Systematic Fixed Income

CHAPTER 5Security Selection – Rate‐Sensitive Assets

OVERVIEW

This chapter lays out the investment opportunity set for rate‐sensitive assets. Our focus is on developed market government bonds, but the insights we cover can also be extended to emerging market government bonds. What seems like a daunting investment challenge spanning over 1,000 bonds can be distilled to a manageable set of well‐defined maturity buckets across developed markets. We cover use of principal components to help focus our scarce investment resources. Success in modeling the level, slope, and curvature (which can be achieved with as few as three assets for each country) will capture most of the return opportunities for government bonds. The chapter then discusses the intuition behind representative measures of value, momentum, carry, and defensive investment themes and evaluates the success of these strategies individually and in combination for developed government bond markets.

5.1 WHAT IS THE INVESTMENT OPPORTUNITY SET FOR DEVELOPED MARKET GOVERNMENT BONDS?

We will use a representative broad government bond index to explore our investment opportunity set. The ICE/BAML Global Government Index (W0G1) is our index of choice. W0G1 tracks the performance of publicly issued investment grade sovereign debt denominated in the issuer's own domestic currency. To be included in the index, a country must (i) be a member of the FX‐G10 or Western Europe, (ii) have an investment grade foreign currency long‐term ...