Over the past 20 years, active fixed income (FI) managers have tended to deliver returns in excess of their benchmarks. This has generated a popular notion that active investing in fixed income markets is “easy.” The aim here is to assess the veracity of that notion. Across a broad set of popular active FI categories, this article finds that passive exposures to traditional risk premia (especially exposure to credit risk) explain the majority of FI manager active returns. The resulting implication is that, contrary to popular belief, traditional discretionary active FI strategies offer little in the way of true alpha and that traditional active FI strategies may significantly reduce the strategic diversification benefit of FI as an asset class. TOPICS: Fixed income and structured finance, performance measurement, fixed-income portfolio management Key Findings • Across US Aggregate, Global Aggregate, and Unconstrained categories, we find that a significant portion of fixed income manager outperformance can be explained by passive exposure to credit risk. • Credit exposure meaningfully reduces the diversification benefit of fixed income. During the worst 10 quarters for equities, active fixed income strategies have underperformed their benchmarks, at times significantly. • After allowing for persistent exposure to credit and to other traditional risk premia, active fixed income managers generate virtually no alpha. This result holds both for managers on average in each category and for individual managers.
{"title":"Active Fixed Income Illusions","authors":"J. Brooks, Tony Gould, Scott Richardson","doi":"10.3905/jfi.2020.1.086","DOIUrl":"https://doi.org/10.3905/jfi.2020.1.086","url":null,"abstract":"Over the past 20 years, active fixed income (FI) managers have tended to deliver returns in excess of their benchmarks. This has generated a popular notion that active investing in fixed income markets is “easy.” The aim here is to assess the veracity of that notion. Across a broad set of popular active FI categories, this article finds that passive exposures to traditional risk premia (especially exposure to credit risk) explain the majority of FI manager active returns. The resulting implication is that, contrary to popular belief, traditional discretionary active FI strategies offer little in the way of true alpha and that traditional active FI strategies may significantly reduce the strategic diversification benefit of FI as an asset class. TOPICS: Fixed income and structured finance, performance measurement, fixed-income portfolio management Key Findings • Across US Aggregate, Global Aggregate, and Unconstrained categories, we find that a significant portion of fixed income manager outperformance can be explained by passive exposure to credit risk. • Credit exposure meaningfully reduces the diversification benefit of fixed income. During the worst 10 quarters for equities, active fixed income strategies have underperformed their benchmarks, at times significantly. • After allowing for persistent exposure to credit and to other traditional risk premia, active fixed income managers generate virtually no alpha. This result holds both for managers on average in each category and for individual managers.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"19 - 5"},"PeriodicalIF":0.0,"publicationDate":"2019-11-19","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"43140258","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This article investigates the linkage between the interest rates term spread and the relative supply factor of long-term Treasury securities since the Debt Ceiling Crisis of 2013. The spread between the long-term Treasury yield and the Federal Funds Rate is defined as the excess return of holding long-term Treasury securities over liquid money. Evidences show that the supply factor has some significant impacts on the term spread between the 10-year yield and the Federal Funds Rate. These effects include long-run causality effect and persistent positive shock. The supply factor explains over a half of the term spread variation at longer horizons. The effects of the supply factor are stronger for the long-term part of the spread. So the recent flattening of the yield curve is partially attributable to the restrictions on the long-term financing of the government. Considering this mechanism, if Congress and the government reach agreements on some other long-term financing tools, the long-term Treasury yields and the term spread may rise unexpectedly. TOPICS: Fundamental equity analysis, accounting and ratio analysis, technical analysis
