middle easten
Reach for yield vs. reach for safety

Reach for yield vs. reach for safety

16-05-2018 | From the field
Interested in low-risk bonds? This paper 1 argues that when corporate bond investors ‘reach for yield’, this leads to opportunities in the ‘safe’ part of the universe, similar to the low-risk effect in equity markets.
  • Patrick  Houweling
    Patrick
    Houweling
    Portfolio Manager
  • Jeroen  van Zundert
    Jeroen
    van Zundert
    Researcher Quantitative Credits

The authors’ first finding was that risk and return were positively related across credit ratings, but that the relation tended to be flat within one and the same credit rating. They used the Distance-to-Default (DtD) measure of Merton (1974) to construct quality and value factors.

For quality, they selected low-risk (high DtD) issuers within credit ratings. For value, per credit rating, they regressed credit spreads on DtD and selected high residual spread issuers. The factors were used in monthly rebalanced quintile portfolios, as well as in a long-only optimized portfolio, controlling for interest rate risk, credit exposure and turnover. These portfolios were tested on USD Investment Grade (IG) and High Yield (HY) universes from 2004 to 2016.

The after-transaction cost information ratios were around 0.45 for IG and 0.80 for HY for both factors. Combined, the IR is 0.60 for IG (1.12 for HY), showing the diversification benefits to be gained from multi-factor investing.

Note that what this paper calls ‘quality’ is commonly called the ‘low risk’ factor. At Robeco, we define quality at the level of the issuer, by looking at profitability, earnings quality, and conservative behavior.

1Kang, Parker, Radell & Smith, 2017, ‘Reach for safety’, SSRN working paper, no.3037745

Stay informed on Quant investing with monthly mail updates
Stay informed on Quant investing with monthly mail updates
Subscribe
From the field
From the field

Our researchers publish many whitepapers based on their own empirical studies; they also follow quantitative research done by others.

Read all articles

Disclaimer

Robeco Institutional Asset Management B.V. (Dubai office) is regulated by the Dubai Financial Services Authority (“DFSA”) and only deals with Professional Clients and does not deal with Retail Clients as defined by the DFSA.

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. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, annual and semi-annual reports, which can be all be obtained free of charge at this website and at the Robeco offices in each country where Robeco has a presence.

Please confirm that you are a professional investor and/or institutional investor and that you have read, understood and accept the terms of use for this website.

I Disagree