A Factor Approach to Smart Beta Development in Fixed Income

As a bull market in bonds that lasted for more than three decades comes to an end, investors increasingly question traditional means of accessing passive fixed income investments. Historically the main return driver of diversified fixed income portfolios has been treasury interest rate exposure, which has performed well in a long period of falling rates in developed markets. The prospect of rising rates in a low yield environment has sparked interest in new approaches to index-linked bond investing. Factor based investing provides a coherent framework for designing outcome-oriented fixed income indices. From that perspective we discuss shortcomings of existing fixed income indices, lay out the risk and return drivers inherent in the asset class, and propose alternative investment approached based on these insights. We conclude with examples of smart beta strategies that aim to provide enhanced diversification across credit and rates factors, an improved risk-return trade-off within a global treasury portfolio, and a value approach to investing in high yield corporate bonds