Investing in US Core Fixed Income with Macro and Style Factors

Abstract

The authors harvest factors—broad and persistent sources of returns—in US core fixed income in three ways. First, they take strategic over- and underweight positions in certain macro factors. Although strategic overweights to rates, or duration, and credit factors have historically resulted in outperforming fixed-income benchmarks, the authors find the long Treasury sector to be the most efficient way to capture rates exposure, and short-duration corporate bonds maximize risk-adjusted returns for credit exposure. Second, the authors time the allocation to rates and credit factors, along with changing high-yield and mortgage exposures. Third, the authors use style factors to select securities. They incorporate a value tilt in Treasuries and value and quality factors in investment-grade and high-yield sectors. Incorporating factors in these ways and building an optimized portfolio to control for deviations relative to the market index resulted in an information ratio of 1.67 over the period of January 2007 to March 2021.

Key Findings

• ▪ The authors introduce strategic and time-varying macro factor exposures to efficiently capture risk premiums in rates and credit.

• ▪ They use security selection by value and quality factors in Treasuries and corporate credit to further enhance performance in US core fixed income.

• ▪ One-third of the outperformance of the broad US core bond benchmark comes from regime-dependent macro tilts, which take more duration and less credit factor exposure during risk-off periods.