Factor investing in credit markets is coming of age

Factor investing in credit markets is coming of age

22-08-2017 | Insight

Factor investing strategies for credit markets are increasingly on the radar of researchers and investors. We see three clear trends: a rising number of academic papers on the topic, a strong demand from investors and a growing range of fixed income ‘smart beta’ funds on offer.

  • Patrick  Houweling
    Co-Head of Quant Fixed Income and Lead Portfolio Manager

Speed read

  • Market trends show a growing tendency towards factor investing in credit markets
  • These strategies can be seen as a diversifier and an alternative to passive investing 
  • Clients are increasingly asking for customized solutions

These days, many investors are familiar with incorporating factor investing or smart beta into their equity portfolios. However, equities are by no means the only asset class in which factors can improve the risk-return profile of a portfolio. Empirical studies show that the concept of factor investing can also be applied to many other markets, in particular to corporate bonds. “I see a growing number of research papers, seminars, products and indices for fixed income smart beta and more specifically for investment grade and high yield credits,” says Patrick Houweling, a quantitative researcher at Robeco and portfolio manager of the QI Global Multi-Factor Credits fund.

According to Houweling, the reason why ‘quants’ started paying closer attention to credits only recently is “plain and simple”. To conduct empirical analysis, quants need data, and historical datasets on individual corporate bonds were hard to find for a long time. Nowadays, such datasets have become more widely available and, as a result, the number of research articles has risen substantially. “We counted as many papers on factor investing in credit markets that were published over the last 18 months as in the five years before,” Houweling says.

‘We counted as many papers on factor investing in credit markets that were published over the last 18 months as in the five years before’

The graphic below illustrates the rapid rise in the number of research papers and broker reports on factor investing in credit markets (per factor) published over the past ten years.

Source: Robeco

A growing market

This trend in the number of articles and reports has occurred alongside the rapidly growing interest on the part of institutional investors in so-called ‘smart beta’ fixed income funds. Various recent surveys confirm this. For example, an annual study by index provider FTSE Russell found that 27% of the participants have either already invested in fixed income smart beta products, or are considering doing so in the next 18 months. “We clearly see rising interest in factor credit strategies,” says Houweling. “Over the past two-and-a-half years, we have held about 250 client meetings and presentations on this topic.”

According to another study by market intelligence consultant Spence Johnson, European respondents anticipated that for fixed income, the annual growth rate in factor investing would be 19%. This is the highest rate of all asset classes. In particular, the consultant expects the popularity of non-equity smart beta products to grow faster than that of equity products. Of the total of EUR 48bn predicted to be invested in ‘other’ smart beta asset classes by European investors in 2019, EUR 42bn is expected to be invested in fixed income strategies.

The asset management industry has also spotted the potential of fixed income smart beta. For example, a recent newspaper article in the Financial Times indicated that 25 smart beta fixed income ETFs are already available, and another 25 are being registered. “The fact that more and more fixed income smart beta products are available in the market is another major trend”, says Houweling.

Stay informed on Credit investing with monthly mail updates
Stay informed on Credit investing with monthly mail updates

Three case studies

There are many ways in which credit portfolios can benefit from factor investing strategies. Different real-life case studies help illustrate the very diverse situations in which this kind of investment approach is worth considering. These case studies also improve our understanding of the implications of applying factors to credit markets.

For example, a large sovereign wealth fund, which had almost its entire credit holdings invested in passive portfolios, was looking for an alternative because passive strategies typically underperform after costs. Moreover, index-based portfolios invest more in companies with a high debt load, which is not comforting for an investor. “This client liked the rules-based and transparent investment process of factor investing, as well as its modest turnover and fees compared to traditional active management,” says Jeroen van Zundert, a quantitative researcher at Robeco. “In the past, these had been key arguments in favor of passive over active investing.”

Similarly, an Italian private bank wanted to replace an underperforming active asset manager. This bank was looking for an investment strategy that would provide distinctive, diversifying alpha. However, it also wanted to achieve alpha using an evidence-based investment philosophy. “Factor investing, being an evidence-based approach to active investing, was therefore a natural fit for this bank,” Van Zundert says.

A third example concerns an Australian insurer which, after implementing factor investing in its equity portfolio, was looking for a factor-based approach for other asset classes too. “This client was attracted to credit factor investing, as the evidence for credit factor investing is mounting, and so is the number of investment products available,” Van Zundert says. “The investor felt the time was right to implement factors in its credit portfolios.”

