In a comprehensive analysis of the cross-sectional determinants of corporate bond excess returns, the authors find evidence of positive risk-adjusted returns associated with four investment characteristics, or “styles” — carry, defensive, momentum and value. These returns are diversifying with respect to both known sources of market risk (e.g., equity risk premium, credit risk premium and term premium) and style returns that have been documented in equity markets (e.g., size, value and momentum).
The authors add that realistic long-only portfolios can be constructed to achieve maximal exposure to these styles. Based on a broad sample of U.S. corporate bonds from January 1997 through November 2013, they found that an active long-only portfolio annually earned 1% in excess of a value-weighted benchmark of all corporate bonds in the BAML dataset, with an Information Ratio of 0.60. This long-only portfolio is aware of transaction costs, trading limits and position constraints, suggesting it is possible to build meaningful corporate-bond portfolios with styles exposures.
The analysis examines the exposures of actively managed credit hedge funds and actively managed credit mutual funds and finds that both have significant exposure to “beta,” primarily through exposure to credit risk premium, as well as minimal exposure to our documented styles with the exception of “carry.” Thus, despite evidence of a robust relation between styles and corporate bond excess returns individual credit funds are underexposed to styles.