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The factor effect in corporate bonds
Patrick Houweling, head of quantitative credit at Robeco
Although much empirical research around factors focuses on equi- ties, the concept and benefits of factor investing apply equally well to corporate bonds.
Award-winning research by Robeco shows how factor investing can also be applied to the corporate bond markets and how systematically allocating to factors — size, quality, low risk, value and momentum – has been demon- strated to deliver higher risk-adjusted returns.
In the academic literature on corporate bonds, low risk and momentum are the best documented fac- tors, while there has been far less research on quality, value and size. In our study, we defined factors consistently with the existing literature. We used readily available bond characteristics (spread, rating, maturity) that are intuitive for corporate bond investors.
Highlights
Increasing evidence to support factor investing in corporate bonds Allocation to multiple factors reduces relative risk; enhancing factors improves performance Multi-asset portfolios also benefit from allocation to bond factors
Multi-factor portfolios offer more stable returns
We examined the risk-return profiles of individual and multi-factor portfolios. Single-factor portfolios have their own distinctive risk-return profile, while delivering higher risk-adjusted returns than the market index. Multi-factor portfolios offer diversification benefits that make the relative performance versus the index more stable over time.
Our findings show that the multi-factor portfolio retains the high sharpe ratio generated by the individual factors, but with smaller drawdowns and a lower tracking error versus the market. We thus conclude that allocating to multiple factors is effective, in investment grade and high yield segments.
Having established the added value of factor investing in the corporate bond market, we looked at other asset classes too – equities and government bonds. Investors who already allocate their equity portfolio to factors may also be interested in extending this to approach to their corporate bond holdings. Our results demonstrate that adopting a multi-factor approach in the corporate bond portion of a tra- ditional multi-asset portfolio boosts its sharpe ratio. While multi-asset investors who already allocate to equity factors and opt to allocate the corporate bond portion of their portfolio to factors too can improve their sharpe ratio still further, as the figure below shows.
26 September 2019 portfolio institutional roundtable: Factor investing
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