Dynamic Risk-Aware Yield Search: A Useful Tool for Fixed Income Investors

Fixed income investors favor higher yields with lower risk. Our objective in this paper is to outline an active fixed income strategy that maximizes yield and is protected against major risk factors affecting fixed income securities. In particular, we look at interest rate risk, credit risk, inflation risk, price volatility, and liquidity risk as different risk factors and are able to tactically change our allocations in favor of a higher yielding fixed income portfolio compared to the benchmark allocation - Barclays US Aggregate Bond Index. In the current low yield environment with flattening yield curves, we find that the strategy favors allocation to the short end of the interest rate curve and inflation-protected securities and the strategy is able to seamlessly incorporate investor views across different risk factors. The strategy returns a portfolio that only takes those risks for which it is appropriately compensated through higher yields. The methodology discussed is quite flexible and can accommodate multiple investor preferences with respect to different risk factors. The strategy is expressed via ETFs to reduce liquidity risk and to contain execution costs.