Despite government bonds being one of the major asset classes invested in global portfolios, 30% of overall market capitalization according to Doeswijk, et al. (2020), little work has been done to investigate whether factors are present in the sovereign bond market. (Here is a deep dive into fixed income factors by Ward). If factors are indeed present in the sovereign bond market do they add value and are they are persistent? This paper attempts at answering these research questions.
What are the Academic Insights?
One of the key features of this study is the extensive length of the sample: from January 1800 to December 2020: 221 years, a time frame with yields rising (wait, they can do that?) and falling cycles (different from other studies which covered a time frame dominated by falling yields). The research covers 16 developed government bond markets.
Several of the key results of the paper are as follows:
Value and Momentum across bond markets ( country allocations), and Low-Risk on the bond curve ( maturity selection) offer attractive factor premiums, with Sharpe ratios of 0.51, 0.24, and 0.40 over the full sample.
These factor premiums are consistent over time, being positive in 72% (Momentum) to 92% (Value) of 10-year rolling periods.
Combining the factors into a simple multi-factor portfolio gives a highly significant Sharpe ratio of 0.56 (t-statistic of 8.22) from 1800 to 2020 and is positive in 89% of the 10-year rolling periods.
A multi-factor bonds portfolio gives robust performance over various macroeconomic states like recessions and expansions, crisis and non-crisis periods, years with either rising or declining yields, years with above or below median inflation, and years with positive or negative equity returns.
There is a strong value add of a multi-factor bonds portfolio to an existing allocation: a multi-factor bonds portfolio has an average return of 3.48% a year at a correlation of –0.05 with the bond market and adding a multi-factor bonds strategy to a passive global government bond portfolio increases returns substantially with little impact on risk.
Why does it matter?
This paper is an important addition to the academic debate on factor investing. In particular, it adds important and robust evidence to the fact that factor strategies in government bonds offer attractive returns and diversify each other. They do so in both a long-short and long-only constrained setting.
The Most Important Chart from the Paper:
We examine government bond factor premiums in a deep global sample from 1800 to 2020 spanning the major markets and maturities. Bond factors (Value, Momentum, Low-risk) offer attractive premiums that do not decay across samples, are persistent over time, and consistent across various market and macroeconomic scenarios. The factor premiums diversify to each other, as well asto bond or equity market risks. A combined multi-factor bond strategy provides the strongest risk-adjusted returns. These results strongly show a consistent added value of government bond factor premiums over a passive bond portfolio.
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016).
Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.
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