singaporeen
Are credit factor premiums robust to inflation?

Are credit factor premiums robust to inflation?

24-09-2021 | Insight
With inflation worries having gained momentum, we investigate how inflation has affected credit factor premiums in the past. We find that multi-factor strategies show robust performance across inflation regimes.
  • Patrick  Houweling
    Patrick
    Houweling
    Co-Head of Quant Fixed Income and Lead Portfolio Manager

Speed read

  • With 5% headline inflation in the US, inflation takes center stage again
  • We find that individual factors exhibit some sensitivity to inflation
  • Multi-factor strategies show robust performance across inflation regimes

Investigating whether factor premiums will survive higher inflation

With the strong economic recovery witnessed so far in 2021, led by the reopening of the global economy following the start of Covid-19 vaccination schemes, inflation worries have gained momentum. We investigate in our article1 how inflation has historically affected credit factor premiums. Overall, we find that while individual factor premiums in corporate bond markets can be somewhat sensitive to inflation changes, the multi-factor strategies provide all-weather performance across inflation regimes. Our conclusions are robust for the choice of investment universe (investment grade or high yield), for unexpected inflation changes and changes in inflation expectations, and after controlling for state-dependent market exposures. Ultimately, we find that investors’ alpha is best protected against rising inflation when combining factors in a multi-factor portfolio.

Ultimately, we find that investors’ alpha is best protected against rising inflation when combining factors in a multi-factor portfolio.

Defining the scope

We analyze the low-risk, quality, momentum, size and value factors that are an integral part of our multi-factor model and have been documented in the academic literature as well as numerous white papers. Our data covers the global investment grade and global high yield universes over the period from January 1994 to December 2020.

To investigate factor performance, we create long-short factor portfolios by going long the top decile portfolio and short the bottom one. Our focus is on the pure credit return associated with corporate bonds by measuring their performance in excess of duration-matched Treasuries.

To better understand the impact of inflation changes for long-only investors harvesting credit factors, we also analyze a multi-factor long-only portfolio. Here we rely on historical simulations for our flagship products, namely the Global Multi-Factor Credits and Global Multi-Factor High Yield strategies, which we complement with live track records to extend the analysis to the end of June 2021.2

Measuring inflation sensitivity

First, we run scenario analyses, i.e., we measure factor performances in months with rising or decreasing inflation expectations and with rising or decreasing unexpected inflation changes. A rising inflationary regime is defined as a positive change, while a decreasing state is defined as a negative change.

In Figure 1, we first 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. This lower Sharpe ratio in deflationary times is typically the result of a lower return, but especially a higher risk.

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.

Figure 1 | Sensitivity of factors to unexpected inflation changes

Source: Robeco, Bloomberg. Period: January 1994-December 2020 for individual factors’ Sharpe ratios (left chart) and January 1994-June 2021 for the market indices’ Sharpe ratios and the multi-factor strategies’ Information ratios (right chart).
With regard to regimes of rising or decreasing inflation expectations, our analysis shows this time that individual factor premiums are more sensitive to the regime.1 When investigating the sensitivity of the Sharpe ratio of the market as well as of the information ratio of the long-only multi-factor flagship solutions, we find that while both the investment grade and the high yield market are sensitive to changes in inflation expectations, the long-only multi-factor strategies deliver highly significant risk-adjusted relative returns in all environments, for both investment universes. The multi-factor models benefit from the diversifying inflation sensitivities of the individual factors and offers a robust all-weather performance.

Controlling factor premiums for inflation sensitivities

The previous analysis shed light not only on performance differences but also on risk differences across inflationary regimes. These findings suggest that inflation and market regimes are related and that the market sensitivity of factors might vary across inflationary regimes. In this second analysis, we therefore investigate whether the conditional factor performances are robust after controlling for market exposures.

We see in Figure 2 that all long-short factors generate positive and significant alphas above and beyond their state-dependent market sensitivity, when we differentiate between positive and negative unexpected inflation changes. The alphas are robust across inflationary regimes and investment universes, with somewhat higher alphas in times of positive inflation surprises. While the alphas remain positive in all inflation regimes, their statistical significance for some factors can be regime dependent. This is in contrast to the long-only multi-factor strategies, which earn a consistently stable alpha across inflationary regimes, after controlling for state-dependent market exposures. We benchmark these alphas against the market indices average performance conditional on the inflation regimes and find that the magnitude of the long-only strategies’ alphas is consistently larger than the conditional market performance.

Figure 2 | Alpha beyond sensitivity to unexpected inflation changes

Source: Robeco, Bloomberg. Period: January 1994-December 2020 for individual factors (left chart) and January 1994-June 2021 for the market indices and the multi-factor strategies (right chart). For the market indices, we report the conditional average return.

We perform a similar analysis when considering the sensitivity of factor premiums to changes in inflation expectations. We find similar results as in the case of unexpected changes in inflation.

1This article is a shortened version of the article “Are credit factor premiums robust to inflation?”, September 2021, Thibault Lair and Patrick Houweling. We refer refer the reader to this full version for a more detailed analysis.
2The live track record of the Global Multi-Factor Credits and Global Multi-Factor High Yield strategies start respectively in July 2015 and July 2018.

