Journal of Investment Strategies

Risk.net

Factor-based tactical bond allocation and interest rate risk management

Andreas Thomann

  • Approach combines macroeconomic and style factors to guide the duration debate.
  • Following the factor signals helps avoid drawdowns and improves the Sharpe ratio.
  • Factor-based strategies historically performed well under rising interest rate regimes.
  • The online appendix shows robustness across various countries and regions.

This paper offers two composite bond market factor investment strategies each for the Swiss bond market and for the global sovereign bond market. These composite factor strategies can be useful tools when making tactical asset allocation decisions between bonds and cash, and they can act as a base for the duration debate. As such, the output of our bond market factors can guide tactical interest rate views and therefore interest rate risk management. To construct these composite factors, we use four economically meaningful individual factors. Following an investment strategy based on a composite bond market factor, constructed as the equally weighted average of individual components, we are able to outperform cash as well as the static buy-and-hold strategy with regard to the Sharpe ratio, annualized standard deviation and maximum drawdown. Testing the composite and individual factors on their performance during periods of historical rising interest rates, we observe improved drawdown results compared with holding the underlying asset passively.

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