Dimensional Fund Advisors, a pioneer of quantitative investment with $680 billion in assets under management, has increased exposure to the short end of the U.S. Treasury curve and to corporate debt, an executive said, seeing opportunities in parts of the debt market that have broadly sold off this year.
U.S. Treasuries yields, which move inversely to prices, have been rising fast this year as unrelenting inflation has fueled expectations of interest rate hikes by the U.S. Federal Reserve.
Corporate bond spreads, or the interest rate premium that investors demand to hold corporate debt over safer Treasuries, have widened amid uncertainty over how aggressive the Fed will be in tightening financial conditions.
But for Dave Plecha, global head of fixed income at Austin, Texas-based Dimensional Fund Advisors, the shift of the U.S. central bank toward less accommodative monetary policy has been fully priced in.
“We are big believers in market prices, and the market is setting a price on what they think the Fed is going to do, and we accept that,” he told Reuters in an interview.
Dimensional’s investment strategy is based on the application of the efficient market hypothesis, which posits that asset prices reflect all the available information about expected returns. A member of its board of directors is economist Eugene Fama, a Nobel laureate whose research gave birth to quantitative investing — an approach that relies on complex mathematical models and algorithms based on historical data.
Short Vs. Long
Plecha said shorter-dated U.S. government bonds are now expected to provide better returns than long-dated ones, and he has therefore in recent weeks increased exposure to Treasuries with tenors of around three years.
“We have a systematic approach that says when curves are steep, we’re going to go out. … There are decades worth of data that show that on average, when yield curves are steep, you collect higher average returns for being farther out than being shorter,” he said. “When curves are flat there is no evidence that supports a higher expected return by moving out a flat curve or an inverted, downwards yield curve.”
The shape of the Treasury yield curve has been generally flattening this year. A closely watched part of the curve measuring the spread between yields on two- and 10-year Treasury notes shows the gap at roughly 38 basis points, nearly 40 points lower than where it ended 2021.
Dimensional has also increased exposure this year to corporate debt with various risk profiles, despite corporate bonds having dropped in price significantly year-to-date.
“When we see widening spreads, we’re not running from that market, we’re heading towards it,” Plecha said.
As spreads widened this year, Dimensional increased allocations to single-A and triple-B credits, as well as, in some cases, to riskier double-B-rated debt, he said.
“Some people say that feels a little contrarian, and I get that comment because they’re widening out because on average people are reducing or getting out of credit. … And we’re saying, this is now when we want to go in.”
This article was provided by Reuters.