Systematic Fixed-Income Investing Comes of Age

What You Need to Know

Bond investors have been challenged by heightened volatility and big drawdowns in the aftermath of the pandemic. In response, investors are increasingly seeking systematic strategies, which can generate active returns while mitigating risk and charging competitive fees. In this paper, we explore the principles, processes and benefits of a systematic fixed-income strategy, an investment approach whose time has come.

Leading active fixed-income managers have long sought to make their investment performance outcomes more consistent and repeatable through process improvements. These enhancements have typically systematized aspects of the investment process without substantially altering the main sources of outperformance or reducing the levels of beta risk.

Now, fully systematic strategies are available that are driven exclusively by quantitative (“quant”) research insights into the alpha-generating potential of factors (also known as “alphas”) in fixed-income markets. Here, research is concentrated at the factor level.

Systematic strategies aim to deliver active excess returns that are uncorrelated with traditional active manager products. Systematic strategies are evidence based and objective and use model-driven investment decisions that remove human biases. Because they target different sources of outperformance and manage tracking-error risk rigorously, systematic strategies can complement traditional active bond approaches. As with any active strategy, systematic portfolios can experience periods of negative performance. But, because of their diversified factor exposures, the probability of large drawdowns from single-factor events is significantly less for well-designed systematic strategies than for traditional active strategies.

Technological advances in data capture, liquidity discovery and trading analysis have made it possible to devise and implement systematic fixed-income strategies in a highly efficient and cost-effective manner. Further, these strategies can be employed across a wide range of fixed-income markets, including US, European and Canadian credit; long-duration US credit; US aggregate mandates; and emerging-market debt.

Also, by boosting returns while improving portfolio diversification, an active systematic approach may raise a fixed-income portfolio’s information ratio, a measure of active return per unit of active risk.

This paper sets out the principles behind systematic fixed-income investing and illustrates how it compares with other approaches. Considering its potential advantages, we believe that systematic fixed-income investing is an idea whose time has come.