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Emerging market equity data help dynamic duration management

Emerging market equity data help dynamic duration management

05-12-2017 | Insight

Expectations for the fundamental drivers of bonds can be derived from financial market information. In particular, data from both developed and emerging equity markets.

  • Johan Duyvesteyn
    Johan
    Duyvesteyn
    Senior Quantitative Researcher and Portfolio Manager

Speed read

  • We use equity market data to predict bond returns
  • Using data from emerging markets improves the model
  • It generates a better and more stable performance

For over 20 years, our duration model, which determines the active duration positioning of our QI Dynamic Duration strategies, has been successfully forecasting returns in the major bond markets using financial market data. Recent research carried out by Robeco showed that incorporating data from both developed and emerging equity markets further improves the model’s ability to derive economic growth expectations and forecast bond returns. This enhancement was recently implemented.

Over the past decades, emerging countries have seen their influence on the global economy increase dramatically. Not only do they now contribute more to growth, they also represent an increasingly important export destination for developed economies. Over time, emerging countries have also become major holders of government bonds issued by their developed counterparts. Given this increasingly important role of emerging economies, it seemed logical to investigate the added value of using information from emerging equity markets in our duration model.

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A good growth indicator

Because of its forward-looking nature, to derive expectations for the fundamental drivers of bond markets, such as economic growth, inflation and monetary policy the model relies on financial market data, rather than official economic statistics such as GDP growth. Such statistics are, by definition, backward-looking, published with a delay and prone to revisions. But until now, the financial market data the model had been using came solely from developed equity markets.

Our study confirmed that strong equity market performance is a good indicator for improving growth expectations or reduced uncertainty about growth prospects. All else being equal, this should lead to negative bond market returns. Conversely, weaker equity market performance usually signals deteriorating economic prospects, pointing to positive bond returns.

‘Including information from emerging equity markets adds considerable value’

Moreover, our research analysis showed that the model’s ability to derive growth expectations improves consistently when the returns of emerging equity markets are included. “Including information from emerging equity markets clearly adds considerable value to the model,” says portfolio manager and quant researcher Johan Duyvesteyn.

Improved performance with emerging market data

Indeed, this enhanced approach generates a better and more stable performance. Taking into account information from emerging equity markets to derive growth expectations improves the backtest results for the entire model. This further strengthens Robeco’s Dynamic Duration strategies’ proposition to benefit from periods with declining bond yields while keeping returns protected when yields rise.

“On a daily basis, developed bond market investors may overlook economic data coming from the emerging world and focus on other important issues making headlines, such as monetary decisions from major central banks, for example,” says Duyvesteyn. “And when investors do finally focus on hard global economic growth data, our strategy is already well positioned thanks to our enhanced approach to deriving economic growth expectations.”