Bond Style Performance and Exploitation
April 6, 2015 - Bonds
Does a factor (style) premium model identify exploitable abnormal corporate bond returns? In their March 2015 paper entitled “Investing with Style in Corporate Bonds”, Ronen Israel, Johnny Kang and Scott Richardson investigate the usefulness of four bond return factors:
- Carry – the fixed spread that must be added to the U.S. Treasuries yield curve such that the discounted payments of the corporate bond match its traded market price.
- Defensive (low-risk) – corporate bond from an issuer with low levels of market leverage (total debt divided by the sum of total debt and market value of equity).
- Momentum – trailing 6-month corporate bond return in excess of the risk-free rate.
- Value – corporate bond with a high carry relative to the issuer’s fundamental distance-to-default (measured via linear regression).
Specifically, they measure the ability of these four factors to explain future excess (negating the role of interest rates) returns of different corporate bonds. They also test exploitability via a long-only portfolio with exposure to the factors. Finally, they check the degrees to which actively managed credit hedge and mutual funds actually exploit the factors. Using monthly data for a broad (but filtered) sample of U.S. corporate bonds/issuers (10,825 bonds and 5,300 issuers) and monthly return data for 213 actively managed credit hedge funds and 218 actively managed credit mutual funds during January 1997 through December 2013, they find that: Keep Reading