A Bond-Picking Model for Corporate Bond Allocation

Abstract

An active investment process in corporate bonds requires an approach that explicitly takes into account the diversification benefits that can be derived from a combination of alpha signals.The main challenge is to find indicators that fulfill at least two conditions.First, each individual alpha signal should achieve consistent performance on a univariate basis, and second, each should exhibit relatively low performance correlation because low correlation is a necessary condition for generating a diversification effect.L’Hoir and Boulhabel show that the combination of three types of signals—valuation signals, equity return signals, and earning momentum signals—fulfills the aforementioned conditions and delivers consistent and stable risk-adjusted returns. The authors present the results of their study for the U.K. corporate bond market.