Escolar Documentos
Profissional Documentos
Cultura Documentos
A
A RNE STAAL s a bull market in bonds that lasted potentially overvalued bonds, an investment
is a managing director at for more than three decades comes approach that is in some ways counterintui-
BlackRock in London,
to an end, investors increasingly tive and counterproductive. Debt issuance in
U.K.
arne.staal@blackrock.com question the traditional means of such indices is highly concentrated in a rela-
accessing fixed income markets. Benchmark tively small number of market participants.
M ARCO CORSI indexing has guided investments ever since Exhibits 1 and 2 below illustrate the lack of
is a director at BlackRock the creation of the first bond indices in 1926 diversification in bond indices using the Bar-
in London, U.K. by Standard and Poors. Existing benchmark clays Global Treasury Index as an example.
marco.corsi@blackrock.com
indices are not without their faults however, As of April 2015, treasury bonds from the
SARA SHORES as they may be impacted by diversification, United States and Japan together comprise
is a managing director liquidity, and transparency issues. These 55% of the market value of an index that
at BlackRock in San shortcomings have been of little concern represents the sovereign debt of 38 countries.
Francisco, CA. while bond markets continued to deliver Even more strikingly, those same two coun-
sara.shores@blackrock.com
high risk-adjusted returns in an environment tries represent almost two-thirds of the total
CHRIS WOIDA of steadily falling interest rates. In the last few risk in the index.
is a director at BlackRock years however, the prospect of rising rates in A very similar observation can be made
in San Francisco, CA. a low yield environment has sparked interest for corporate credit indices. Exhibit 3 shows
chris.woida@blackrock.com in new approaches to bond investing. At the that 10% of the issuers in the Barclays U.S.
same time, the notion of passively managed Corporate Index represent more than 55%
portfolios that move away from cap weight- of both the market value and the total risk
ingoften called smart betahas gained of the index.
a strong foothold among equity investors. Market-cap-weighted equity indices
In the pages that follow, we examine how suffer from similar concentration issues, but
best to extend this way of thinking to fixed arguably the implications for fixed income
income. indices go beyond limited diversification.
While market value of any instrument
INEFFICIENCIES IN FIXED ref lects the discounted sum of expected
INCOME INDICES cash f lows, and therefore is in essence for-
ward looking, notional amount of debt out-
Since market value of debt is determined standing is entirely backward looking in
by both bond prices and notional amount nature. Unlike equity indices, fixed income
outstanding, a cap-weighted index empha- index composition often ref lects historical
sizes positions in highly indebted issuers and issuance dynamics to a larger degree than
EXHIBIT 3
Barclays U.S. Corporate Index Issuer Weights and Risk Contribution
Source: Barclays as of April 2015The issuers represented in the Barclays U.S. Corporate Index (about 2100 issuers) are partitioned into deciles based on
weight and risk contribution. For each decile, the charts display its cumulative weight (left chart) and risk contribution (right chart). Notice that the partition
into deciles is done by ranking the issuers according to their weight (left chart) or risk contribution (right chart); the list created in this way is then partitioned
into 10 consecutive groups (each one a decile) containing an equal number of issuers.
differences in forward looking valuations. While the Other problems stem from the market structure
primary users of benchmark indices, bond investors, aim in fixed income. Benchmark indices aim to represent
to achieve high returns, issuer dynamics are based on a returns on markets for the average investor; in the end,
desire to minimize cost of capital by bond issuers. The the sum total of outstanding instruments has to add up
result is that the high weights of dominant issuers can go to the sum total of investor positions. Unfortunately,
hand in hand with relatively unattractive characteristics unlike most equity benchmarks, broad fixed income
such as relatively low fundamental quality and yields. To indices are not directly investable because of liquidity
illustrate, Exhibit 4 highlights the lack of relationship challenges and limited price transparency. Many instru-
between benchmark weight and yield to maturity. ments contained in such indices are held in buy-to-hold
Source: Barclays as of April 2015The chart displays the cumulative weight and yield to maturity for each country included into the Barclays Global
Treasury Index.
