The real shock of the current COVID-19 crisis was the speed at which it arose and spread, quickly numbing most sectors of the global economy, affecting the entire planet within weeks and prompting a massive policy response from central banks and governments.
Corporate bonds, just as other risk assets, have undergone a brutal price correction due both to a sharp rise in risk aversion among investors and sector-specific or company-specific concerns. As a result, many funds underperformed in recent weeks.
Yet this ‘uncharted territory’ is also an interesting out-of-sample case study to assess the behaviour and robustness of investment strategies, in particular, quantitative strategies such as multi-factor investment approaches.
Multi-factor strategy: generating pure alpha with no hidden beta
The performance of our multi-factor corporate bonds strategy has remained firm. This illustrates both our selection of resilient bonds and robust portfolio construction.
The investment philosophy underpinning multi-factor investing is to use a set of diversified factors, such as quality, value, low risk and momentum, to rank and select corporate bonds. We blend value criteria – selecting bonds with attractive yield premiums relative to their credit risk – and quality and low-risk indicators to avoid the riskiest issuers. The result tends to be an effective balance.
Another critical feature of our multi-factor credit strategy is its portfolio construction. Our goal is build portfolios with no hidden beta. That means the strategy maintains the same risk profile as the underlying benchmark, both in terms of interest rate duration and credit risk. By virtue of this approach, any outperformance over the benchmark will be ‘pure alpha’ created from bond selection.
This sets our approach apart from many traditional investment processes. These tend to take significant directional positions, usually by taking more credit risk than their benchmark, to generate excess returns.
The benefits of our ‘beta-one’ portfolio construction can be seen in the limited deviations of performance from the benchmark during sharp corrections – unlike many traditional credit funds that suffered periods of massive underperformance.
What comes next for corporate bond markets in general and multi-factor portfolios in particular?
Predicting the end of a crisis is always hazardous and even more so given the unique nature of the current pandemic. The duration and impact of lockdowns on the economy are hard to estimate and will remain so until the first signs emerge that the virus has been contained.
While policymakers have developed tools to deal with financial crises, there is no playbook for dealing with the large-scale real economy freeze the world is currently facing. The recovery path will depend on how effectively monetary and fiscal policy measures are transmitted to the real economy and how consumers and businesses respond.
At the moment, different recovery scenarios are possible. At BNPP AM, we expect a ‘U-shaped’ recovery. 
Even so, for investors with a medium-term investment horizon, we can argue that corporate bond markets - especially investment-grade - still look attractive.
Of course, on the one hand, credit risk premiums are much higher than they were a few month ago. Credit risk has also increased as some companies will undoubtedly default, whatever the recovery path.
On the other hand, monetary and fiscal packages of unprecedented magnitudes have been announced, with central banks and governments explicitly opting for a ‘whatever it takes’ approach. In particular, the ECB’s and US Federal Reserve’s quantitative easing initiatives include significant corporate bond purchase programmes that will mechanically support markets.
During the recovery, we believe there is also reason to expect multi-factor strategies to perform well in relative terms. Indeed, these strategies have tended to generate the most outperformance just after a market fall when dispersion across issuers creates many opportunities to earn alpha returns.
For instance, 2009 was the best year in the long-term simulations for our multi-factor portfolios, both for euro and US dollar investment-grade credit (see Exhibits 1 and 2 below from our short paper Outperforming Corporate Bond Indices with Factor Investing) as credit markets rebounded strongly.
More recently, looking at the live history, the best quarterly outperformance occurred in the first quarter of 2019, just after the correction of Q4 2018.
It’s time to keep calm and carry on
The economic crisis caused by the coronavirus has had a brutal impact on corporate bond markets. Over coming months, numerous ratings downgrades and defaults will doubtless occur because of the economic shock. Meanwhile, the crisis has prompted unprecedentedly strong policy measures across the globe to provide support to businesses.
For those willing to remain invested in corporate bond markets, multi-factor strategies can be an attractive solution. They should continue to prove resilient to credit events due to their robust portfolio construction and the inclusion of quality and low-risk criteria in their selection of issuers. And multi-factor strategies are usually able to generate significant alpha when the recovery comes.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay
Past performances or achievement is not indicative of current or future performance
The above-mentioned asset classes are for illustrative purpose only, are not intended as solicitation of the purchase of such financial Instruments and does not constitute any investment advice or recommendation