Important information

This information is for informational purposes only and should not be construed as an offer to sell or an invitation to buy any securities or products, nor as investment advice or recommendation.
The contents of this document have not been reviewed by the Monetary Authority of Singapore (“MAS”). Robeco Singapore Private Limited holds a capital markets services license for fund management issued by the MAS and is subject to certain clientele restrictions under such license.
An investment will involve a high degree of risk, and you should consider carefully whether an investment is suitable for you.

Logo

Important Information

Warning/Important note: This website contains information which is only available to qualified investors as defined below. If you are not a qualified investor, please click “I Disagree” to leave the website.

By clicking on "I agree", I declare that: 

  • I am a qualified investor as defined under 1
  • I have read and understood the Terms and Conditions and Disclaimers as described under 2

1 - This website may only be accessed directly or indirectly by the following persons in Singapore:

1) “institutional investor” under section 304 of the Securities and Futures Act (Cap.289)(“SFA”), which means:
(i) the Government; (ii) a statutory board as may be prescribed by regulations made under section 341 of the SFA; (iii) an entity that is wholly and beneficially owned, whether directly or indirectly, by a central government of a country and whose principal activity is (A) to manage its own funds; (B) to manage the funds of the central government of that country (which may include the reserves of that central government and any pension or provident fund of that country); or (C) to manage the funds (which may include the reserves of that central government and any pension or provident fund of that country) of another entity that is wholly and beneficially owned, whether directly or indirectly, by the central government of that country; (iv) any entity (A) that is wholly and beneficially owned, whether directly or indirectly, by the central government of a country; and (B) whose funds are managed by an entity mentioned in sub-paragraph (iii); (v) a central bank in a jurisdiction other than Singapore; (vi) a central government in a country other than Singapore; (vii) an agency (of a central government in a country other than Singapore) that is incorporated or established in a country other than Singapore; (viii) a multilateral agency, international organisation or supranational agency as may be prescribed by regulations made under section 341 of the SFA; (ix) a bank that is licensed under the Banking Act (Cap.19); (x) a merchant bank that is approved as a financial institution under section 28 of the Monetary Authority of Singapore Act (Cap.186); (xi) a finance company that is licensed under the Finance Companies Act (Cap.108); (xii) a company or co-operative society that is licensed under the Insurance Act (Cap.142) to carry on insurance business in Singapore; (xiii) a company licensed under the Trust Companies Act (Cap.336); (xiv) a holder of a capital markets services licence; (xv) an approved exchange; (xvi) a recognised market operator; (xvii) an approved clearing house; (xviii) a recognised clearing house; (xix) a licensed trade repository; (xx) a licensed foreign trade repository; (xxi) an approved holding company; (xxii) a Depository as defined in section 81SF of the SFA; (xxiii) an entity or a trust formed or incorporated in a jurisdiction other than Singapore, which is regulated for the carrying on of any financial activity in that jurisdiction by a public authority of that jurisdiction that exercises a function that corresponds to a regulatory function of the Authority under this Act, the Banking Act (Cap.19), the Finance Companies Act (Cap.108), the Monetary Authority of Singapore Act (Cap.186), the Insurance Act (Cap.142), the Trust Companies Act (Cap.336) or such other Act as may be prescribed by regulations made under section 341 of the SFA; (xxiv) a pension fund, or collective investment scheme, whether constituted in Singapore or elsewhere; (xxv) a person (other than an individual) who carries on the business of dealing in bonds with accredited investors or expert investors; (xxvi) the trustee of such trust as the Authority may prescribe, when acting in that capacity; or; (xxvii) such other person as the Authority may prescribe.

2) “relevant person” under section 305(1) of the SFA, which means:
(i) An accredited investor; (ii) a corporation the sole business of which is to hold investments and the entire share capital of which is owned by one or more individuals, each of whom is an accredited investor; (iii) a trustee of a trust the sole purpose of which is to hold investments and each beneficiary of which is an individual who is an accredited investor; (iv) an officer or equivalent person of the person making the offer (such person being an entity) or a spouse, parent, brother, sister, son or daughter of that officer or equivalent person; or (v) a spouse, parent, brother, sister, son or daughter of the person making the offer (such person being an individual).

3) any person who acquires the units [in a collective investment scheme] as principal if the offer is on terms that the units may only be required at a consideration of not less than $200,000 (or its equivalent in a foreign currency) for each transaction, whether such amount is to be paid for in cash or by exchange of units in a collective investment scheme, securities, securities-based derivatives contracts or other assets, and if the following condition is satisfied: (i) the offer is not accompanied by an advertisement making an offer or calling attention to the offer or intended offer; (ii) no selling or promotional expenses are paid or incurred in connection with the offer other than those incurred for administrative or professional services, or by way of commission or fee for services rendered by any of the persons specified in section 302B(1)(d)(i) to (vi) of the SFA; and (iii) no prospectus in respect of the offer has been registered by the Authority or, where a prospectus has been registered (A) the prospectus has eAccxpired pursuant to section 299 of the SFA; or (B) the person making the offer has before making the offer 1. informed the Authority by notice in writing of its intent to make the offer in reliance on the exemption under this subsection; and 2. taken reasonable steps to inform in writing the person to whom the offer is made that the offer is made in reliance on the exemption under this subsection.