portfolios, are traded in low volume, and most are traded ment strategies (see Ang et al. [2009] for a study on
over-the-counter rather than on exchanges. This makes the performance of the Norwegian Government Pen-
traditional fixed income indices challenging to replicate sion Fund). Well-known examples include portfolio
in investor portfolios and imprecise tools for the purpose managers exploiting FX carry (long high-yielding
of measuring actual investment outcomes. currencies, short low-yielding currencies), active bond
managers extending the duration of their portfolios
FROM FACTORS TO SMART BETA beyond the benchmark (accessing the term premium
in fixed income), credit managers overweighting high
The increased concern about the shortcomings of yield bonds (accessing the credit carry risk premium),
passive fixed income strategies benchmarked to tradi- equity managers increasing the weight of value stocks
tional indices coincides with a renewed focus across in their portfolios (earning the equity value premium),
the investment industry on understanding the drivers commodity funds exploiting roll congestion strategies
of return and risk across asset classes. During the credit (long deferred contracts, short front contracts), and
crisis of 2008, many actively managed investments hedge funds harvesting the short volatility premium
experienced steep losses in line with risky asset classes, (by selling delta-hedged options).
bringing increased scrutiny to portfolio allocations. To illustrate the extent of these systematic expo-
Confronted by this lack of diversification across active sures in actively managed fixed income portfolios, we
and passive investments, researchers and market partici- perform a principal components analysis1 on the
pants sought to analyze active returns and understand excess returns of a universe of 655 active European
true drivers of performance. The results solidified the bond managers. The results of this analysis are shown in
understanding that a large part of active returns can be Exhibit 5; the first two factors generated by the prin-
explained by a set of well-established, systematic invest- cipal component analysis explain about 75% of the
Source: Lipper database as of February 2015. The principal component analysis is run over monthly returns since January 2004 to February 2015. Funds
with less than five years history have been excluded from the analysis (the universe includes EUR denominated active funds (excluding absolute returns)
classified as bond funds by Lipper).
active risk 2 of such managers, suggesting that most of The concept of factor investing and smart beta
their excess returns are driven by common exposures in has not been widely adopted in every asset class. Equity
their portfolios. Not surprisingly, we calculate that the investors have embraced non-cap-weighted index strate-
first factor is very highly correlated with longer term gies and factor investing to the greatest extent. At least
interest rates, indicating yield extension of active port- since the publication of the seminal paper on common
folios beyond the benchmark in an attempt to generate factors in equity returns by Fama and French [1992,
additional term premium return. The second factor 1993] and Carhart [1997], equity investors have been
appears related to the slope of the interest rate curve aware of the importance of systematic factors such as
while the third seems to capture spread exposure. Kahn valuation (as measured, for example, by book-to-market
and Lemmon [2014] suggest similar results for actively ratios), quality (as measured, for example, by the stability
managed U.S. bond portfolios through direct regression of earnings and dividend policies), size (as measured
of active performance on bond and credit factors. by market capitalization), momentum (as measured by
The interest and credit rate exposures identified relative past price performance), or risk anomalies (as
above are examples of factors; commonality in returns measured by the outperformance of low-risk portfolios,
across instruments with similar underlying exposures compared to high-risk portfolios). While the existence
to the forces that determine investment outcomes. Both of these factors has been widely recognized for many
passive and active investments are exposed to these years (and often provide the building blocks for actively
forces. In many cases, factors capture risk premiums (and managed strategies), only recently have investors sought
therefore generate excess returns by providing expo- to achieve exposure to these factors through a more pas-
sure against an identified and priced economic risk), sive and rules-based approach.
but they can also represent behavioral phenomena or Fixed income has always been a highly analytical
pricing pressures driven by market structure. In the same and structured asset class, but investors have not yet
manner that long-only market-capitalization-weighted widely started to investigate factor-based approaches to
investments in risky assets capture the overall market risk bond investing with particular investment objectives. The
premium (or beta), these strategies capture alternative considerable inefficiencies in benchmark fixed income
sources of returns available in the markets. Indices that indices and the relative lack of transparent pricing of bond
deviate from market-capitalization weighting to explic- instruments suggest there is a myriad of opportunities
itly capture exposure to one or more of these factors can for better passive fixed income solutions. By identifying
be thought of as providing access to a form of alternative, the drivers of risk and return for the asset class, we can
or smart, beta. design strategies with clear objectives to meet specific
outcomes and seek better risk-adjusted returns.
