BNP AM

The official blog of BNP Paribas Asset Management

Separating the wheat from the chaff in fixed income

Like most things in life, investing has its ups and downs. Prudent investors, especially those worried about losing money, but also people who prefer stability to volatility, often choose to invest in bonds – lending money to companies, governments and other entities for, hopefully, a consistent return.

Bonds are often seen as a less risky asset class compared to, for example, equities. Alas, even the safest investments carry some risk. Here too, it is important to select the best, most reliable bonds for investment. Such selection requires diligent research and this is where the Fixed Income team of the Quantitative Research Group (QRG) at BNP Paribas Asset Management comes in.

“We use quantitative analysis to help clients invest wisely,” says QRG Fixed Income team leader Zine Amghar. He points out that his team’s objective is not to pick the ‘winners’, as one might try to do with stocks, for example, but to ensure that investors make steady returns and avoid losing money. “It’s a straightforward remit,” he says, “but not a simple one.”

Screening for risk and return

Let’s take the European corporate bond market as an example. Today, this comprises some 800 companies which currently have roughly 5 000 bonds outstanding, each with their own contract terms as well as risk levels. Zine Amghar and his team design the algorithms that automate the analysis of data about the companies and the bonds they issue. Those algorithms assess the probability that the issuers default on the payment of their bonds - either immediately or over time.

This enables the Fixed Income team to assign a score to each bond based on its attractiveness as an investment, weighing its expected return against the risk that the issuer may default on payments. This process is known as screening the investment universe.

“Other examples of investment universes we screen include bonds issues by US companies, government bonds, and bonds issued in emerging markets and even currencies,” says Zine.

Serving both quant and fundamental managers

“Our scores constitute one building block in the investment decision-making process,” says Zine Amghar. “It’s not the only one, but it’s an important one.”

The QRG Fixed Income team works for two groups within BNP Paribas Asset Management – quantitative portfolio managers and fundamental portfolio managers.

  • Quantitative portfolio managers rely mostly on quantitative data signals to determine which bonds are in clients’ best interests.
  • Fundamental portfolio managers rely instead on their detailed analysis of a vast array of market information – financial statements, company earnings, forecasts, etc. – as well as less quantifiable information on the company’s reputation, senior management statements, strategic decisions, and so on.

Designing a quant portfolio and testing strategies

Designing effective algorithms and computer models for the quantitative portfolio managers necessarily involves working with them closely, says Zine Amghar. “They speak our language, so we sit with them and together we create the purest possible strategy – according to which a specific set of quantitative signals will be implemented.”

To verify the rationale behind the strategies we develop, Zine Amghar and the team apply the algorithms they produce to a mass of historical market data. “That’s the beauty of our system,” he says.

“All the buy and sell signals from the strategies we propose are tested for the results they would have produced in the past. In this way, we end up with empirical evidence that our signals would have brought value to customers. This of course doesn’t constitute a guarantee that this will happen again, but it shows that the strategy was able to do so in the past. That’s already pretty good.”

Sifting through fundamental data and scoring bond issuers

Fundamental portfolio managers decide which bonds to buy and sell based on their assessment of fundamental financial information, but the QRG Fixed Income team can still help them, says Zine Amghar.

“Even if they wanted to, the fundamental managers would never have enough time to sift through the financial statements of hundreds of companies. We do that job for them, gathering all the financial statements and applying the most relevant criteria by which to score the respective companies in a systematic way.”

“Our assessment provides managers with a view on which companies we consider best and worst, and all those that fall into a grey area in the middle. We provide no final answers, but at least portfolio managers get a score for each company. They may decide to buy a certain company’s bond despite us giving it a low score because they know more about that company – information that we quants can’t know because it is not quantifiable. At the same time, a positive quantitative score might tip them off to an opportunity they hadn’t spotted. Hence the value of our input.”

Identifying opportunities with state-of-the-art methods

The QRG Fixed Income team’s research results help BNP Paribas Asset Management portfolio managers identify the best opportunities among a vast number of possibilities using quantitative methods. These methods are often the topic of academic papers by Zine Amghar and all those working with him.

“What we do is state-of-the-art in our industry,” says Zine. “Papers like these strengthen our reputation as thought leaders in the quantitative finance industry because they are reviewed by academics and only published when our claims are validated. This external check helps to increase the confidence of clients in what we do and shows that we strive to do it well.”

Even non-quants understand that.

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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. This document does not constitute investment advice.

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 performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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