Credit Quants Push Strategy That Lured Trillions in Stock Market
(Bloomberg) -- A small group of pioneers is hoping that factor investing, which has grown into a multi trillion-dollar market in equities, can become the next big thing in the world of corporate bonds — particularly with Donald Trump’s agenda sending shock waves across assets.
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This cohort has spent years trying to make inroads into the debt market with factor investing, which buys and sells securities based on characteristics like how cheap they are or how much their prices move around. But progress has been slow and patchy, held back by everything from technical challenges to academic disputes.
Now, with electronic trading firmly established, a raft of fixed-income ETFs coming online and volatility flaring across bonds, interest in the approach is rising fast, according to Andrew Johnson, a credit strategist at Barclays Plc. A promising track record has helped: factor-powered credit strategies have beaten a Bloomberg index of investment-grade corporate bonds for four straight years, according to data compiled by Nasdaq eVestment that tracks offerings by mostly long-only asset managers.
“I was having none of these conversations a year ago,” Johnson said. “Now I can think of at least four funds who I know are doing it.”
True, factor approaches remain a fraction of the $8 trillion world of US corporate debt. But advocates point out the potential, with more than $2 trillion in ETFs using factors in the equity market and the likes of Dimensional Fund Advisors, a pioneer of the strategy in stocks, growing to manage $777 billion.
The number of factor-driven credit strategies has increased 23% over the last five years, eVestment data show. In a more opaque corner, where banks conjure up trades for clients via structured products known as Quantitative Investment Strategies, the list of similar offerings has doubled over the same stretch, according to data compiled by Premialab.
To those who are able to harness the data, credit presents a potentially more rewarding market than equities, according to Andrew Dassori, chief investment officer at Wavelength Capital Management LLC, who has focused on factor investing for over a decade. Just consider: While a company is usually listed under one stock ticker, a single firm can appear in the credit world via a litany of bonds with varied structures, rates, durations and covenants.
“The data in fixed income hasn’t been as picked over as it has been in equities, which can naturally lead to more opportunities to seek mispricings systematically using factors,” Dassori said.
Factor investing seeks to deliver diversification and potentially outperformance by targeting specific traits of companies or securities that over time are believed to drive returns above what the broader market offers. Besides value and volatility, common factors also include momentum and carry, which are based on a bond’s prevailing price moves and credit spreads, respectively.
Historically, factor investing has been a challenge in credit because of a lack of data and sluggish execution speeds. That’s a problem for an approach that seeks to go long or short hundreds of securities based on algorithm-derived signals.
But since the pandemic unleashed a drive toward digitization, electronic platforms have mushroomed, helping slash the cost of trading. The accompanied rise of portfolio trades — which bundle a basket of securities in one order — naturally suits factor investing’s regular need to make large portfolio adjustments in one fell swoop. Meanwhile, Wall Street’s biggest banks have been striving to provide real-time pricing.
“As the market continues to get more efficient, you are going to see these strategies become more deployable,” said Marty Mannion, co-head of TD Securities Automated Trading.
Skeptics question whether it’s worth paying up for the complex trade. Strategies tracked by eVestment delivered an average 2.4% gain in 2024, so investors would have been better off parking that money simply in cash.
The lackluster performance can be blamed on a placid market where credit spreads shrunk to a record and dispersion narrowed, according to James Donaldson, a portfolio manager at Grantham Mayo Van Otterloo. The firm, which launched the GMO Systematic IG Credit Strategy in 2020, is planning to offer a similar strategy in the ETF wrapper.
Should the investing approach manage to prove its worth during a major selloff, adoption can pick up quickly, said Donaldson.
“We’re still in early innings and that’s probably why you have a lot of asset owners still needing to be comfortable with this approach and waiting for things to be more battle-tested,” he said.
The strategy has held up along with the broad credit market during the latest equity selloff. A benchmark for credit-factor strategies kept by Premialab is up 1% this year through Monday.
Agile Investment Management launched last year utilizing three factors as part of its credit investment process: carry, defensive and value. Depending on where the market is in an economic cycle, the firm adjusts how much is allocated to each style.
Such an approach appeals to clients because it’s easier to identify the source of a portfolio’s returns in a tangible manner, according to Jon Birtwell, a partner at Agile.
“It’s explainable performance attributed to very specific factors,” he said. “It’s not someone putting a finger in the air and saying, ‘Oh, you outperformed, you just got lucky.’”
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