Income

Factor investing in fixed income securities

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By Theodoros Georgantonis

Widely associated with equities, the use of factors is gaining ground as a means of identifying opportunities within the fixed income universe.

Factor investing has been a staple of stock markets since the early 1990s. However, its growth in fixed income markets has been slower, primarily due to structural issues such as limited data availability, limited liquidity weaker and a larger universe of issuers. In recent years, we have expanded our quantitative efforts to include analysis of fixed income securities – and certain portfolios – based on factor exposures.

A key question is: why should investors consider factor investing in fixed income securities? The answer is that factor research complements fundamental research by identifying uncorrelated risk factors that may generate more efficient returns at the portfolio level. Additionally, we have observed that investing in these risk factors tends to generate persistent and actionable risk premia across market cycles. Based on our work, we believe that two conclusions are important:

First, certain factors (similar in some cases to stock-related factors) tend to be correlated with persistent excess returns. Importantly, our work controls for bond characteristics and “beta” characteristics such as duration, spread, industry, rating, etc. volatility, size, illiquidity and quality.

Second, we find that a factor approach has continued to work in the rising rate environment and widening credit spreads that we have seen in recent months. During this period (December 1, 2021 to February 11, 2022), we found (in our hypothetical internal analysis) that five of the seven factors contributed positively or had a stable performance for a hypothetical portfolio of fixed income securities.

Going forward, we expect factor-based approaches within fixed income investing to continue to grow in importance. As investors face an increasingly complex investment environment, the potential for capturing uncorrelated returns and building more efficient portfolios will only grow in importance for bond investors.

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