EXHIBIT 6
Distribution of the Relative Idiosyncratic Risk for U.S. Equities and IG Corporate Bonds
Source: Barclays, Bloomberg, and Blackrock as of April 2015. The chart displays the density function of the ratio idiosyncratic risk over systematic risk
across the constituents of the S&P 1500 Composite Equity Index and the Barclays U.S. Corporate Index).
EXHIBIT 7
Mapping Fixed Income Factors
EXHIBIT 8
Explaining the Returns of the Barclays U.S. Treasury Index
Source: Barclays as of April 2015. The chart shows the R-square of a rolling linear regression of the Barclays U.S. Treasury Index monthly returns vs. the
changes in the one-year rate (24-month window).
EXHIBIT 9
Sector Return Dispersion in U.S. Equities and IG Corporate Bonds
Source: Barclays and Bloomberg. The chart displays the cross sectional standard deviation of monthly returns across the 24 GICS Industry Groups3 of the
S&P 500 Index and the 18 Industry Groups4 of the Barclays U.S. Corporate Index. The two classification levels have been chosen in order to have a com-
parable numbers of sectors for the two indices.
Source: Barclays and Blackrock. Charts based on the monthly returns of the Euro Aggregate Index from Oct 2001 to Jan 2015. Risk is measured by
rolling 24-month realized volatility. Return is measured by the 12-month cumulative return.
in their portfolio. Credit spreads have added little on In the first case, we choose exposure to fixed income
average, but do show cyclicality based on the market factors based on a diversification scheme that intends to
environment. balance risk impact from different exposures. Indirectly
this can lead to improved risk-return profiles over time
DESIGNING FIXED INCOME SMART BETA but the primary objective is to make sure the index is
not mainly exposed to a very limited number of return
An understanding of the factors that drive fixed drivers. In the second case, we aim to embed perfor-
income returns provides the building blocks for sys- mance related investment objectives in the index, related
tematically considering smart beta approaches in fixed for example to valuation measures. In the third case, we
income. So far, alternatives to market cap indices have isolate fixed income factors to provide building blocks to
mostly been proposed on an ad hoc basis. For example, be used in portfolio construction. We give examples of
GDP-weighted or fiscal-strength-weighted treasury possible smart beta approaches in all three categories.
indices aim to provide alternative approaches that break
the link between issuance, price, and investment expo- Example 1: Macro Factor Diversification
sure. Both approaches capture some notion of the issuers in Aggregate Indices
ability to pay its debt but neither represent a clear invest-
ment objective. Alternative approaches in corporate We are at an inf lection point in fixed income mar-
credit are often addressed from a quality perspective kets in which the potential for rising rates in the U.S. and
based on fundamental screening, but do not typically strong global demand for safe assets can potentially
encompass a multi-factor approach, nor balance credit lead to scenarios in which duration can no longer be
factors relative to rates and other factors. relied upon as a sole return driver.
We believe that smart beta in fixed income indices Historically, credit spreads have contributed rela-
should provide investable solutions that aim to deliver tively little to the total returns and risk of benchmark
on clear objectives. We consider three categories for indices, but they have often provided offsetting returns
potential objectives: to duration driven performance. This suggests there are
untapped diversification benefits in both risk (which
1. Better diversification. could be lowered through appropriately scaled offsetting
2. Improved risk versus return profiles. positions) and returns (which could be higher on average
3. Precision exposure to isolated fixed income as different macroeconomic exposures will deliver at dif-
factors. ferent points in the business cycle). We investigate if we
EXHIBIT 11
Historical Allocation of the Risk-Balanced Strategy
EXHIBIT 12
Risk and Return Breakdown
Source: Barclays and Blackrock. Charts based on the monthly returns of the Barclays U.S. Aggregate Index and the risk-balanced strategy from
Jan 2010 to Mar 2015. Left chart: the risk is measured by 24-month realized volatility (annualised) averaged over the last five years.
