The US investment grade (IG) bond market has evolved to become a “fertile opportunity” for systematic strategies, according to fixed income portfolio managers at GMO.

Since the global financial crisis in 2009, the US IG market has seen the number of bonds issued increase by 147%, and the number of issuers increase by 65%. 

Liquidity has also improved over the past decade thanks to the proliferation of electronic trading platforms, the introduction of portfolio trading, and the rapid growth of fixed income exchange-traded-funds (ETFs).

Both of these factors has created “a ripe opportunity for systematic investing”, said James Donaldson, Rachna Ramachandran and Mina Tomovska in a recent note published by the firm.

They say that growth of investment-grade issuance has created “a rich dataset” where they’ve tested a quantitative investment process over multiple credit and economic cycles.

“The ability to quantify both the value offered and the risk posed by almost every security in the IG universe allows us to construct a diversified portfolio that resembles the market in its broad, aggregate risk metrics – be that spread, duration, or sector exposure,” they said.

The potential for alpha in such a systematic strategy comes from factor tilts that a position may represent.

“The factor models that drive security selection are designed to take advantage of valuation dispersions that fundamental credit analysis may not capture,” they said. “The ultimate goal is to exploit several dislocations across a broad swathe of the market.”

While factor-driven investing has been widely adopted in the equity markets for years now, the approach is still relatively new for investing in corporate bonds.

The portfolio managers argued that most bond investors still rely on fundamental analysis and have “struggled to differentiate themselves in recent years”.

In their view, a diversified, systematic portfolio “ensures minimal idiosyncratic risk”, and building a portfolio with varied cohorts of sectors and maturity buckets “avoids unintended macro exposure”.

“We posit that scalability may be a contributing factor, as analysts may have crowded into consensus trades led by ‘tried and true’ traditional methods,” they said.

“We believe a systematic investment approach employing quantitative signals can exploit the gaps in fundamental coverage and harvest alpha from overlooked opportunities.”

Last week, GMO launched a systematic investment grade credit ETF, which uses a systematic, factor-based approach to the US investment grade corporate credit market.