Systematic bond investing aims to apply quantitative models and rules-based processes to fixed income markets. Compared to traditional discretionary active management, systematic strategies have the advantages of transparency, consistency and potential diversification benefits. This article provides an example of systematic style investing strategies in global government bonds, utilizing value and momentum signals.
Value strategy ranks bonds by real yield spread
The value strategy aims to identify relatively cheap bonds by comparing their nominal yields to inflation expectations. Specifically, we can rank global government bonds based on their real yield spreads – the difference between nominal yields and matched-maturity consensus inflation forecasts. Intuitively, bonds with higher real yields offer greater compensation for inflation and may be considered cheap. We can long the top tercile of bonds with the highest value signals and short the bottom tercile.
Momentum strategy selects winners based on past returns
The momentum strategy simply buys recent winners and sells recent losers. We can rank global government bonds by their trailing 12-month excess returns over duration-matched government bonds. The strategy will overweight bonds that have performed well over the past year and underweight recent underperformers, essentially betting on the continuation of return trends.
50/50 combination blends complementary signals
By combining the value and momentum strategies in a 50/50 allocation, we create a diversified systematic portfolio exploiting two independent alpha signals. Academic research has found value and momentum to be complementary and largely uncorrelated in fixed income markets. Blending these orthogonal style premia can provide attractive risk-adjusted returns compared to individual Signals.
In summary, systematic bond investing provides transparent and rules-based strategies like value and momentum for extracting diversified alpha. Blended style portfolios can balance complementary return drivers.