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Corporate bonds are an important
component of many fixed income portfolios, because they offer exposure to the
credit risk premium— an additional source of returns beyond those from
default-free, government bonds. Yet, though it seems intuitive to expect a
higher return for bearing corporate default risk, past research has found
limited evidence to support it. Why the disconnect? Is there a premium for
investing in credit, and how large has it been?
Research on this topic has traditionally looked at the simple difference between long-term corporate bond returns and long-term government bond returns. But this simple difference misses a key fact: corporate bonds tend to have lower interest rate durations than government bonds. Correcting for this, we find strong evidence, across many decades and markets, of a credit risk premium whose risk-adjusted returns are in line with other major market risk premia.
Importantly for investors, we find the credit risk premium to be different from the commonly known term (or bond) premium and equity risk premium. That means the addition of corporate bonds—a source of return with unique risk characteristics—may help investors build more efficient portfolios.
Factors in Fixed Income Markets
Momentum, value and other factors exist not only in
equities—we also find evidence of their efficacy in government and corporate
bonds. The notion of each factor in bonds shares much with its counterparts in
Of course, the, implementation will differ somewhat. Value in bonds aims to distinguish cheap versus expensive bonds by using a fundamental anchor to measure against, but the specific metrics differ from those used for equities. In government bonds, for example, value can use yield-based measures: observed yield relative to an "anchor" of inflation expectations. The intuition for corporates is similar: value might consider the credit spread (rather than pure yield), relative to a fundamental anchor such as default expectations.
Factors in fixed income markets have decades of evidence to support their inclusion in many portfolios. These factors also have delivered returns that are diversifying to each other, suggesting a multi-factor approach may lead to even better results.
Active Systematic Fixed Income Managers Invest?
Given multiple systematic sources of returns in fixed income
markets, which do active bond managers actually harvest?
The answer varies across categories and from manager to manager, but we find exposure to credit tends to explain a lot. Taking the Core-Plus bond category as an example, we find about 95% of active returns can be attributed to exposure to high yield credit over the past 10 years.
What this means for many investors is that seemingly diversified allocations across multiple fixed income funds might result in one active bet on credit, and much smaller exposures, if any, on other factors such as value or momentum—ones that may be as diversifying, and have as much evidence supporting their efficacy. In our view, these investors may be missing out on an opportunity to outperform.
November 18, 2016
This paper aims to increase familiarity of the credit asset class and provide an overview of our approach to systematic credit investing. We introduce credit instruments and outline a framework for understanding sources of credit excess returns.Read more
April 1, 2016
A disciplined, systematic approach to over/underweight securities based on well-known factors, or styles, such as value, momentum, carry and defensive (sometimes called “quality”), can offer alternative sources of outperformance not only within equities, where these ideas have long been studied and applied, but also within fixed income markets.Read more
In this quick video primer, we cover the challenges and potential benefits of using a disciplined, repeatable approach to investing in bonds.
From white papers to data sets, we’ve compiled our most relevant, advanced thinking on systematic fixed income.Read more