{"title":"Relative Shortage of Long-Term Treasury Securities and the Flat Yield Curve","authors":"Peng Zhang","doi":"10.3905/jfi.2019.1.078","DOIUrl":"https://doi.org/10.3905/jfi.2019.1.078","url":null,"abstract":"This article investigates the linkage between the interest rates term spread and the relative supply factor of long-term Treasury securities since the Debt Ceiling Crisis of 2013. The spread between the long-term Treasury yield and the Federal Funds Rate is defined as the excess return of holding long-term Treasury securities over liquid money. Evidences show that the supply factor has some significant impacts on the term spread between the 10-year yield and the Federal Funds Rate. These effects include long-run causality effect and persistent positive shock. The supply factor explains over a half of the term spread variation at longer horizons. The effects of the supply factor are stronger for the long-term part of the spread. So the recent flattening of the yield curve is partially attributable to the restrictions on the long-term financing of the government. Considering this mechanism, if Congress and the government reach agreements on some other long-term financing tools, the long-term Treasury yields and the term spread may rise unexpectedly. TOPICS: Fundamental equity analysis, accounting and ratio analysis, technical analysis","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"68 - 76"},"PeriodicalIF":0.0,"publicationDate":"2019-10-10","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"47778234","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Using time-series recoveries implicit in 334 defaulted bonds issued by bankruptcy-filing firms in the United States, this article examines the influence from default information leakage on the recovery process. By distinguishing default from bankruptcy filing, results show that the recoveries shortly after default or filing can substitute for each other; however, neither is a good estimator for the recovery at bankruptcy resolution. Results document the assembled determinants that drive the level of recoveries postdefault. Characterizing a higher value of changes in recoveries are reductions in credit quality, issuance amount or macro condition, or rises in asset size, or market awareness of default information leakage. As bondholders perceive default-relevant information earlier than the formal filing, distressed bond trading activities originating from the pressure to sell intensify with high transaction costs, decreasing the expectation on recoveries at filing. Alternatively, this brings in positive influence on the recoveries at bankruptcy resolution and magnifies the changes in recoveries for disvalued bonds. TOPICS: Project finance, statistical methods, credit risk management Key Findings • By distinguishing default from formal filing, our article confirms that the recoveries shortly after default or fling can substitute for each other; however, neither is a good estimator for the recovery at bankruptcy resolution. • As the market perceives default information leakage, distressed bond trading activity originating from the pressure to sell leads to lower expectation on recoveries at the instant of filing. • Alternatively, it brings in higher ultimate recoveries, resulting in large deviation in recoveries at filing with bankruptcy resolution.
{"title":"Implications of Default Information Leakage on Recoveries","authors":"Mao-Wei Hung, Wen-Hsin Tsai","doi":"10.3905/jfi.2019.1.075","DOIUrl":"https://doi.org/10.3905/jfi.2019.1.075","url":null,"abstract":"Using time-series recoveries implicit in 334 defaulted bonds issued by bankruptcy-filing firms in the United States, this article examines the influence from default information leakage on the recovery process. By distinguishing default from bankruptcy filing, results show that the recoveries shortly after default or filing can substitute for each other; however, neither is a good estimator for the recovery at bankruptcy resolution. Results document the assembled determinants that drive the level of recoveries postdefault. Characterizing a higher value of changes in recoveries are reductions in credit quality, issuance amount or macro condition, or rises in asset size, or market awareness of default information leakage. As bondholders perceive default-relevant information earlier than the formal filing, distressed bond trading activities originating from the pressure to sell intensify with high transaction costs, decreasing the expectation on recoveries at filing. Alternatively, this brings in positive influence on the recoveries at bankruptcy resolution and magnifies the changes in recoveries for disvalued bonds. TOPICS: Project finance, statistical methods, credit risk management Key Findings • By distinguishing default from formal filing, our article confirms that the recoveries shortly after default or fling can substitute for each other; however, neither is a good estimator for the recovery at bankruptcy resolution. • As the market perceives default information leakage, distressed bond trading activity originating from the pressure to sell leads to lower expectation on recoveries at the instant of filing. • Alternatively, it brings in higher ultimate recoveries, resulting in large deviation in recoveries at filing with bankruptcy resolution.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"22 - 37"},"PeriodicalIF":0.0,"publicationDate":"2019-10-09","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"49191067","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2019-09-30DOI: 10.3905/jfi.2019.29.2.001
Stanley J. Kon
{"title":"Editor’s Letter","authors":"Stanley J. Kon","doi":"10.3905/jfi.2019.29.2.001","DOIUrl":"https://doi.org/10.3905/jfi.2019.29.2.001","url":null,"abstract":"","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"1"},"PeriodicalIF":0.0,"publicationDate":"2019-09-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"43642558","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2019-09-30DOI: 10.3905/jfi.2019.29.2.026
