Reach for Safety

The Journal of Fixed Income, 2018, https://doi.org/10.3905/jfi.2018.27.4.006

Posted: 20 Sep 2017 Last revised: 21 May 2019

See all articles by Johnny Kang

Johnny Kang

BlackRock, Inc

Tom Parker

BlackRock, Inc - San Francisco

Scott Radell

BlackRock, Inc

Ralph Smith

BlueCove

Date Written: September 15, 2017

Abstract

In the corporate bond market, investor propensity to reach for yield creates an opportunity for factor-based investors to “reach for safety” following an economic intuition that parallels low-risk factor investing in equities. Given this insight, we motivate a measure of credit safety based on the Merton (1974) distance-to-default variable, which we use to define quality and value factors. We demonstrate that both factors help explain the cross-section of corporate bond returns in an uncorrelated and complementary manner. Since these factors have performed particularly well in their bottom quintiles, we demonstrate how they can be used as screens within long-only portfolios. In addition, we show how incorporating our quality and value insights in a long-only optimization setup can generate significant outperformance net of estimated transaction costs versus traditional value-weighted market portfolios.

Keywords: Asset Pricing, Factor-Based Investing, Fixed Income

Suggested Citation

Kang, Johnny and Parker, Tom and Radell, Scott and Smith, Ralph, Reach for Safety (September 15, 2017). The Journal of Fixed Income, 2018, https://doi.org/10.3905/jfi.2018.27.4.006. Available at SSRN: https://ssrn.com/abstract=3037745 or http://dx.doi.org/10.2139/ssrn.3037745

Johnny Kang (Contact Author)

BlackRock, Inc ( email )

400 Howard Street
San Francisco, CA 94010
United States

Tom Parker

BlackRock, Inc - San Francisco ( email )

400 Howard Street
San Francisco, CA 94105
United States

Scott Radell

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

Ralph Smith

BlueCove ( email )

10 New Burlington Street
London
United Kingdom

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