Systematic fixed income investing has become an increasingly popular investment approach in recent years. By following rules-based strategies, investors can effectively manage the risks and enhance the risk-adjusted returns of their fixed income portfolios. In this article, we will look at the principles behind systematic fixed income investing, discuss some common strategies used, and walk through an example to illustrate how this approach can be applied in practice to help investors achieve their portfolio objectives.
Core principles of systematic fixed income investing
Systematic fixed income investing aims to remove emotion and human biases from the investment process. It follows prespecified, rules-based strategies that are grounded in academic research and historical data analysis. Some key principles include:
– Diversification across many factors and fixed income sectors to reduce risks. Common factors used include value, momentum, carry, defensive, macroeconomic and others.
– Regular rebalancing of the portfolio back to target allocations, which helps maintain a consistent risk profile over time.
– Discipline and consistency in applying the rules, avoiding ad hoc changes based on investor emotion or market sentiment.
– Transparency into portfolio positions, risks and performance attribution to understand what is driving returns.
Common systematic fixed income strategies
Some well-known systematic fixed income strategies include:
– Style investing strategies: Value, momentum, carry and defensive style factors have demonstrated effectiveness historically in fixed income markets, similar to equities. Portfolios can be constructed long-short or long-only on one or multiple factors.
– Risk premia strategies: Targeting rewards for bearing different well-known risk factors like credit, duration, liquidity and more. Can help enhance portfolio diversification.
– Smart beta strategies: Rules-based approaches, often fundamentally weighted, designed to outperform traditional market cap weighted bond indexes.
– Macroeconomic strategies: Utilizing macroeconomic indicators like employment, inflation, etc. to tactically adjust portfolio duration or credit exposures.
– Automated trading strategies: Algorithmic trading strategies that aim to systematically capture short-term pricing anomalies and market inefficiencies.
A systematic fixed income portfolio example
Here is an illustrative example of how a systematic fixed income portfolio may be constructed in practice:
– The portfolio targets global government and investment grade corporate bonds across various maturities.
– It utilizes a multi-factor approach, diversifying across value, momentum, carry and defensive factors. Individual country-maturity segments are ranked on each factor.
– Each month, fixed income securities are selected within each segment based on factor rankings. The portfolio is rebalanced to target weights.
– Risk and return attribution analysis is regularly conducted. Factor exposures are monitored and managed to remain consistent with portfolio objectives.
– Portfolio risk and return outcomes are expected to consistently reflect the historical efficacy of underlying factors rather than manager skill.
Systematic fixed income investing provides a rules-based, disciplined approach to lower portfolio volatility and enhance risk-adjusted returns. By diversifying across many factors and fixed income sectors, investors can aim to efficiently harvest risk premia over time. Walking through a detailed portfolio example helps illustrate the principles of systematic fixed income in practice.