Karan Bhanot, Carl F. Larsson
The authors analyze the determinants of credit spreads of 674 US dollar denominated covered bonds, issued by institutions domiciled in twenty-one countries, over the sample period 1/2001 to 1/2016. Even though covered bond contracts include strong credit enhancements, there is considerable heterogeneity in observed credit spreads through time and in the cross-section. The authors find that measures of sovereign risk and country specific legal frameworks are among the most important explanatory factors for differences in spreads across these bonds. TOPICS: Project finance, statistical methods, credit risk management Key Findings • The authors study the determinants of US dollar denominated covered bond credit spreads for bonds issued in twenty-one countries during the period 1/2001 to 1/2016. • Despite carrying strong credit enhancement features, US dollar denominated covered bonds still exhibit variation in spreads both through time and in the cross-section of issuer country of domicile. • Empirical results suggest sovereign risk and country-level legal frameworks are important determinants of US dollar denominated covered bond credit spreads.
{"title":"The Dollar Denominated Covered Bond Market: A Cross-Country Analysis of Credit Spreads","authors":"Karan Bhanot, Carl F. Larsson","doi":"10.3905/jfi.2019.29.2.026","DOIUrl":"https://doi.org/10.3905/jfi.2019.29.2.026","url":null,"abstract":"The authors analyze the determinants of credit spreads of 674 US dollar denominated covered bonds, issued by institutions domiciled in twenty-one countries, over the sample period 1/2001 to 1/2016. Even though covered bond contracts include strong credit enhancements, there is considerable heterogeneity in observed credit spreads through time and in the cross-section. The authors find that measures of sovereign risk and country specific legal frameworks are among the most important explanatory factors for differences in spreads across these bonds. TOPICS: Project finance, statistical methods, credit risk management Key Findings • The authors study the determinants of US dollar denominated covered bond credit spreads for bonds issued in twenty-one countries during the period 1/2001 to 1/2016. • Despite carrying strong credit enhancement features, US dollar denominated covered bonds still exhibit variation in spreads both through time and in the cross-section of issuer country of domicile. • Empirical results suggest sovereign risk and country-level legal frameworks are important determinants of US dollar denominated covered bond credit spreads.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"26 - 43"},"PeriodicalIF":0.0,"publicationDate":"2019-09-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"44510395","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In this article, the authors propose a definition of value in Treasury bonds that, the authors believe, is more satisfactory than definitions found in the recent literature, and that allows for statistically significant and economically relevant predictions of cross-sectional excess returns. The authors’ value pricing factor exploits the differences between the market and the theoretical values of Treasury bonds, where the theoretical value is assessed using an economically-justifiable Gaussian dynamic term structure model. The authors show that the profitability of the strategy they build using their value signal is statistically and economically significant and is closely linked to the Treasury market volatility. The authors provide an explanation for this strong link using arguments similar to what can be found in the recent literature on liquidity in Treasuries; and the authors show that their value signal is not subsumed by the best-known return-predicting factors. With an eye to practical applications, the authors also present a long-only version of their strategy. TOPICS: Analysis of individual factors/risk premia, factor-based models, style investing
{"title":"Defining and Exploiting Value in US Treasury Bonds","authors":"R. Rebonato, J. Maeso, L. Martellini","doi":"10.3905/jfi.2019.1.071","DOIUrl":"https://doi.org/10.3905/jfi.2019.1.071","url":null,"abstract":"In this article, the authors propose a definition of value in Treasury bonds that, the authors believe, is more satisfactory than definitions found in the recent literature, and that allows for statistically significant and economically relevant predictions of cross-sectional excess returns. The authors’ value pricing factor exploits the differences between the market and the theoretical values of Treasury bonds, where the theoretical value is assessed using an economically-justifiable Gaussian dynamic term structure model. The authors show that the profitability of the strategy they build using their value signal is statistically and economically significant and is closely linked to the Treasury market volatility. The authors provide an explanation for this strong link using arguments similar to what can be found in the recent literature on liquidity in Treasuries; and the authors show that their value signal is not subsumed by the best-known return-predicting factors. With an eye to practical applications, the authors also