Fixed income factor investing has become increasingly popular for enhancing portfolio returns while managing risks. By tilting portfolios towards certain fixed income factors like value, momentum and quality, investors can tap into the risk premia associated with these factors. This article provides an overview of fixed income factor investing strategies, their rationale and effectiveness.
Factor-based strategies aim to capture risk premia
The rationale behind fixed income factor investing lies in capturing the excess returns or risk premia associated with certain factors. Academic research shows factors like value, momentum and low risk tend to deliver positive premiums over the long run across various asset classes including fixed income.
Multifactor models combine factors for diversification
Investors can adopt single factor or multifactor model strategies. Multifactor models allow exposure to a combination of factors, providing more diversification. For instance, combining value and momentum factors in one model allows investors to tap two different sources of excess returns.
Factors can be weighted based on volatility regimes
Advanced fixed income factor strategies adjust factor exposures dynamically based on changing market conditions. When volatility is high, momentum factors tend to perform better while value factors outperform when volatility is low. Machine learning techniques can help create such adaptive multifactor models.
Fixed income factor investing provides an effective approach to enhance risk-adjusted returns. By systematically targeting factors that deliver positive long-term premiums, fixed income portfolios can be tilted towards higher expected returns.