Factor Investing in Emerging Market Credits

Abstract

We examine factors in a novel dataset on the cross-section of emerging market hard currency corporate bonds. We find that the size, low-risk, value, and momentum factors predict future excess returns. Single-factor and multi-factor portfolios obtain economically and statistically significant premiums. Further, alphas remain significant after controlling for exposures to developed market credit factors. The factor portfolios benefit from bottom-up allocations to countries, sectors, ratings, and maturity segments, as well as from bond selection within these segments. Higher risk-adjusted returns of factor portfolios also can be found within liquid subsamples of the market. TOPICS: Fixed income and structured finance, emerging markets, analysis of individual factors/risk premia, portfolio construction Key Findings ▪ We examine factors in the cross-section of emerging market hard currency corporate bonds and find that the size, value, momentum, and low-risk factors predict future excess returns. ▪ Factor portfolios yield significant alphas in the Capital Asset Pricing Model, and a multi-factor portfolio that allocates equally to the four factors shows even stronger results, due to the low pairwise correlations among the individual factors. ▪ Alphas remain significant versus developed market credit factors, and the results hold within countries, sectors, ratings, maturities, and liquid subsamples.