Systematic Fixed Income

CHAPTER 2Fixed Income – Strategic Asset Allocation

Overview

This chapter undertakes a detailed examination of the return properties of fixed income securities. We start with an additive decomposition of total returns into “rates” and “spread” components. The influence of interest rates on fixed income securities is large and it pervades all fixed income securities. We will see the importance of rates declines when there is greater risk of nonpayment of the cash flows. This helps us structure our thinking for later chapters when we build a framework to forecast returns of fixed income securities: Exactly what component of returns should we focus on? We will then document the variety of betas (traditional market risk premia) that are commonly accessible in fixed income markets and show how they help diversify in the context of strategic asset allocation decisions. We will explain how and why fixed income allocations should be a core part of asset owner portfolios. This will involve a detailed discussion of yields and determinants of yields, setting up the stage for our next chapter on tactical allocations within fixed income.

2.1 WHAT ARE THE KEY DRIVERS OF FIXED INCOME SECURITY RETURNS?

In Chapter 1 we introduced the terms yield and duration. We will now turn to utilizing these measures to decompose the total returns to fixed income securities. We will start with the Bloomberg Global Aggregate Index and we will decompose the total returns of the Global Treasury, Global Government ...