Abstract:
BACKGROUND : This study focuses on diversifying fixed income attribution beyond yield and
duration by identifying new risk premia applicable to various investment strategies.
AIM : To identify cross-sectional bond risk factors in the South African sovereign bond market,
capitalising on non-parallel shifts during high-risk macroeconomic events, developing a
strategy to extract persistent alpha from higher order interest rate risks and disproving the
strong efficient market hypothesis.
SETTING : This study finds that during high-risk macro events, non-parallel shifts increase in
frequency. Empirical evidence suggests that post the 2008 financial crisis, there have been
increased occurrences of risk-on/off events and researchers believe high risk macro events will
increase in prominence. As such, most active US fixed income managers have reduced duration
risk (from parallel shifts) in favour of alternative risk premia.
METHOD : This study exploits slope and curvature risks, by utilising a butterfly strategy. Ten
bond risk factors are back-tested and analysed during interest rate cycles, curve scenarios and
risk-off periods from 1998 to 2023.
RESULTS : The top-ranked strategies displayed strong and persistent outperformance over the
bottom-ranked strategies for most of the bond factors especially during risk-on episodes. The
Bond All-Factor Rank demonstrated improved diversification by balancing upside and
downside risks. Trade costs are an important factor that requires pragmatic management.
CONCLUSION : Geopolitical risks are increasing in frequency and developing a strategy to exploit
non-parallel risk premia is an attractive proposition.
CONTRIBUTION : This study identified new bond risk factors beyond the conventional spread
factor to extract non-parallel risk premia.