present a long-only version of their strategy. TOPICS: Analysis of individual factors/risk premia, factor-based models, style investing","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"25 - 6"},"PeriodicalIF":0.0,"publicationDate":"2019-09-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"42252233","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Non-US dollar-denominated external emerging market debt issuance in euros, yen, and sterling has grown substantially in recent years. This article is the first study to explore how non-dollar external emerging market bonds violate covered interest rate parity relative to their dollar-denominated external emerging market debt counterpart bonds for a given country. Such mispricing in the post-Great Recession era creates arbitrage opportunities for investors and suggests that emerging market country policymakers could create fiscal savings by instead issuing external sovereign debt in dollars more cheaply (versus non-dollar developed world currencies like euros, yen, and sterling) and swapping the proceeds to non-dollar currencies with currency forward and spot transactions. Such hypothetical fiscal savings from switching to dollar funding collectively are estimated to be more than $1 billion annually. TOPICS: Fixed income and structured finance, exchanges/markets/clearinghouses, emerging markets Key Findings • This article is the first study to explore how non-dollar external emerging market bonds violate covered interest rate parity relative to their dollar-denominated external emerging market debt counterpart bonds for a given country. • Such mispricing creates investment opportunities and suggests that by instead more cheaply issuing external sovereign debt in dollars (versus non-dollar developed world currencies like euros, yen, and sterling) and swapping the proceeds to non-dollar currencies, emerging market country policymakers could create substantial fiscal savings by switching to dollar funding.
{"title":"Covered Interest Rate Parity Deviations in External Emerging Market Sovereign Debt","authors":"Jonathan S. Hartley","doi":"10.3905/jfi.2020.1.080","DOIUrl":"https://doi.org/10.3905/jfi.2020.1.080","url":null,"abstract":"Non-US dollar-denominated external emerging market debt issuance in euros, yen, and sterling has grown substantially in recent years. This article is the first study to explore how non-dollar external emerging market bonds violate covered interest rate parity relative to their dollar-denominated external emerging market debt counterpart bonds for a given country. Such mispricing in the post-Great Recession era creates arbitrage opportunities for investors and suggests that emerging market country policymakers could create fiscal savings by instead issuing external sovereign debt in dollars more cheaply (versus non-dollar developed world currencies like euros, yen, and sterling) and swapping the proceeds to non-dollar currencies with currency forward and spot transactions. Such hypothetical fiscal savings from switching to dollar funding collectively are estimated to be more than $1 billion annually. TOPICS: Fixed income and structured finance, exchanges/markets/clearinghouses, emerging markets Key Findings • This article is the first study to explore how non-dollar external emerging market bonds violate covered interest rate parity relative to their dollar-denominated external emerging market debt counterpart bonds for a given country. • Such mispricing creates investment opportunities and suggests that by instead more cheaply issuing external sovereign debt in dollars (versus non-dollar developed world currencies like euros, yen, and sterling) and swapping the proceeds to non-dollar currencies, emerging market country policymakers could create substantial fiscal savings by switching to dollar funding.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"92 - 99"},"PeriodicalIF":0.0,"publicationDate":"2019-09-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"46944429","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Effective duration, calculated by parallel shifts of the yield curve, is the standard measure of portfolio-based interest rate risk. Key rate durations, obtained by shifting individual key rates, describe how the risk is distributed along the term structure. Ordinarily the sum of the key rate durations equals the effective duration. However, in the case of tax-exempt municipal bonds the sum and the effective duration may differ. The reason is that the prices of discount munis are tax-affected, and the applicable tax rate depends on the size of the discount. The authors’ result has ramifications for the hedging of muni portfolios, and for the measurement of interest rate risk under the recently introduced SEC N-Port regulation. TOPICS: Risk management, fixed income portfolio management Key Findings • The tax effect on the price of a discount muni depends on the size of the discount (applicable tax rate around 20% if de minimis, 40% if not). • Because bumping individual key rates has smaller effects on price than shifting the entire yield curve, the applicable tax rates may differ. • Consequently key rate durations for munis may not add up to effective duration, creating challenges for portfolio hedging and SEC risk reporting.
