Implementing Value and Momentum Strategies in Credit Portfolios

Abstract

Implementing quantitative signals in a corporate bond portfolio can be challenging owing to high transaction costs, large variations of liquidity across individual bonds, and the requirement to follow a benchmark index. The authors design realistic simulations that illustrate the performance and characteristics of quantitatively managed portfolios of liquid corporate bonds with attractive value and momentum characteristics. They show how to implement a turnover budget to explicitly control rebalancing volumes. Such realistic strategy portfolios have significantly outperformed the Bloomberg Barclays US Corporate Bond Index after transaction costs, with information ratios above 1 since 2007. The results of this study support the case for style factor investing in credit.

TOPICS: Performance measurement, portfolio construction, simulations, style investing

Key Findings

• ▪ Relative value and equity momentum styles can be successfully implemented in corporate bond portfolios net of transaction costs.

• ▪ We explain how to overcome challenges related to identifying liquid tradable securities with attractive value and momentum characteristics, keeping transaction costs in check, and following a benchmark index at the same time.

• ▪ Index-tracking portfolios that match key exposures of the US Corporate index, but also overweight bonds with attractive value and momentum characteristics, significantly outperformed the benchmark index after transaction costs, with information ratios above 1 since 2007.