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By Theodoros Georgantonis
Largely associated with equities, the use of factors is gaining traction as a way to identify opportunities within the fixed income universe.
Factor investing has been a staple in equity markets since the early 1990s. However, its growth in fixed income markets has been slower mainly due to structural issues such as limited data availability, lower liquidity and a larger universe of issuers. Over the past few years, we have expanded our quantitative efforts to include analyzing fixed income securities—and certain portfolios—based on factor exposures.
A key question is, why should investors consider factor-based investing within fixed income? The answer is that factor-based research complements fundamental research by identifying uncorrelated risk factors that potentially could generate more efficient returns at the portfolio level. Also, we have noticed that investing in these risk factors tends to generate persistent and exploitable risk premia over market cycles. Based on our work, we believe two conclusions are important:
First, certain factors (in some cases similar to equity factors) tend to be correlated with persistent excess returns. It’s important to note that our work controls for bond features and “beta” characteristics such as duration, spread, industry, rating, etc. For the fixed income overall, we have identified seven exploitable factors that include bond and equity momentum, value, low volatility, size, illiquidity and quality.
Second, we find that a factor-based approach has continued to work in the environment of rising rates and wider credit spreads that we’ve observed in recent months. During this period (December 1, 2021 to February 11, 2022), we’ve seen (in our hypothetical internal analysis) that five of the seven factors contributed positively or had flat performance for a hypothetical fixed income portfolio.
Looking forward, we expect factor approaches within fixed income investing to continue to grow in prominence. As investors deal with an increasingly complex investment environment, the potential for both capturing uncorrelated returns and building more efficient portfolios will only become more important for bond investors.
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