Global corporate bonds systematically managed
There’s been a noticeable increase in demand for corporate bonds following the rise in interest rates in 2022. While yields of less than 1% on euro-hedged credit indices were pretty much the norm in previous years, yields of 4% and more are now being achieved on individual corporate bonds. In turn, demand for corporate bonds has increased. Dr. Harald Henke takes a look at the benefits of investment grade (IG) credit and why now is a good time to consider systematic approaches to investing in the global corporate bond market.
Dr. Harald Henke
Head of Fixed Income Strategy
Corporate bonds are back
Investors have been dealing with a prolonged period of low corporate bond yields. Yields on euro-denominated credits were consistently below 1% between July 2019 and February 2022, apart from a brief period around the start of the coronavirus pandemic. For global corporate bonds, the (unhedged) yield was below 1.75% between July 2021 and October 2022. When you factor in the average hedging cost of USD investments in euros, which averaged 0.73% over this period, the return was around one percent.
Those days are over. Since the end of summer 2022, a European investor has been able to consistently get a running yield of more than 3% on an investment in corporate bonds. As a result, flows into the corporate bond asset class have increased significantly. We see several reasons why corporate bonds offer advantages over government bonds:
- Excess return: Because they’re riskier than safer government bonds, corporate bonds have a higher yield. This return advantage can be consumed by price losses caused by rising spreads in individual years, but on average, the index has had a realised excess return of 1.15% per year between 2001 and 2023. There have been times in phases of spread rallies when the annual excess return was as high as 17.3%.
Figure 1: Excess returns of Global IG Credit over government bonds with the same maturity
- Diversification: Government bond indices often have only a few issuers with sometimes high weightings, forcing investors into high individual issuer risks when they track benchmarks. By comparison, the Bloomberg Global Aggregate Corporate Index has almost 16,500 bonds from almost 2,000 issuers (as of September 2024). With a solid investment process, it is easy and effective to diversify the unsystematic risks of individual companies.
- Risk mitigation: Corporate bonds have an interest rate component and a spread component. Historically, these two components have often moved in opposite directions: rising spreads have often gone hand in hand with falling interest rates, meaning that total returns have often been very stable. Although the years of low interest rates were characterised by a positive correlation between the two parameters, the rise in interest rates to historically more typical levels since 2022 has also shifted the correlation back into the usual negative range.
Figure 2: Correlation between credit spreads and interest rates in different interest rate regimes
Take advantage of new possibilities in bond investing with a systematic approach
While many fund managers use traditional fundamental analysis to construct corporate bond funds, an interesting alternative has emerged over the last two decades in the form of systematic credit strategies. These strategies try to build portfolios that rely on systematic factors like carry, value or momentum. As these factors are, on average, linked to a risk premium or market inefficiency, systematic strategies can generate outperformance.
The following reasons make a case for adopting a systematic approach to credit strategies:
- While systematic approaches have become more common in the market, there still is not a large share of the overall credit allocation invested in them. As a result, it is still comparatively easy to capture the premia associated with systematic credit factors. This results in stable and replicable outperformance with low tracking error and drawdowns.
Figure 3: Systematic factor premiums
- Rigorous risk management: Systematic strategies are characterised by a high level of diversification and risk management. The aim of the strategy is to harvest the risk premia associated with systematic factors such as carry, momentum or value. Downgrades from IG to the high-yield segment can be forecast and proactively avoided using a downgrade model.
- Style diversification: Traditional fundamental managers have on average a higher risk than the benchmark. This is reflected in a performance pattern that is highly dependent on market conditions. In phases of falling spreads (negative market spread changes), these strategies tend to outperform significantly. In phases of rising spreads (positive market spread changes), fundamental credit funds often underperform significantly. This dependency on the state of the market is virtually non-existent with systematic strategies.
Figure 4: Market dependency of fundamental and Quoniam’s systematic strategies
Why chose a quantitative-systematic strategy for global fixed income?
Given what we are seeing in the current market right now, there are many compelling reasons why quantitative-systematic strategies should be successful:
- End of central bank intervention policies: As inflation rose in 2022, most central banks started to wind down their intervention policies. Bond purchases and their reinvestments, zero or negative interest rates and a generous supply of liquidity to the markets are all things of the past. In this kind of environment, politics plays a smaller role and more fundamental market factors come into play. A factor model can help us identify and quantify these factors very effectively and in a systematic way.
- Risk management is becoming more important again: In the past few years, central banks have been quick to step in and help market participants in crises. As a result, price drops were often only short-term, so the best strategy was to hold on to positions. Looking ahead, it’s becoming more important to avoid risks, because you can’t assume that central banks will step in to support every market downturn. One of the advantages of systematic strategies is their ability to handle risks effectively.
- Risk of rising spreads: The US economy is struggling, while the economic crisis in Europe is getting worse. We’ve already seen rising spreads in parts of August and September 2024. If this trend continues, traditional fundamental approaches are likely to underperform because they are frequently overweight risk. In such a phase, the value of systematic strategies becomes particularly apparent.
Quoniam Asset Management has been active in the area of global corporate bonds since 2009 and offers institutional investors attractive conditions for investing in global corporate bonds. Union Investment Luxembourg S.A. will shortly be launching a new sub-fund Global Credit on the QFS SICAV fund platform, which will be managed by Quoniam Asset Management GmbH.
