Systematic investing in credit has become an increasingly popular strategy for investors in recent years. As opposed to stock picking or market timing, systematic investing relies on rules-based algorithms and models to make investment decisions. For credit products like bonds, a systematic approach can help mitigate risks while still providing attractive returns. In this article, we will explore some methods and examples for how to systematically invest in credit.
Using value and momentum factors in corporate bond portfolio
One approach is to screen the credit universe and rank bonds based on valuation and momentum factors. For the value factor, metrics like credit spread vs default expectations or distance-to-default can be used to identify relatively cheap bonds. Momentum signals include past 6-month excess bond returns or issuer equity returns. An algorithm would go long cheap bonds with positive momentum and short expensive bonds with negative momentum. This type of model has shown significant alpha over market benchmarks.
Rotating between credit sectors and quality segments
Another systematic strategy is rotating between credit sectors and quality segments based on momentum and carry signals. The model would tilt exposure toward parts of the market that have recently outperformed and offer higher yields. For example, during risk-on regimes, the strategy may allocate more to high yield bonds, emerging market debt, and investment grade corporates. During risk-off regimes, it would rotate into Treasuries and mortgage-backed securities.
Time-series momentum across geographies
Global credit investors can benefit from time-series momentum strategies applied across countries and regions. Such models go long credits in countries where recent performance has been strong and short countries with weak performance. Combining cross-sectional and time-series momentum in this way has demonstrated effective crisis alpha and diversification.
Risk parity weighting for fixed income
Risk parity is another systematic approach suitable for credit investing. It equalizes the risk contribution across portfolio constituents by leveraging low-risk assets and deleveraging high-risk assets. For diversified fixed income portfolios, risk parity can improve Sharpe ratios versus traditional market cap weighting.
In summary, systematic credit investing utilizes valuation, momentum, carry and risk premia factors within rules-based models. It aims to maximize returns while reducing risks and drawdowns. Investors interested in the credit asset class should consider adding systematic strategies to their portfolio.