Factor Investing in Fixed Income

Why should investors consider credit factors in fixed income?

Aug 27, 2017 | Jay Raol and Shawn Pope

A substantial body of academic research, coupled with a long track record of use in portfolios, has led to a wider 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 key characteristics used to explain equity risk and return. In over 50 years of research, three general reasons have been given for why factors earn excess returns. First, factors are by-products of the collective behaviour biases of investors that result in sub-optimal investing. Second, factors can earn higher returns for higher risk. And third, structural differences, such as liquidity differences between securities, can lead to excess returns. Often, a single factor’s risk and return encompasses all three explanations.

Factors should exist in all asset classes 

While factor investing is quite established in 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 behaviour to investment returns. As such, there is no reason to believe they cannot be applied to other asset classes, such as fixed income.

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