{"title":"The Key Rate Durations of Municipal Bonds","authors":"A. Kalotay, Joel Buursma","doi":"10.3905/jfi.2019.1.073","DOIUrl":"https://doi.org/10.3905/jfi.2019.1.073","url":null,"abstract":"Effective duration, calculated by parallel shifts of the yield curve, is the standard measure of portfolio-based interest rate risk. Key rate durations, obtained by shifting individual key rates, describe how the risk is distributed along the term structure. Ordinarily the sum of the key rate durations equals the effective duration. However, in the case of tax-exempt municipal bonds the sum and the effective duration may differ. The reason is that the prices of discount munis are tax-affected, and the applicable tax rate depends on the size of the discount. The authors’ result has ramifications for the hedging of muni portfolios, and for the measurement of interest rate risk under the recently introduced SEC N-Port regulation. TOPICS: Risk management, fixed income portfolio management Key Findings • The tax effect on the price of a discount muni depends on the size of the discount (applicable tax rate around 20% if de minimis, 40% if not). • Because bumping individual key rates has smaller effects on price than shifting the entire yield curve, the applicable tax rates may differ. • Consequently key rate durations for munis may not add up to effective duration, creating challenges for portfolio hedging and SEC risk reporting.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"61 - 64"},"PeriodicalIF":0.0,"publicationDate":"2019-08-22","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"47521167","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This study shows how primary market supply influences the secondary market liquidity of outstanding bonds. Liquidity is higher around new bond issuance by the same issuer and in the same maturity segment. It rises once the new issue is priced and remains elevated for several days. The effect is mostly attributed to switch trades between old and new bonds. It increases by the volume issued and decreases by the amount of similar paper outstanding. The liquidity surge is positively linked to the new bond’s attractiveness; it is stronger during times of positive market sentiment. TOPICS: Project finance, statistical methods, credit risk management Key Findings • Liquidity is higher around new bond issuance by the same issuer and in the same maturity segment. • The supply-liquidity effect increases by the volume issued and decreases by the amount of similar paper outstanding. • The liquidity surge is positively linked to the new bond's attractiveness, and it is stronger during times of positive market sentiment.
