equity momentum in corporate bonds.

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equity momentum in corporate bonds.

Anando Maitra, CFA - Head of Systematic Research

Anando Maitra, CFA

Head of Systematic Research
Jamie Salt - Analyst

Jamie Salt

Analyst

Equity and credit spreads have been closely linked historically, in line with their common “risk-on” characteristics. We find that equity markets not only move in-line but in-fact tend to lead both corporate bond markets and credit rating agencies. This implies that equities price movements can be used as a leading indicator for investing in credit.

In a new study, conducted in collaboration with academia, we analyze the performance of a strategy built using equity momentum in corporate bonds (EMB). We run various robustness checks to show a persistence of this effect across credit market dimensions. We compare and contrast this phenomena with the traditional equity momentum strategy in equities and other momentum strategies within credit. We show that the EMB strategy is very different from traditional equity momentum strategies and posit that materiality considerations within the more illiquid credit markets are responsible for this phenomena.

 

Key points

  • Globally, equity and credit markets are highly correlated, reflecting the “risk-on” nature of both assets which is consistent with the structural model proposed by Merton (1974) 
  • Using a comprehensive data-set of USD denominated bonds since 2000, we show that equity markets are not only correlated but also lead corporate bond performance as well as rating agencies 
  • Over the past 14 years, an Equity Momentum in Bonds (EMB) strategy that is long the top quintile by equity momentum outperforms the bottom quintile by over 6%/y in IG and by over 13%/y in HY corporate bond markets 
  • The leading relationship of equities over corporate bonds is robust across rating categories, spreads and liquidity buckets and is not related to market effects 
  • We show that the EMB strategy is not explained by the traditional equity momentum (EM) strategy but is more closely linked to changes in fundamentals 
  • We also show that the time dynamics (term-structure) of the EMB strategy is very different from the traditional EM strategy thereby suggesting different underlying drivers 
  • We propose “materiality” considerations as a key driver of this phenomena in which under-reaction to moderate equity price moves can potentially explain the lead-lag relationship

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