This site is part of the Informa Connect Division of Informa PLC

This site is operated by a business or businesses owned by Informa PLC and all copyright resides with them. Informa PLC's registered office is 5 Howick Place, London SW1P 1WG. Registered in England and Wales. Number 3099067.

Wealth & Investment Management
search
FundForum International

Five parameters for a USD bond analysis model

Posted by on 30 April 2018
Share this article

The US dollar dominates the global bond market. This applies to every segment – not just US government bonds but also investment-grade and high-yield corporate bonds from the US, as well as government and corporate bonds from emerging market countries denominated in USD.

The yield advantage could be a major reason why USD bonds are such an attractive portfolio component. The interest differential between US Treasuries and 10-year German Bunds, around 2.4%, is at an all-time high since at least 1989[1]. The size of the market and liquidity are other important factors in favour of US dollar-denominated securities. Each of the USD bonds categories is reflected in corresponding indices, which are investable via ETFs. However, the USD bond segment has become so wide, a systematic and neutral approach to risks and rewards can be of interest.

DWS has built an analysis model based on five parameters:

1. Sensitivity to interest rates

This primarily concerns the extent to which an index reacts to changes in US interest rates. The most important indicator is the duration, which encapsulates the price sensitivity of the bond in relation to rate changes. Particularly for riskier bonds and indices, quantitative factors must also be taken into account. Generally, indices with riskier bonds tend to have lower interest rates risk, for a comparable level of duration.

2. Credit risk

The most important issue is how the index reacts to increasing credit market risks. In order to find a common denominator for the analysis, the evaluation of a variety of key figures is necessary. First, there is the historical risk of default, based on fundamental ratings. Generally the USD bond market encompasses more “distressed issuers” such as CCC bonds than in European markets. The risk of B and CCC rated bonds shall not be underestimated.

3. Valuation

This approach concerns the extent to which investors are currently being compensated for assuming the credit risk in a particular index, i.e. the attractiveness of the index in comparison to other segments. Generally, this indicator is a tactical one and hence variable, as it is directly linked to available credit spreads, whereas the other indicators remain very consistent across time.

4. Market liquidity

Even if a segment of the bond market is assessed as being attractive, it also must be investable. For instance, the proportion of bonds in the index that have a rating below investment-grade is taken into consideration here. The size of the market mirrored by the index also gives indications of how representative and scalable the investment strategy is. This can be helpful to investors determining whether an index can be used within a core investment, or whether the index is more suitable for less regulatory-constrained investors

5. Contribution to diversification

This parameter is important for investors already having investments in USD bonds and who want to benefit from risk diversification, in order to reduce the volatility of the overall return. One indicator takes into account the correlation of the risk premium (spread) with the broad IG USD bond market ("aggregate").

The following conclusions, amongst others, can be deduced from the evaluations in these five parameters, as per end of March 2018:

  • The investment-grade segment offers an interesting value proposition, due to its long duration, the (relative) steepness of the credit spread curve and high credit quality. It has however the highest rates sensitivity.
  • Emerging market bond indices provide good risk diversification for a portfolio, high-yield corporate bonds even more so.
  • In addition, because of their short duration and low correlation with government bonds, high-yielding corporate bonds have the potential to move favourably against other USD asset classes in prospective phases of rising interest rates.
[1] As at 25 April 2018, source: Bloomberg

www.xtrackers.com
DWS Group
DWS Group GmbH & Co. KGaA (DWS) is one of the world's leading asset managers with EUR700bn of assets under management (as of 31 Dec 2017). Building on more than 60 years of experience and a reputation for excellence in Germany and across Europe, DWS has come to be recognized by clients globally as a trusted source for integrated investment solutions, stability and innovation across a full spectrum of investment disciplines.
We offer individuals and institutions access to our strong investment capabilities across all major asset classes and solutions aligned to growth trends. Our diverse expertise in Active, Passive and Alternatives asset management – as well as our deep environmental, social and governance focus – complement each other when creating targeted solutions for our clients. Our expertise and on-the-ground-knowledge of our economists, research analysts and investment professionals are brought together in one consistent global CIO View, which guides our strategic investment approach. DWS wants to innovate and shape the future of investing: with staff from 35 nationalities, speaking more than 75 languages rooted in 22 countries, we are local while being one global team.

Share this article

Sign up for Wealth & Investment Management email updates

keyboard_arrow_down