The Rise of Fixed Income Factor Investing
Systematic factor-based investing in fixed income is still in its early stages. This brief report reviews the critical challenges involved and the assesses landscape of available strategies.
IN THIS PAPER
The fixed income challenge: while there has been significant progress in recent years in gathering data to support systematic fixed income strategies, these still face greater portfolio construction and implementation difficulties than their equity counterparts. Many emergent strategies have only partially dealt with these obstacles.
What strategies are available? The 100+ strategies encompass a range of geographies and credit types but can be categorised into two broad groups: ‘passive substitutes’, which seek to deliver benchmark returns net of fees and costs, and ‘alpha generators’. The report surveys the landscape in terms of factor(s) used, markets covered, performance, fees and more.
Developing an allocation: These can be seen as complementary to or competitive against existing fixed income strategy types. As an alternative to ‘passive’, these strategies can mitigate the structural underperformance associated with passive fixed income investing. They offer relatively low correlation with traditional active fixed income strategies, so can also be viewed as a portfolio diversification tool. The introduction of factor investing should be paired with strong examination (or re-examination) of active managers in the portfolio and their risk premia exposures.
While “smart beta” is now firmly established within equities, systematic factor investing in fixed income is still in its early stages. The number of such strategies has doubled in the past three years, with well over 100 now available (page 6). Managers are still, predominantly, in the phase of testing investor appetite for such offerings to see whether they can attract suitably substantial volume.
Factor investing, particularly multi-factor investing, is of course not “new” in fixed income. Active credit managers have always sought to invest in credits of good quality at good value and capturing positive momentum, essentially playing on recognised risk premia. However, there are inherent challenges that have made – and continue to make – fully systematic fixed income strategies more problematic than their equity counterparts due to the specific characteristics of bonds themselves. These challenges demand the development of a sophisticated infrastructure
This brief report is intended to assist investors that are either considering this sector or already implementing systematic factor-based investment strategies in their portfolios.
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