U.S. Corporate Bond Yield-based Momentum

Is there pervasive yield momentum among U.S. corporate bonds? In their November 2016 paper entitled “Is Momentum Spanned Over Corporate Bonds of Different Ratings?”, Hai Lin, Chunchi Wu and Guofu Zhou investigate whether momentum exists in all segments of the U.S. corporate bond market. Their approach to momentum measurement is unconventional, involving cross-sectional regression of bond returns on multiple simple moving averages (SMA) of bond yields. They call their result “trend momentum” to distinguish it from conventional momentum based on simple past return. Specifically, they each month:

1. Calculate yield SMAs over the last 1, 3, 6, 12, 24, 36, 48 and 60 months for each bond.
2. Regress returns for all bonds on respective prior-month yield SMAs to generate correlations (betas) between returns and past yield SMAs, thereby dynamically determining relative importance of yield SMA measurement intervals.
3. Calculate expected (for next month) yield SMA betas as average calculated betas over the past 12 months.
4. Estimate expected return (for next month) for each bond based on current yield SMAs and expected yield SMA betas.
5. Rank bonds based on expected returns into fifths (quintiles) or tenths (deciles).
6. Calculate gross trend momentum factor return as the difference in average (equal-weighted) actual returns between quintiles/deciles with the highest and lowest expected returns.

Using yields, returns, ratings and other characteristics for a broad sample of U.S. corporate bonds during January 1973 through September 2015, they find that:

• There is strong evidence of trend momentum overall and across bond ratings spectrum. Specifically:
  • For all bonds, average gross monthly trend momentum factor returns are 0.97% based on extreme quintiles and 1.48% based on extreme deciles.
  • Average gross monthly trend momentum factor returns range from 0.85% for AAA bonds to 1.21% for junk bonds based on extreme quintiles and from 1.07% for AA bonds to 1.58% for junk bonds based on extreme deciles.
• Portfolios with high trend momentum returns tend to hold bonds with relatively high yields, small size (issuance amount) and recent issue.
• Portfolios with the lowest trend momentum returns still have positive returns.
• Average bond trend momentum return is roughly equal in magnitude to average conventional stock momentum return, but correlation of returns between them is low.
• Bond trend momentum is stronger (especially for junk bonds):
  • After implementation of the Trade Reporting and Compliance Engine in July 2002.
  • When market sentiment is low.
  • During slow economic growth.
• Bond trend momentum is robust to controls for standard bond risk factors/characteristics and for conventional bond momentum.
• Monthly trend momentum factor portfolio turnover rates (based on quintile sort) is in the range 52%-60%, depending on bond segment, indicating breakeven trading frictions in the range 1.4%-2.2%.

In summary, evidence indicates that U.S. corporate bond trend momentum based on multiple yield SMAs is significant and pervasive across rating segments.

Cautions regarding findings include:

• The bond trend momentum methodology is complex and compute-intensive, and thereby beyond the reach of most investors. Assembling and maintaining a portfolio of individual corporate bonds is also problematic for individuals. Delegating portfolio development/management to a fund manager would involve fees.
• Short selling of specific bonds as specified for trend momentum factor portfolios may not be feasible.
• There may be snooping bias in the specification of expected yield SMA betas as 12-month averages of past calculated betas.

For simpler conventional bond momentum analyses, see:

• “Simple Fidelity Bond Mutual Fund Momentum Strategy”
• “Momentum in U.S. Corporate Bond Returns”
• “Momentum Timing of Junk Bond Fund?”