Revenue drivers for CHF corporate bonds

Which factors signal future returns on corporate bonds? Samuel Manser examined four factors in terms of their effect and practicability.

Interview with Samuel Manser

Samuel Manser has been a Fixed Income Portfolio Manager in Asset Management at Zürcher Kantonalbank since 2012.

Samuel Manser, you have investigated the effect of factors on the return of corporate bonds traded in Swiss francs. Your analysis (paywall) was recently published in the scientific journal Financial Markets and Portfolio Management. Why did you take a close look at this particular bond segment?

The market for corporate bonds in Swiss francs combines a broad debtor universe with an excellent data situation. Nevertheless, research into return factors mainly deals with bonds in US dollars. The motivation behind the investigation was to focus on the Swiss market as well as apply and review the previous findings for the first time. The insights gained also make our investment processes even more effective.

«Carry», «value», «equity momentum spillover» and «defensive» are the four factors you analysed. Let's first look at the «carry» factor.

The carry is a significant part of why returns from bonds differ. As a rule, the higher the carry is, the higher the returns and the higher the risk. The latter is reflected in high volatility, which is why the carry is not a reliable signal for higher returns. Historically, however, the carry was a more reliable signal in the domestic debtor segment than in the foreign segment. One reason for this is that significantly more borrowers from the foreign segment fell into the high-yield range due to credit rating downgrades. Despite a high carry, these debtors suffered noticeable price corrections.

In other words, you can't rely on the carry factor. What about the «value» factor?

Value also uses the carry, but compares it with fundamental credit risk. This can be quantified, for example, based on the credit rating or an estimated probability of default. For instance, a borrower valued favourably may offer a high carry within its rating peer group or in terms of its probability of default. A high carry relative to fundamental credit risk corresponds to a favourable valuation and promises higher returns. My analysis shows that a consistent value characteristic is also a reliable signal for future returns for CHF bonds.

The findings from the research show that the factors for future performance are also relevant for CHF corporate bonds.

Samuel Manser, Senior Portfolio Manager

Now to the somewhat wordy «equity momentum spillover» factor. What exactly does this signal?

«Equity momentum spillover» compares the share price performance of equities and bonds. Bonds from companies whose equities have risen sharply in recent months show higher returns in the following months than bonds from companies whose equities have fallen sharply. Although this is a promising signal of excess return, it is unfortunately not practicable in the portfolio.

Why is that?

The spillover effect requires a high portfolio turnover because equity winners and losers often alternate. Bonds have high transaction costs, especially in the CHF market. These costs determine whether these observations can also be realised profitably. Nevertheless, the factor can offer added value as a complement to others and can be used as a signal for deteriorating or improving debtors.

What about the fourth factor «defensive»?

High-quality investments generate high risk-adjusted returns. This effect is reflected in various asset classes and bond markets, and the factor is intended to allow this effect to also be used for CHF corporate bonds. In fact, it also has a role to play here, but defensive bonds do not offer higher absolute returns due to the lower risk. This is why the factor is only worthwhile in combination with carry or value.

How do you use the factors in portfolio construction?

The findings from the research show that the factors for future performance are also relevant for CHF corporate bonds. They also point to the limits of practicability. We use the findings in three targeted ways. Firstly, they allow us to perform broad, up-to-date screening on the universe. This supports us in our fundamental debtor assessment. Secondly, they are used for debtor monitoring. Thirdly, factor changes act as an early warning system. These include, for example, changes in carry, value or share price (equity momentum spillover).