Why a multi-factor approach to fixed income is a safe bet



A factor-based approach to investing is nothing new. Investment managers have been using quantitative, factor-based approaches when building equity strategies for decades, and they’ve enjoyed a lot of success. It’s not been until recent years, though, that fixed income products employing similar approaches have started to enter the marketplace.

 “There’s actually an ability to cross over information from the equity market to the bond market,” says Mark Stacey, Senior Vice-President and Co-CIO of AGFiQ, AGF's quantitative investment team. “One of the interesting components about factors for fixed income is that the risk tends to be more well-defined. There is a better linkage between taking that risk and getting paid off in fixed income than there is in equities.”

Momentum, value, quality and, specific to fixed income, carry factors have all been proven to have a predictive relationship to performance in bonds, though the underlying definitions of these factors may differ between equity and fixed-income approaches.

Many of the first factor-based approaches in the market were single-factor strategies. Academic research supported the fact that single factors provide long-term performance, but over the short term, they may not be the best bet.

 “With a multi-factor approach you’re getting diversification and exposure to factors that have been well-thought-out and proven to provide long-term performance,” Stacey explains. “When they don’t all work together, that diversification is what helps.”

When investors take a group of multi-factors, they benefit from the wealth of information coming from each, and so they get either a low correlation or, sometimes, in the case of momentum and value, a negative correlation.

“People always talk about the alternative assets and getting negative correlation,” Stacey says. “You actually lower your total risk when you use multi-factor versus a single factor, and so you get a lower volatility profile, a lower drawdown, and the benefit of diversification.”

Even with the prospect of higher volatility and a normalization of interest rates, a multi-factor approach can still benefit investors.

“If you get exposure to all of the factors, you can navigate through periods of volatility rather than trying to time the factor because factor timing is very difficult, and you can get very much offside from a factor perspective when you don’t have the other factors helping out and mitigating during times of volatility and uncertainty,” Stacey explains.

When it comes to the fixed-income space, Stacey notes that there is a shift towards quant research. “There’s a real advantage to having the ability to analyze data from a quantitative perspective and then have a very consistent investment approach around that, and that’s something that quantitative process can do,” he notes.

AGFiQ recently launched the first fixed-income ETF in Canada to use a quantitative, multi-factor approach to the asset class. The product allows investors to get exposure to global bonds – both corporate and sovereign. Unlike other products, it doesn’t take on credit or duration risk.

“What really drives and differentiates this, makes it complementary to other products, is the fact that we are looking at the bonds and the opportunities where the most attractive bonds globally are using our factors,” Stacey says