On the Dynamics of EMU Bond Portfolios: Is the Diversification of Risk Factors Driving to Convergence of Fund Exposure?

Abstract

We show that the persistent style of European Monetary Union (EMU) bond portfolios generates significant crowdedness in common factors—curve level and steepness. Despite fund categorization, our results suggest that bond portfolios show low risk-factor diversification. However, we found less-crowded trades that deserve investors’ attention and could improve diversification. In line with previous research, we argue that a transitory shift from the current levels of crowdedness and risk factors in the EMU is imminent and almost inevitable. Finally, we propose a framework for analysis that ide.tifies crowdedness, helps monitoring of the exposure at risk, and suggests investment process enhancements, which could improve investors’ diversification.

TOPICS: Fixed income and structured finance, fixed-income portfolio management, developed