According to Houweling, these different case studies show that there are three main reasons why clients may choose a factor-based strategy for credit markets. First, it acts as a style diversifier for those who already invest in classic credit products. The quantitative, rules-based strategy offers diversification by generating alpha in a different way.

Second, for passive investors, factor investing can be an attractive alternative, as it does not have the structural weaknesses and inefficiencies associated with traditional market cap-weighted benchmarks. On the other hand, like passive index-based investing, factor investing also offers transparency, low turnover and modest fees. Third, it provides an opportunity to implement the factor investing approach in a client's portfolio for multiple asset classes. Applying multi-factor investing to both equities and credits enhances returns, without increasing risk.

Benefit from factor investing
Benefit from factor investing
Discover the essentials of factor investing
Read more

Tailor-made strategies

Now that the use of factor investing in the credit market is coming of age, asset owners have started to think beyond regular off-the-shelf products. Houweling and Van Zundert underscore that investors increasingly ask for tailor-made solutions. For example, clients may have specific requirements regarding the investment universe, the factor mix or the level of turnover. They may also have particular risk constraints or ESG targets. “In those cases, we can definitely customize the standard solution,” says Van Zundert.

One way to adapt a strategy to a client-specific requirement is by adjusting the investment universe. “For instance, a German pension fund did not want to have exposure to financials, so we developed an ex-financials solution,” says Van Zundert. Another example of possible customization has to do with the way bonds should be dealt with if they have been downgraded from investment grade to high yield status. Most investors allow some high yield bonds in their investment grade portfolio, but some do not want to invest in high yield at all. Constraining the time-to-maturity of the investable bonds, in order to better match a client’s liability structure for example, is another customization option.

In addition to these investment universe adjustments, factor investing can also be combined with other concepts. For example, a UK-based pension fund wanted to combine factor investing with the ‘buy-and-maintain’ approach. Buy-and-maintain means that after a bond is bought, the intention is to hold the bond until maturity, unless it becomes too risky. The low risk and quality characteristics, which also imply low turnover, are useful for determining which bonds to buy and, if necessary, to sell. “This is why we proposed adjusting the factor mix in order to make it more suitable for a buy-and-maintain approach,” says Van Zundert.

‘Since factor investing is rules-based, the incorporation of additional sustainability rules, is relatively straightforward’

Last but not least, improving the sustainability profile of a factor portfolio is another important area of possible customization. In some cases, for example, clients want to reduce the CO2 emissions, water use, energy consumption and waste generation of the portfolio compared to the benchmark. Since a factor strategy is already rules-based, the incorporation of additional rules, such as environmental footprint reductions or other ESG dimensions, is relatively straightforward.

Thorough research needed

But despite the growing number of products and research papers available, investors should always look at new strategies with a critical eye, says Houweling. “Asset managers have to do their own thorough research,” he warns. “Especially when it comes to the practical implementation of factor strategies in the credit market and dealing adequately with the illiquidity of corporate bonds. After all, we think that some fixed income smart beta strategies are ‘smarter’ than others.”

Robeco has long been a pioneer in quantitative research on factor-based investing in credit markets. We started researching factor-based credit selection models at the end of the 1990s and have been managing internal factor credit portfolios since 2005. We have also been offering standalone factor credit strategies since 2012.

In 2014, Houweling and Van Zundert wrote the research paper Factor investing in the corporate bond market1. In this academic study, the first of its kind, they argued that factor strategies can also be implemented in credit markets. They concluded that a multi-factor credit portfolio would have generated attractive Sharpe and information ratios over the 1994-2014 research period. This paper was later published in the well-known Financial Analysts Journal, the academic journal of the CFA Institute.

Following the research on the application of factors to corporate bonds, Robeco turned theory into practice and launched the Robeco QI Global Multi-Factor Credits fund in 2015, which provides global exposure to investment grade corporate bonds which score well in terms of the factors value, momentum, low-risk, quality, and size. This fund uses a disciplined, research driven investment process to efficiently capture factor premiums, avoiding unrewarded risks and unnecessary turnover.

