Factor Investing in Corporate Bond Markets: Enhancing Efficacy Through Diversification and Purification!
Forthcoming The Journal of Fixed Income
Posted: 22 Aug 2019 Last revised: 6 Sep 2019
Date Written: August 20, 2019
We show that factors from value, quality, low risk and momentum styles play an important role in explaining the cross-section of corporate bond expected returns for the U.S. and Euro Investment Grade and U.S. BB-B non-Financial High Yield universes. We demonstrate the importance of purifying factor data by neutralizing a number of risk biases that are present in the factors: controlling for sectors, option-adjusted spread (OAS), duration and size biases significantly increases the predictive power of style factors. We propose a new simple approach for efficiently neutralizing the biases from multiple risk variables and demonstrate its superiority relative to stratified sampling and optimization as alternative control methods. We also measure the added value from diversifying the number of factors in each style. Finally, we show that the results are robust in relation to transaction costs and can be used to design strategies that aim at outperforming traditional benchmark indexes.
Keywords: factor investing, smart beta, corporate bonds, credit, factor premiums, high yield, investment grade, low-risk, value, momentum, quality
JEL Classification: G11, G12, G14, E44
Suggested Citation: Suggested Citation