Multi-factor credit strategies provide all-weather outperformance. This applies across inflation regimes, as well as in various interest rate environments.
Inflation worries and rates surges have afflicted markets over the last twelve months. Inflation has moved higher, driven to a large extent by the strong post-Covid economic recovery and the war in Ukraine. Developed market central banks have reacted firmly by, among others, implementing rate hikes not seen in decades. Market interest rates have surged in response.
In a previous article,1 we showed that multi-factor corporate bond strategies provide all-weather performance across inflation regimes. We use the recent extreme inflation developments to reassess the robustness of our findings. Given the sharp increase in interest rates over the same period, we extend our analysis to rates dynamics.
Overall, we reconfirm that multi-factor credit strategies provide all-weather outperformance, not only across inflation regimes, but also in various interest rate environments. Our conclusions are robust in the investment grade as well as high yield investment universes. As individual factors do show some sensitivities to the macro environment, we find that investors’ alpha is best protected against macro dynamics when combining factors in a multi-factor portfolio.
Inflation and rates changes over the past year have been extreme by historical standards and are in the top 5% of their respective historical distributions. Figure 1 shows that US headline CPI inflation has hovered around 2% for most of the sample period, in line with the Fed’s inflation target. However, it rose to 5.1% in June 2021 and then surged to 9.1% in June 2022, the highest level in 30 years. The US 10-year yield rose from below 1.5% in June 2021 to above 3% in June 2022, reaching one of the highest levels over the past 10 years, as the Fed hiked rates to contain inflation pressures.
Over the past 12 months, our Robeco QI Global Multi-Factor Credits and Robeco QI Global Multi-Factor High Yield flagship strategies (henceforth GMFC and MFHY) outperformed their benchmark by respectively 21 bps and 33 bps, in conditions that were difficult for credit markets – as evidenced by the fact that both benchmarks lost about 14% in total return terms.2
We analyze the low-risk/quality, value, momentum and size factors, which are an integral part of our multi-factor investment process. These have been well documented in the academic literature and in numerous white papers.3 We use Robeco’s enhanced factor definitions and rely on data from January 1994 to June 2022, covering the global investment grade and global high yield universes separately.
In Figure 2, we investigate the sensitivity of factor premiums to unexpected inflation changes. The chart on the left shows the Sharpe ratios of the individual long-short factor portfolios conditional on a rising or decreasing inflationary regime, for both investment grade and high yield. We see that the Sharpe ratios of the factors vary with the regime and are generally lower in regimes of decreasing inflation. Furthermore, we find that the Sharpe ratios are positive in all environments.
In the chart on the right, we investigate the sensitivity of the Sharpe ratios of the market indices, and the information ratios of the multi-factor strategies. We find that the returns of the investment grade credit market are higher when inflation increases unexpectedly, while the Sharpe ratio of the high yield market seems insensitive to unexpected inflation changes. The long-only multi-factor strategies deliver highly significant information ratios in all environments, for both investment universes, that are higher when inflation surprises on the upside. The higher information ratios are mostly the result of lower tracking errors in inflationary regimes, while the outperformances are hardly affected.
In Figure 3, we display the individual long-short factor premiums, the market returns and the outperformance of the multi-factor strategies over the last 12 months, in both investment grade and high yield markets. During that period, we experienced extreme inflationary pressures with nine months of rising inflation. As shown in the left chart, we find that, on the one hand, most of the factors exhibiting positive premiums in inflationary regimes in the full sample analysis also displayed positive performance out of sample, with the exception of the value factor in investment grade. On the other hand, the magnitude of the factor premiums was smaller than expected. One potential explanation for this behavior is that inflation was not the only dynamic at play and that other concerns (e.g. the risk of a recession) also influenced the factor premiums.
In the right chart with the long-only results, we investigate the market returns and the outperformances of the multi-factor strategies. We see large negative credit returns of the investment grade and high yield markets, which were concentrated in months with unexpected inflation increases. The long-only multi-factor strategies delivered small positive outperformance in an inflationary environment for both investment universes.
Overall, we see from the above results that the very extreme unexpected inflation changes over the last year did not alter our conclusions. The outperformance over that period of our flagship products GMFC and MFHY provides further out-of-sample evidence of the ability of a multi-factor approach to deliver alpha in a rising-inflation environment.
When considering changes in interest rates, we follow the same methodology as for the above analysis on inflation sensitivities. We are now interested in the coincident relationship between factor premiums and changes in interest rates, over the same measurement period.
In Figure 4, the left graph again shows the Sharpe ratios of the individual long-short factor portfolios. We see this time that individual factor premiums are sensitive to the interest rate regime: when interest rates are rising, the low-risk/quality factor underperforms and the value factor performs strongly. Size, on the other hand, seems to be agnostic to changes in interest rates, while momentum earns a higher premium in a decreasing-rate environment. The performance differences between the factors suggest that combining factors in a multi-factor model might offer a more robust all-weather performance.
In the chart on the right, we show our findings on the sensitivity of the Sharpe ratios of the market indices and the information ratios of the multi-factor strategies. We find that the credit returns of the investment grade credit and high yield markets are markedly different across interest rate regimes. They are positively associated with rate changes, increasing (decreasing) when the interest rates are rising (falling). More importantly, the long-only multi-factor strategies deliver highly significant information ratios in all environments, for both investment universes. The differences in information ratios are mostly the result of tracking error variations across interest rate regimes, while the outperformances are hardly affected.
Overall, credit factors are more sensitive to changes in interest rates than to inflations dynamics. Nevertheless, multi-factor solutions offer consistent outperformance across regimes by exploiting the diversification in factor premiums across states. Ultimately, we find that investors’ alpha is best protected against changing macroeconomic conditions when combining factors in a multi-factor portfolio.
1 See “Are credit factor premiums robust to inflation?”, September 2021
2 Source: Robeco. Based on Robeco QI Global Multi-Factor Credits IH EUR share versus its benchmark the Bloomberg Global Aggregate Corporates index (hedged to EUR) and Robeco QI Global Multi-Factor High Yield IH EUR share versus its benchmark the Bloomberg Global High Yield Corporate ex Financials index (hedged to EUR) in the period July 2021 - June 2022. The currency in which the past performance is displayed may differ from the currency of your country of residence. Due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. The value of your investments may fluctuate. Past performance is no guarantee of future results. Returns gross of fees, based on gross asset value. In reality, costs (such as management fees and other costs) are charged. These have a negative effect on the returns shown.
3 For more information on these factors, see our white papers “The Low-Risk Anomaly in Credits” (2012), “Smart Credit Investing: The Size Premium” (2013), “Smart Credit Investing: Residual Equity Momentum” (2013), “Smart Credit Investing: The Value Premium” (2016), “The Quality of Low-Risk Credits” (2016) and “Factor investing in investment grade & high yield corporate bonds: an overview” (2018).
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.
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:
3. Local legal and sales restrictions
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.
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.