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Factor investing: it works for credits too

21-09-2015 | UK | Insight | Patrick Houweling, PhD
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Factor investing has been successfully applied to equity markets. It can also work in the corporate bond market and can generate substantial premiums.


Pension funds, insurance companies and sovereign wealth funds increasingly apply factor investing to equities in their portfolios. And now they would also like to apply this concept to credits. “These investors believe that factor investing can give long-term outperformance in equities and have started to wonder why they should stop there,” says portfolio manager and researcher Patrick Houweling of Robeco Global Multi-Factor Credits.

The concept of factor investing in credits is similar to equities, explains Houweling. “It is a disciplined way of constructing portfolios where we apply rules to identify which companies or bonds score well on specific metrics. All decisions are based on research: both academic and our own proprietary research.”

”In 2014, Houweling, together with quantitative researcher Jeroen van Zundert, wrote an academic research paper entitled ‘Factor investing in the corporate bond market’. The study is the first of its kind to show that factor strategies can be attractive in credit markets. A multi-factor credit portfolio is found to generate substantial premiums in the form of better risk-adjusted returns. The presence of these premiums was no surprise to Houweling. “Many of the explanations that apply to equities are also relevant to corporate bonds. Consider for example, human behavior, incentives and the structure of the financial sector.”

‘We make sure that the portfolio is well diversified across companies and factors’

Besides the research paper, the strategy builds on Robeco’s earlier factor investing experience in equities and low-risk investing in credits. The strategy is innovative, says Houweling. “We have packaged the results of our research into a corporate-bond strategy that we can offer to clients.”

So how does the strategy work? It invests in global investment-grade bonds, and enables institutional investors to take advantage of four factors: Low Risk, Value, Momentum and Size. Low Risk selects low-risk bonds issued by low-risk companies, Value selects bonds that are cheap relative to their associated level of risk and Momentum selects recent winners. In addition to these three factors, which Robeco also uses in its equity factor strategies, the Size factor has been included. Amongst others to take advantage of the liquidity premium, which plays a more significant role in less liquid markets than it does for equities.

The strategy aims for a better return than the market with a similar risk profile. Diversification is a way to reduce risk. “We make sure that the portfolio is well diversified across companies and factors,” says Houweling. “Performance should not come from one or two winners. Instead, it should come from the exposure to factors. And by combining multiple factors in a portfolio you can achieve more stable performance.” It is a strategy that pays off in the long run, concludes Houweling. “There can be periods of time when specific factors underperform the market, but we are confident that these factors will outperform in the long run.”

Institutional investors have shown considerable interest in the strategy. “Some see it as an alternative to their actively managed portfolios, while others regard it as a replacement for their index portfolios.” Clients also like the fact that the strategy is research driven, he adds. “There is a huge body of academic literature that proves the existence of the factor premiums. Factor investing represents a different style of generating performance to the more traditional ways of managing credits and we firmly believe that it deserves a place in a diversified bond portfolio.”

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