EXHIBIT 14
Comparison Between Standard and Tilted Weights
EXHIBIT 15
Performance Comparison Between Standard Weights and Tilted Weights
Source: Blackrock and Barclays. All figures are based on monthly returns since June 2011 to January 2015. Returns and volatility are annualised. Yield
and Duration are as of January 2015. Index performance is shown for illustrative purposes only. One cannot invest directly in an index.
Source: Barclays and Blackrock. Charts based on monthly returns from June 2011 to January 2015.
Exhibit 14 shows a selection of the current country To illustrate, we test the performance of a strategy
weights generated by the standard market capitalization that invests in all the bonds included in the Barclays U.S.
weighting scheme and by applying our tilting rule. The High Yield Index that were rated as investment grade at
main effect of the tilting is a shift of weight from Japan, the time of their issuance. The bonds are market-cap-
Italy, and France towards the U.S., Germany, and South weighted and the basket is rebalanced on a monthly
Korea. basis.
Exhibits 17 and 18 compare the performance of the
Example 3: Fallen Angels Provide Smart newly created strategy with the performance of the Bar-
HY Exposure clays U.S. High Yield Index (used here as a benchmark).
The fallen angels strategy outperforms the benchmark
Fallen angels are high yield bonds rated as invest- in terms of (risk-adjusted) returns with a slightly higher
ment grade at the time of issuance that were subsequently level of volatility and drawdown. The duration of the
downgraded. The downgrade event triggers the exclu- strategy is historically higher than for the benchmark and
sion of these bonds from the main corporate indices and the yield to maturity is comparable (see Exhibit 19), but
a subsequent sell off driven by benchmarked investors the outperformance is mainly driven by mean-reverting
(trying to reduce tracking error or not allowed to hold credit spreads of fallen angels, not different exposure to
securities below the investment grade). The result of this rates factors.
activity is pressure on the bonds price with associated
underperformance of the fallen angels with respect to CONCLUSION
high yield bonds showing similar characteristics. Once
the selling pressure instigated by the rating migration is The risk and return of broad fixed income indices
over, the price tends to revert to the equilibrium level. are driven predominately by interest rate (or risk free
This phenomenon has been extensively analyzed in duration) factors. While historically investors have been
academic and practitioner literature (see Ben Dor, Xu well compensated for outsized exposures to interest rate
[2010] or Ellul et al. [2010] for more details) and pro- risk, with interest rates near lower bounds across the
vides an interesting opportunity to generate returns in developed world, the outlook for continued rewards from
excess of a standard high yield benchmark by buying market-cap-benchmarked fixed income investing now
fallen angels bonds after the downgrade and holding looks less appealing. Rate dominated portfolios provide
them over a long enough period to capture the reversal diversification versus equities and other risky asset classes
trend. By doing so we refine our exposure to HY credit in multi-asset portfolios, and will retain their value as
spread factors. a hedge in f light-to-quality environments. However,
Source: Barclays as of April 2015. Chart based on monthly returns from August 1998 to March 2015.
EXHIBIT 18
Performance of the Fallen Angels Strategy vs. the Barclays U.S. HY Index
Source: Barclays as of April 2015. All figures are based on monthly returns since August 1998 to March 2015. Returns and volatility are annualised.
Yield and Duration are as of March 2015. Index performance is shown for illustrative purposes only. One cannot invest directly in an index.
EXHIBIT 19
Rolling Duration and Yield
Source: Barclays as of April 2015. Charts based on monthly data since August 1998 to March 2015.
we question the ability of conventional fixed income better position passively oriented portfolios for an uncer-
strategies to generate attractive long-term returns in the tain future. They seek to provide improved risk-adjusted
current macroeconomic environment on a stand-alone returns by building portfolios to deliberately capture and
basis. Innovation in core fixed income investing may diversify the sources of risk and return in fixed income.
therefore be necessary to navigate increased uncertainty Time will tell if these promises will be fulfilled, but the
in the macroeconomic landscape. Smart beta fixed opportunities are surely worth pursuing.
income approaches bring this innovation. They aim to