A bond portfolio’s exposure to investment factors is what “really counts” in its returns, even if the portfolio is not explicitly labelled a factor strategy, researchers say.
Invesco studied a broad range of US core bond portfolios and found factors drove much of their active performance even if the portfolios did not explicitly target factors.
The firm said its analysis showed factors could have explained 66% of a bond manager’s outperformance over the past decade.
“In other words, investors are factor investors whether they know it or not, said Stephen Quance, director of factor investing at the asset manager.
Invesco makes the claim in a paper, ‘Active bond returns – powered by factors’.
In the firm’s words, investment factors are directly observable characteristics of securities, which can be used as part of live strategies to help investors achieve particular outcomes.
The value factor – which identifies bonds priced lower than their peers – often helps explain excess returns, the researchers said.
Additional fixed income factors include the carry factor, which explains risk-adjusted excess returns from holding higher-yielding bonds; the liquidity factor, which explains risk-adjusted excess returns from holding less liquid bonds; and the quality factor for risk-adjusted excess returns from holding low-volatility bonds.
Invesco’s researchers sampled 65 investment managers representing the largest managers in the Lipper Core Plus peer group over the period from January 1, 2007, to June 30, 2018. They observed that the median manager had a significant exposure to carry, liquidity and value.
The majority of bond managers were able to beat their benchmarks, at least partially, by holding older, smaller issue size bonds with lower ratings and longer maturities compared to the benchmark average.
To a lesser extent, managers held securities that were cheap relative to their sector and rating peers.
If bond portfolios have inherent factor exposures, the researchers believe it would pay off to identify the exposures and, if appropriate, adjust them to better align a portfolio’s risk profile with the investor’s return objectives.
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