Why should investors consider credit factors in fixed income?

The adoption of fixed income factors allows investors to decide which risks and returns are appropriate for their portfolios

Mar 31, 2018 | Jay Raol and Shawn Pope

A substantial body of academic research and a long track record of use in portfolios has led to a growing acceptance of factor investing within the investment community. Most of the academic research and practical implementation of factors has been done in the equity asset class, where factors have been used to explain equity risk and return.

Factors should exist in all asset classes

While factor investing is quite established within equities, there is much less academic research and a much shorter track record when it comes to fixed income portfolios. However, we believe the underlying reasons for factors are not asset class-specific. Factors simply connect investor behavior to investment returns. As such, there is not reason to believe they cannot be applied to other asset classes, such as fixed income.

However, factors are only recently being harvested in fixed income portfolios. What are the reasons for this lag in adoption? First, fixed income securities are inherently more complex than equities, causing fixed income factor research to be slower to evolve. For example, while equities of one issuer are interchangeable, bonds are typically not. Bonds of the same issuer can have different maturities, levels of liquidity, embedded optionality and can make up different parts of the capital structure.
 

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