At the heart of the investment process lies Robeco’s quantitative multi-factor model, which ranks bonds in terms of their factor characteristics. The strategy is designed to deliver long-term outperformance throughout the credit cycle. This makes it possible to avoid the losers while also picking the winners.

1Factor Investing in the Corporate Bond Market’, Patrick Houweling and Jeroen van Zundert, Financial Analysts Journal, 2017, Vol. 73, No. 2.

Important information

The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.



1. General
Please read this information carefully.

This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. The Company does not hold client assets and is subject to the licensing condition that it shall seek the SFC’s prior approval before extending services at retail level. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.

2. Important risk disclosures
2. Important risk disclosures Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:

  • Some Funds are subject to investment, market, equities, liquidity, counterparty, securities lending and foreign currency risk and risk associated with investments in small and/or mid-capped companies.
  • Some Funds are subject to the risks of investing in emerging markets which include political, economic, legal, regulatory, market, settlement, execution, counterparty and currency risks.
  • Some Funds may invest in China A shares directly through the Qualified Foreign Institutional Investor (“QFII”) scheme and / or RMB Qualified Foreign Institutional Investor (“RQFII”) scheme and / or Stock Connect programmes which may entail additional clearing and settlement, regulatory, operational, counterparty and liquidity risk.
  • For distributing share classes, some Funds may pay out dividend distributions out of capital. Where distributions are paid out of capital, this amounts to a return or withdrawal of part of your original investment or capital gains attributable to that and may result in an immediate decrease in the net asset value of shares.
  • Some Funds’ investments maybe concentrated in one region / one country / one sector / around one theme and therefore the value of the Fund may be more volatile and may be subject to concentration risk.
  • The risk exists that the quantitative techniques used by some Funds may not work and the Funds’ value may be adversely affected.
  • In addition to investment, market, liquidity, counterparty, securities lending, (reverse) repurchase agreements and foreign currency risk, some Funds are subject to risk associated with fixed income investments like credit risk, interest rate risk, convertible bonds risk, ABS risk and the risk of investments in non-investment grade or unrated securities and the risk of investments made in non-investment grade sovereign securities.
  • Some Funds can use derivatives extensively. Robeco Global Consumer Trends Equities can use derivatives for hedging and efficient portfolio management. Derivatives exposure may involve higher counterparty, liquidity and valuation risks. In adverse situations, the Funds may suffer significant losses (even a total loss of the Funds’ assets) from its derivative usage.
  • Robeco European High Yield Bonds is subject to Eurozone risk.
  • Investors may suffer substantial losses of their investments in the Funds. Investor should not invest in the Funds solely based on the information provided in this document and should read the offering documents (including potential risks involved) for details.

3. Local legal and sales restrictions
The Website is to be accessed by “professional investors” only (as defined in the Securities and Futures Ordinance (Cap.571) and/or the Securities and Futures (Professional Investors) Rules (Cap.571D) under the laws of Hong Kong). The Website is not directed at any person in any jurisdiction where (by reason of that person’s nationality, residence or otherwise) the publication or availability of the Website is prohibited. Persons in respect of whom such prohibitions apply or persons other than those specified above must not access this Website. Persons accessing the Website need to be aware that they are responsible themselves for the compliance with all local rules and regulations. By accessing this Website and any of its pages, you acknowledge your agreement with understanding of the following terms of use and legal information. If you do not agree to the terms and conditions below, do not access this Website or any pages thereof.

The information contained in the Website is being provided for information purposes.

Neither information nor any opinion expressed on the Website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.

4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.

5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.

6. Third party websites
This website includes material from third parties or links to websites maintained by third parties some of which is supplied by companies that are not affiliated to Robeco. Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage. Third party off-site pages or websites are provided for informational purposes only.

7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.

8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.

9. Privacy
Robeco guarantees that the data of persons accessing the Website will be treated confidentially in accordance with prevailing data protection regulations. Such data will not be made available to third parties without the approval of the persons accessing the Website, unless Robeco is legally obliged to do so. Please find more details in our Privacy and Cookie Policy.

10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong. 

Please click the “I agree” button if you have read and understood this page and agree to the Disclaimers above and the collection and use of your personal data by Robeco, for the purposes for which such data is collected and used as set out in the Privacy and Cookie Policy, including for the purpose of direct marketing of Robeco products or services. Otherwise, please click “I Disagree” to leave the website.

I Disagree