Systematic exposures to duration and credit quality could help investors struggling with thin yields and spectre of inflation
While factors are more prominently used in the world of equity investment, new research is providing more support for the use of similar techniques in fixed income.
In a new study from Northern Trust Asset Management, researchers explored how low-cost systematic approaches can potentially lead to better outcomes for fixed-income investors.
As reported by Institutional Investor, the researchers drew from the insight that most fixed-income managers’ excess returns derive from bond duration and issuer quality. That theory was supported by their research: they found that 70% of excess returns within active fixed-income funds could be attributed to simple exposures to factors such as duration and credit.
“This suggests that managers may outperform in the long run simply because of static beta exposures to these systematic factors vis-à-vis longer duration biases or an overweight to specific credit sectors,” said the paper’s primary authors Manan Mehta, NTAM’s head of quantitative fixed income research, and Mike Hunstad, head of quantitative strategies.
While that may be bad news for some active fixed-income managers trying to justify their fees, the research opens up interesting possibilities for investors to seek market-like exposures through cheap exchange-traded or traditional mutual funds. With better data, bond prices, and trading efficiency in corporate bonds, the body of research on factors within the fixed-income space has expanded significantly.
Beyond opening more opportunities to earn income without carrying too much credit risk or tying up capital in illiquid investments, the research indicated that systematic factors may provide investors with more sources of return as they grapple with low yields and possible future inflation.
Aside from duration and issuer credit quality, NTAM found other factors – many mirroring those found in stocks such as value, momentum, and low volatility – that could offer potential sources of systemic beta.
A global investment-grade strategy that utilizes quality and value factors, the paper found, produces more yield than the benchmark (1.55% vs. 1.33%), while carrying a similar level of credit risk.
“Factors provide the ability to move beyond term and credit positioning and create additional portfolio levers,” the researchers said. “They are an attempt to explain and achieve improved returns by exposing portfolios to compensated drivers of returns.”
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