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Abstract
This article investigates the application of factor investing in corporate bonds. The authors analyze five different long-only factor investment strategies (Value, Equity Momentum, Carry, Quality, Size) within the USD investment grade and high yield market. These factors can explain a significant part of the cross-sectional variation in corporate bond excess returns. Combinations of the single factors turn out to be superior in risk-adjusted terms. Because the correlations between the single factors are low, a combined multi-factor signal benefits from diversification among the factors. A signal blending strategy is particularly suitable for active approaches targeting high alpha. This strategy leads to alphas up to 1.27% within investment grade and 5.90% within high yield. In contrast, a portfolio blending strategy is better aligned with more passive approaches, targeting low turnover and low tracking error.
TOPICS: Factor-based models, style investing, performance measurement
Key Findings
• The authors find a strong positive relationship between Value, Equity Momentum, Size, Carry, and Quality and future returns for USD denominated corporate bonds.
• Due to the attractive correlation structure of the single factors, a multifactor strategy enhances the risk return profile even further.
• The authors’ multifactor strategy leads to alphas up to 1.27% (5.90%) in IG (HY) even after transactions costs are taken into account.
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US and Overseas: +1 646-931-9045
UK: 0207 139 1600