Investors’ fascination with factors may have started with research by famed economists Fama & French. Her work examined stock returns over long time periods and then isolated specific stock drivers. At its core, factors are specifically focused attributes that determine the return of an asset class. Fama & French’s work has shown us how size, value, growth and quality have worked over the long term and under different market conditions.
Since then, numerous fund groups and asset managers such as research affiliates, AQRand Dimensional have conducted additional research and created funds covering various factors to enhance returns.
However, fixed income investors have been left out in the cold in much of this research and fund launches. That’s a shame, because fixed income could be the biggest beneficiary of so-called fundamental indexing and factor investing.
For one thing, most bond indices are flawed. Many traditional bond indices — like the benchmark index Bloomberg US Aggregate Bond Index — are constructed by weighting the bonds based on outstanding debt. Firms with more promissory notes on their books receive a higher ranking in the index. Think of it this way: when you use the index, you’re essentially betting that the person with the most credit card debt will be the long-term winner. That seems counterintuitive.
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