index are the maturity, or more specifically the weighted average maturity, as well as the duration, or sensitivity to changes in interest rates.
Investment dictionary. Academic. 2012.