US corporate bond momentum profits have increased significantly over time. But momentum strategies are only profitable for the lower-grade bonds and do not seem to compensate for risk, illiquidity, or lack of information. It also appears that investors could exploit momentum in US corporate bond returns by choosing past winners out of lower-grade issues.
What’s Inside?
The authors find significant price momentum in US corporate bonds. Momentum profits are generated by non-investment-grade (NIG) bonds, which represent a growing segment of the US corporate bond market, and have risen sharply over time. Momentum profits are even higher for NIG bonds that are issued by private firms. Bond momentum profits come mainly from winners and are not just derived from equity momentum. Furthermore, bond momentum does not seem to compensate for bond-specific risk, illiquidity, market opaqueness, transaction costs, and trading frictions. But the authors recognize that such momentum could possibly be attributed to a slow diffusion of information.
How Is This Research Useful to Practitioners?
The authors find that there is strong evidence of momentum returns in US corporate bonds. Momentum profits have risen over time, both in the overall bond sample and among NIG bonds. Bond momentum profits are significant in the second half of the sample period (1991–2011), when there was a strong link between momentum profits and the availability of NIG bonds. Momentum profitability is higher for NIG bonds issued by private firms. Bond momentum profits are derived mainly from past winners.
A momentum strategy is not profitable for investment-grade bonds. During the first half of the sample (1973–1990), momentum returns were low given the scarcity of NIG bonds. Although bonds and stocks depend on the same underlying fundamentals of the issuer, bond momentum does not necessarily emanate from equity-related momentum. Furthermore, bond momentum does not seem to compensate for systematic or bond-specific risk, illiquidity, market opaqueness, transaction costs, and trading frictions. The authors acknowledge that bond momentum could possibly be attributed to a gradual diffusion of information (private firm bonds) and a more difficult interpretation of information (NIG bonds).
Fixed-income portfolio managers intending to invest in US NIG bonds will find the conclusions of this research useful. It would seem that selecting past winners out of NIG bonds could produce momentum profits.
How Did the Authors Conduct This Research?
The authors conduct an analysis of corporate bond momentum profitability using data from the Lehman Brothers Fixed Income Database, DataStream, Bloomberg, TRACE, and Mergent’s Fixed Income Securities Database/National Association of Insurance Commissioners Database. They analyze a sample period from 1973 to 2011 that includes 3.75 million bond-month return observations from 81,491 US bonds of 9,709 issuers. Profits from bonds over a six-month period are sorted into deciles and compared with subsequent profits. About 91% of the NIG bonds survive after seven months. Momentum profits in NIG bonds yield 1.21% per month. They are highest for NIG bonds issued by private firms (2.82% per month). Bond momentum profits are significant in the second half of the sample period, 1991–2011, and amount to 0.59% per month across all bonds and 1.92% per month for lower-grade issues. Bond momentum profits are derived mainly from winners and do not necessarily relate to equity momentum.
Abstractor’s Viewpoint
There have been various debates on whether bonds can generate momentum profits over time. The authors find strong evidence of momentum profits in US corporate bonds over the more recent time periods. Momentum profits are significant for lower-grade bonds. The results are interesting. Although I do have concerns that the data used in the models are US related and that other countries may experience different trends, this research suggests that a momentum strategy adopted for US non-investment-grade bonds could prove profitable over time. The authors’ work also challenges claims that momentum profits depend on systematic risk, bond-specific risk, opaqueness, and transaction costs.