Fixed income investing provides stable returns, but selecting the right factors is crucial. Value, momentum, carry and defensive are four major fixed income factors with proven factor premiums. An allocation strategy spread across countries for the first three and across maturities for defensive in a composite multi-factor portfolio creates high risk-adjusted returns. Such factor-based investing diversifies risks and leads optimized portfolios.
Value Factor Looks for Undervalued Bonds
The value factor aims to identify cheap vs expensive bonds using anchors like distance-to-default for corporates and yield spread over inflation for governments. It profits from mean reversion to anchor.
Momentum Factor Rides Price Trends
Bonds exhibiting persistence in recent excess returns tend to continue the trend, which the momentum factor capitalizes. Combining bond and related stock momentum improves factor strength.
Carry Factor Harvests Yield Spread
Higher yielding bonds tend to deliver better returns than lower yields due to passage of time. The carry factor ranks bonds on yield spread to profit from this effect.
Defensive Factor Favors Short Maturities
Short duration bonds act as safe haven during sell-offs. The defensive factor goes long short duration while selling equal duration longer bonds within country.
A multi-factor approach combining value, momentum, carry and defensive provides the best fixed income factor investing example with high risk-adjusted returns. It diversifies traditional risk factors and macroeconomic risks for stable portfolio optimization.