{"title":"How New Bond Issuance Influences the Liquidity of Covered Bonds","authors":"Michael Weigerding","doi":"10.3905/jfi.2019.1.072","DOIUrl":"https://doi.org/10.3905/jfi.2019.1.072","url":null,"abstract":"This study shows how primary market supply influences the secondary market liquidity of outstanding bonds. Liquidity is higher around new bond issuance by the same issuer and in the same maturity segment. It rises once the new issue is priced and remains elevated for several days. The effect is mostly attributed to switch trades between old and new bonds. It increases by the volume issued and decreases by the amount of similar paper outstanding. The liquidity surge is positively linked to the new bond’s attractiveness; it is stronger during times of positive market sentiment. TOPICS: Project finance, statistical methods, credit risk management Key Findings • Liquidity is higher around new bond issuance by the same issuer and in the same maturity segment. • The supply-liquidity effect increases by the volume issued and decreases by the amount of similar paper outstanding. • The liquidity surge is positively linked to the new bond's attractiveness, and it is stronger during times of positive market sentiment.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"44 - 60"},"PeriodicalIF":0.0,"publicationDate":"2019-08-21","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"44486114","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
T. Heckel, Zine Amghar, Isaac Haik, Olivier Laplénie, Raul Leote de Carvalho
We show that factors from value, quality, low-risk, and momentum styles play an important role in explaining the cross-section of corporate bond expected returns for the US and Euro Investment Grade and US BB-B Nonfinancial High Yield universes. We demonstrate the importance of purifying factor data by neutralizing a number of risk biases that are present in the factors: controlling for sectors, option-adjusted spread, duration, and size biases significantly increase the predictive power of style factors. We propose a new simple approach for efficiently neutralizing the biases from multiple risk variables and demonstrate its superiority relative to stratified sampling and optimization as alternative control methods. We also measure the added value from diversifying the number of factors in each style. Finally, we show that the results are robust in relation to transaction costs and can be used to design strategies that aim at outperforming traditional benchmark indexes. TOPICS: Analysis of individual factors/risk premia, factor-based models, style investing Key Findings • Factors from value, quality, low-risk, and momentum styles play an important role in explaining the cross-section of corporate bond expected returns for the US and Euro Investment Grade and US BB-B Nonfinancial High Yield universes. • The forecasting efficacy of style factors increases significantly if biases such as sectors, option-adjusted spread, duration, and size in the factor data are neutralized. Diversifying the number of factors in each style also significantly improves the forecasting efficacy. • We propose a new simple approach for increasing the forecasting efficacy of style factors by efficiently neutralizing the biases from multiple risk variables. We demonstrate the superiority of this approach over stratified sampling and optimization.
{"title":"Factor Investing in Corporate Bond Markets: Enhancing Efficacy Through Diversification and Purification!","authors":"T. Heckel, Zine Amghar, Isaac Haik, Olivier Laplénie, Raul Leote de Carvalho","doi":"10.3905/jfi.2019.1.074","DOIUrl":"https://doi.org/10.3905/jfi.2019.1.074","url":null,"abstract":"We show that factors from value, quality, low-risk, and momentum styles play an important role in explaining the cross-section of corporate bond expected returns for the US and Euro Investment Grade and US BB-B Nonfinancial High Yield universes. We demonstrate the importance of purifying factor data by neutralizing a number of risk biases that are present in the factors: controlling for sectors, option-adjusted spread, duration, and size biases significantly increase the predictive power of style factors. We propose a new simple approach for efficiently neutralizing the biases from multiple risk variables and demonstrate its superiority relative to stratified sampling and optimization as alternative control methods. We also measure the added value from diversifying the number of factors in each style. Finally, we show that the results are robust in relation to transaction costs and can be used to design strategies that aim at outperforming traditional benchmark indexes. TOPICS: Analysis of individual factors/risk premia, factor-based models, style investing Key Findings • Factors from value, quality, low-risk, and momentum styles play an important role in explaining the cross-section of corporate bond expected returns for the US and Euro Investment Grade and US BB-B Nonfinancial High Yield universes. • The forecasting efficacy of style factors increases significantly if biases such as sectors, option-adjusted spread, duration, and size in the factor data are neutralized. Diversifying the number of factors in each style also significantly improves the forecasting efficacy. • We propose a new simple approach for increasing the forecasting efficacy of style factors by efficiently neutralizing the biases from multiple risk variables. We demonstrate the superiority of this approach over stratified sampling and optimization.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"21 - 6"},"PeriodicalIF":0.0,"publicationDate":"2019-08-20","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"46832897","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}