Factor Approach to Fixed Income Allocation

Abstract

This article outlines the application of a systematic factor approach to fixed income investment/risk management. We show that using a parsimonious set of factors explains the returns in fixed income portfolios very well. In turn, this implies that forecasting the returns for these parsimonious factors is an efficient and targeted approach to active management. We further show that it is possible to create a portfolio with balanced exposure to the identified risk factors that, in turn, provides a framework for evaluating the efficacy of active management.