Systematic fixed income investing has become increasingly popular among institutional investors in recent years. By adopting quantitative, rules-based approaches, systematic fixed income strategies aim to exploit various risk premia and systematic return patterns in global bond markets. In this article, we will use several fixed income papers from top researchers as examples to illustrate the key features, return drivers and implementation considerations of systematic fixed income investing.
Value, momentum, carry and defensive as four main style factors
Researchers have identified value, momentum, carry and defensive as four main style factors that have historically earned risk premiums in global government and corporate bond markets. Value strategies aim to capture the tendency for cheap assets to outperform expensive ones. Momentum strategies seek to benefit from the continuation of recent return trends. Carry strategies gain from higher-yielding assets outperforming lower-yielding equivalents. Defensive strategies favor shorter-maturity bonds as a proxy for low risk.
Diversification across various fixed income segments
A well-diversified systematic fixed income portfolio would allocate risk budgets across various fixed income market segments, such as developed and emerging market government bonds, investment grade and high yield corporate bonds. By combining multiple factors and diversifying across market segments, these strategies can achieve high Sharpe ratios and low correlations to traditional risk factors.
Customized benchmarks and constraints
Systematic fixed income strategies are customized to each client’s unique objectives and constraints. Managers construct customized benchmark indices to match the client’s risk profile. Common constraints include limits on tracking error, interest rate duration, credit spread duration and exposure to high yield bonds.
Lower turnover and trading costs
Because systematic strategies trade less frequently than traditional active managers, their turnover and trading costs tend to be lower. Monthly or quarterly rebalancing is common. Keeping turnover low also helps maintain the strategy’s transparency and capacity.
Sophisticated risk management
Advanced risk modeling tools are used to manage risks and generate returns. Bond risk factors like duration and credit spreads are explicitly targeted. Scenario analysis and stress testing evaluate performance under extreme market conditions. Overall portfolio risk is controlled by managing factor exposures and diversification.
In summary, systematic fixed income investing aims to efficiently harvest risk premia across global bond markets. Diversification, customization, lower costs and advanced risk management are key features. For suitable investors, these strategies can provide attractive risk-adjusted returns and diversification benefits.