4) Or otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.

If you are not any of the types of persons described above, you are not authorized to enter this website and you should leave this website immediately.

2 Terms and Conditions
You acknowledge that you have read these Terms and Conditions (“Terms”) prior to accessing the website located at www.robeco.com/sg (“Website”) and you agree to be bound by the Terms.  If you do not agree to all of the Terms, you are not an authorised user and you should not use the Website. The Website is owned by Robeco Singapore Private Limited (company registration number: UEN. 201541306Z), which is licensed by the Monetary Authority of Singapore (“MAS”) pursuant to the Securities and Futures Act (Cap.289) (“SFA”) of Singapore, and is managed by Robeco Singapore Private Limited and/or its affiliates (collectively, as “Robeco”). The Website is intended for and should be accessed by institutional investors or accredited investors (as defined under Section 4A of the SFA) of Singapore.  The Website is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject the Robeco to any registration or licensing requirement within such jurisdiction.  It is your responsibility to observe all applicable laws, rules and regulations of any relevant jurisdiction. The content contained in the Website is owned by Robeco and/or its information providers and is protected by applicable copyrights, trademarks, service marks, and/or other intellectual property rights.  You may not copy, distribute, modify, post, frame or link the Website, including any text, graphics, video, audio, software code, user interface, design or logos.  You may not distribute, modify, transmit, reuse, repost, or use the content of the Website for public or commercial use, including all text, images, audio and/or video.  Robeco may terminate your access to the Website for any reason, without prior notice. Neither Robeco, nor any of its associates, nor any director, officer or employee accepts any liability whatsoever for any loss arising directly or indirectly from the access of the Website.  You agree to indemnity and hold Robeco, its associates, directors, officers or employees harmless against any and all claims, losses, liability, costs and expenses arising from your use of the Website due to violation of the Terms. Robeco reserves the right to change, modify, add or remove any parts of the Terms at any time and for any reason.  The Terms shall deemed to be effective immediately upon posting. The Terms shall be governed by, and shall be construed in accordance with, the law of Singapore.

Disclaimers
The Website has not been reviewed by the MAS. Accordingly, the Website may not be accessed directly or indirectly to persons in Singapore other than (i) to an institutional investor under Section 304 of the SFA, (ii) to a relevant person pursuant to Section 305(1), or any person pursuant to Section 305(2), and in accordance with the conditions specified in Section 305, of the SFA, or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. 

Nothing in the Website constitutes tax, accounting, regulatory, legal or investment advice.  The Website is for informational purposes only and should not be construed as an offer to sell or an invitation to buy any securities or products, nor as investment advice or recommendation or for the purpose of soliciting any action in relation to Robeco’s businesses, or solicitation by anyone in any jurisdiction in which such an offer or solicitation is not authorised or to any person to whom it is unlawful to make such an offer and solicitation. Any reproduction or distribution of information from the Website, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited.  By accessing to the Website, you agree to the foregoing.  

The funds referred to in the Website are for information only.  It is not a recommendation or investment advice, nor does it mean the funds is suitable for all investors.  The contents of the website is not reviewed by the MAS.  Any decision to participate in the funds should be made only after reviewing the sections regarding investment considerations, conflicts of interest, risk factors and the relevant Singapore selling restrictions.  You should consult your professional adviser if you are in doubt about the stringent restrictions applicable to the use of the Website, regulatory status of the funds, applicable regulatory protection, associated risks and suitability of the funds to your objectives.

Any decisions made based on the information contained in the Website are the sole responsibility of yours.  Any investments made or to be made shall be with your independent analyses based on your financial situation and objectives.  The investments and strategies contained in the Website may not be suitable for all investors and are not guaranteed by Robeco.  

Investment involves risks and may lose value.  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.  The Website may contain projections or other forward looking statements regarding future events or future financial performance of countries, markets or companies and such projection or forecast is not indicative of the future.  The information contained in the Website, including any data, projections and underlying assumptions are based upon certain assumptions, management forecasts and analysis of information available on an “as is” basis and without warranties of any kind, whether express or implied, and reflects prevailing conditions and Robeco’s views as of the date published or indicated, and maybe superseded by subsequent events or for other reasons.  The information contained in the Website are accordingly subject to change at any time without notice and Robeco are under no obligation to notify you of any of these changes.  Robeco expressly disclaims all liability for errors and omissions in the information presented in the Website and for the use or interpretation by others of information contained in the Website.

Robeco Singapore Private Limited holds a capital markets services licence for fund management issued by the MAS and is subject to certain clientele restrictions under such licence.  An investment will involve a high degree of risk, and you should consider carefully whether an investment is suitable for you.

I Disagree