Why risk-factor investing in fixed income is complex
Although factor investing has been applied to a wide array of asset classes, its footprint in the fixed-income sector remains small. This is due to the challenges that are specific to bond markets, such as the vastness and complexity of the bond universe itself.
Equities are standardized, interchangeable instruments that are transparently traded on an exchange. By contrast, bonds are not standardized at all. There are many different types of issuers, including corporations, governments, and supranational organizations. And each issuer can issue bonds with different maturities, optionality, seniority, and currency.
There are other factors to contend with as well. While numerous new bonds are issued every day, existing bonds can also be called and repaid. To make matters worse, third-party data, such as credit ratings, plays a crucial role in how bonds are priced, but this data is updated only periodically and lacks sufficient granularity.
This complexity makes quantitative comparisons between bonds extremely difficult, which in turn makes factor modeling for fixed income a very challenging exercise.