While factor approaches, those targeting historical drivers or sources of return, have become more common in equity portfolios, systematic approaches in fixed income securities have been adopted more slowly. This is despite academic research dating back to the work of Nobel laureate Eugene Fama in the 1970s who discovered that forward rates, as expected future bond yields, contain useful assessments of differences in expected yields between bonds. not held to maturity. The first strategies that systematically exploited the link between forward rates and expected duration and credit premia – the differences in expected yield between risk-free bonds of different maturity and corporate and risk-free bonds of the same maturity, respectively – were launched in the 1980s and now have nearly 40 years of live performance. These strategies show that you can beat the market without trying to identify mispriced bonds or interest rate changes over time.
As is the case with factor investing in equities, investors need to deepen their analysis of factors related to bond solutions, such as bond and issuer characteristics. Given the large number of factors offered, investors may wonder which ones to follow and how best to implement a systematic approach to fixed income investing. One way to gain clarity is to consider the new insights or information that an alternative variable brings. One might ask: does the variable in question provide new information about expected bond yields, beyond what is already known about forward rates?
To answer this question, we undertook a comprehensive analysis of global bonds. Using both portfolio and statistical, or regression-based approaches, we tested many variables to determine what information, if any, they provide about cross-sectional differences in expected corporate bond returns.