Factor investing in emerging local currency bonds

Factor investing refers to applying systematic (‘quant’) strategies to any asset class. For developed bond markets there is quite some literature showing that factors like low risk, value, carry and momentum can help an investor to beat passively investing in the bond market index. In this project we are interested whether a factor approach can also work for Emerging Local Currency (EMLC) Bonds. These are government bonds issued by emerging countries in their own currency (as opposed to in e.g. US dollars, a ‘hard current’).

We expect that in this project several challenges will need to be overcome that are much less applicable to developed markets:

  • Currency risk: 75% of the risk of the EMLC JP Morgan index is currency risk. We will need to control this risk. Time permitting we could also test factors on EM currencies. Or testing EMLC factors on Interest Rate Swaps which avoid FX risk altogether
  • The pure bond risk will see large differences over time between countries
  • Also the co-movement, ‘beta’, with the market will differ a lot between countries
  • The classic factors are focused on ‘interest rates’, not potential credit risk

Hence smart portfolio construction will play a key role. We think these (methodological) challenges will help getting a high thesis grade for a quantitative study.

Also commercially the benefits could be large, because EMLC assets are generally managed in a fundamental way, not a quant way. In asset classes where factor investing is already established there is huge interest for it by institutional investors. Robeco already has more than EUR 50 billion assets under asset management in factor funds in developed government bonds, corporate bonds, and developed and emerging equities. Can you fill the gap?

Are you interested?
Let us know your motivation and send it together with your top-3 favorite internship topics, your CV and list of grades to
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Cepni, Gul, and Gupta (2020). “Local currency bond risk premia of emerging markets: The role of local and global factors”, Finance Research Letters 33.

Martens, Beekhuizen, Duyvesteyn and Zomerdijk (2019) “Carry investing on the yield curve”, Financial Analysts Journal 75 (4), pp51-63