Preface xiii

Acknowledgments xv

About the Author xvii

Chapter 1 Setting the Stage 1

1.1 What is fixed income? 1

1.2 How big are fixed income markets? 3

1.3 What does it mean to be systematic? 8

1.4 Which fixed income markets will this book focus on? 15

1.5 Commonly used fixed income analytics 17

1.6 Other fixed income considerations 24

References 28

Chapter 2 Fixed Income – Strategic Asset Allocation 29

2.1 What are the key drivers of fixed income security returns? 29

2.2 What traditional risk premia can be harvested in fixed income? 36

2.3 The strategic diversification benefit of fixed income 50

2.4 Is the strategic diversification benefit of fixed income threatened in a low-interest-rate environment? 54

References 55

Chapter 3 Fixed Income – Tactical Asset Allocation 57

3.1 Market timing – term premium 57

3.2 Market timing – credit premium 70

3.3 Other considerations 83

References 88

Chapter 4 Incumbent Active Fixed Income Managers 89

4.1 Framework for active fixed income management 89

4.2 US Aggregate (Core Plus) benchmarked fixed income managers 94

4.3 Global Aggregate benchmarked fixed income managers 97

4.4 Unconstrained Bond Funds 100

4.5 Emerging Market fixed income managers 102

4.6 Credit long/short managers 104

References 108

Chapter 5 Security Selection – Rate-Sensitive Assets 109

5.1 What is the investment opportunity set for developed market government bonds? 109

5.2 Reducing the dimensionality 112

5.3 A framework for security selection of government bonds (investment themes) 119

5.4 A framework for security selection of government bonds (level, slope, and curvature) 123

5.5 Extensions 131

References 135

Chapter 6 Security Selection – Credit-Sensitive Assets 137

6.1 What is the investment opportunity set for developed market corporate bonds? 137

6.2 Dimensions of active risk taking within corporate bonds 145

6.3 A framework for security selection of corporate bonds (investment themes) 149

6.4 A framework for security selection of corporate bonds (performance) 158

6.5 Extensions 163

References 170

Chapter 7 Security Selection – Emerging Markets (Hard Currency) 173

7.1 What is the investment opportunity for emerging market fixed income? 173

7.2 A framework for security selection of hard currency emerging market bonds (investment themes) 178

7.3 A framework for security selection of emerging market hard currency bonds (performance) 182

7.4 Extensions 184

References 186

Chapter 8 Portfolio Construction Considerations 187

8.1 Choices in the investment process (design and investment universe) 187

8.2 Choices in the investment model (expected returns) 191

8.3 Choices in the portfolio construction process (optimization, rebalancing, trading) 199

8.4 Other topics 207

References 208

Chapter 9 Liquidity and Trading Considerations 209

9.1 Some context for the liquidity challenges of fixed income assets 209

9.2 Basics for trading credit-sensitive assets 210

9.3 Electronification of trading for credit-sensitive assets 219

9.4 Primary markets – liquidity provision 221

9.5 Secondary markets – liquidity provision 226

9.6 Ancillary topics 228

References 232

Chapter 10 Sustainability 233

10.1 Interest in ESG/sustainability 233

10.2 Sustainable investing with credit-sensitive assets 235

10.3 Sustainable investing with rate-sensitive assets 249

References 256

Chapter 11 Putting It All Together 259

11.1 What might a successful systematic fixed income investing process look like? 259

11.2 Some final thoughts 272

Reference 277

Index 279

PRAISE FOR SYSTEMATIC FIXED INCOME

“Systematic Fixed Income is the definitive companion for portfolio managers and students of fixed-income markets. Dr. Richardson expertly lays the subject open, clearly explaining the how and why of tactical and strategic allocation of fixed-income portfolios. There is no substitute for this book.”
—DARRELL DUFFIE, Adams Distinguished Professor of Management and Professor of Finance, Graduate School of Business, Stanford University

“Dr. Richardson’s book is a thoughtful compilation of knowledge that he has accumulated throughout his distinguished career as both an academic and a practitioner. I strongly recommend it to anyone interested in learning about fixed income investing—systematic or otherwise.”
—NAVNEET ARORA, Ph.D., Head of Global Quantitative Strategies, Citadel

“Scott Richardson, one of the pioneers of systematic fixed income investing and leading practitioners in the field, has produced a highly readable guide to the process, navigating the difficulties with clarity, directness, and data. Referencing the latest research, much of which he has authored, this book will spearhead the next generation of fixed income management.”
—STEPHEN KEALHOFER, Founder and Head of Research, KMV, DCI

“Electronification of global fixed income markets has set the stage for successful systematic investing. Scott Richardson has been in the vanguard of systematic fixed income investing as an academic and practitioner. In this extremely useful book, Scott leverages his experience to provide a consistent, and practicable, guide for investors seeking alpha from timing and security selection in global fixed income.”
—ROSS GARON, Global Head of Quantitative Strategies at Millennium

“In this comprehensive and insightful book, Scott Richardson describes the promise of a systematic approach to global fixed-income markets, showing how investors can address the challenges arising from the fragmentation of fixed-income markets into many thousands of finite-lived assets. The book is a compelling proposal for a modern approach to fixed-income asset management.”
—JOHN CAMPBELL, Morton L. and Carole S. Olshan Professor of Economics, Harvard University

"Systematic investing—driven by models and data—has made major inroads in equity investment, but not in fixed income. This book is long overdue, and Scott Richardson is the ideal author. Combining his clear grasp of theory, coupled with his long practicioner experience, it is a 'must read' for fixed-income investors."
—STEPHEN SCHAEFER, Professor, London Business School

"This book is a must read for any serious investment professional or aspiring student interested in systematic fixed income. Scott Richardson is one of the most experienced hands-on global professionals in this space bringing a unique combination of insights that span both academia and industry."
—ANDREW JACKSON, Head of Research, Vinva Investment Management

Fixed income is a ubiquitous and necessary component of asset owner portfolios. The markets are enormous and constitute an impactful diversifier alongside equity allocations. Improved data sources and electronification of markets now allow for systematic investment approaches to be realistically applied to fixed income markets. The potential for asset owners is significant.

In Systematic Fixed Income: An Investor’s Guide, renowned finance professional Dr. Scott Richardson delivers a comprehensive framework for identifying the relevant sources of risk and return in public fixed income markets. In the book, the author conducts a robust and accessible analysis of the strategic and tactical roles that fixed income can play in asset allocation. He also covers systematic security selection for rate and credit sensitive fixed income assets across developed and emerging markets.

Equipped with a full understanding of what drives returns, readers will explore the implementation challenges—including liquidity and risk—that must be overcome for investors to be successful with systematic fixed income portfolios.

The result is a strategy for preserving the diversifying potential of fixed income as an asset class while adding diversifying returns via security selection.

Systematic Fixed Income: An Investor’s Guide proves and highlights the powerful diversifying potential of a well-implemented systematic fixed income allocation. It will earn a place in the libraries of institutional investors and asset managers everywhere, as well as advanced degree students of finance, business, and investment.