In the last few years the bond universe has grown exponentially. The US corporate bond market has increased from $4.6 trillion in 2005 to $9.6 trillion in 2019. In an ultra-low interest rates environment, the trend is bound to continue while innovations in the bond market will enable further growth. The digitisation of bond issuance, still in its infancy, will make it easier and cheaper for issuers to place their bonds in the market while the enhanced distribution enabled by pooling bonds into ETF’s will provide sustained demand for them. A growing bond market creates more opportunities for active managers to generate alpha. With a larger pool of assets to choose from, price movements take longer to spread through the system to find a new equilibrium. This gives savvy investors more chances to identify mispriced bonds.
Alpha can be generated by departing from the market allocation, overweighting some bonds and underweighting others. This requires comparing bonds against each other in a dynamic way to uncover relative value dislocations. This is a computationally intensive exercise, as the possible combinations scale exponentially with the number of bonds. In the US investment grade universe alone there are more than ten thousand bonds which results in over fifty million possible pairs.
Katana is purposely designed to identify dislocations in relative value. Every day, Katana’s algorithms compare all bonds against each other to detect variations in the relative value offered by different bonds. To demonstrate the power of this approach, we regularly publish trade ideas to swap a bond that has become relatively expensive for another that is cheap. The ideas are made public at katanalabs.io/relative-value-insights. Alpha is generated when there is compression in the difference in credit spread between the bond bought and the one sold. In the table below we show the performance of all the ideas published during May 2021.
As the table shows, all of the trade ideas have performed within 15 days except one where the spread difference widened marginally. Similarly, all ideas with at least 30 days since publishing but one show spread compression. Furthermore, in each of the ideas the swap meant an increase in the spread received at the moment of doing the trade. This means that an investor following Katana’s recommendations would have increased carry in the portfolio while also generating a favourable price movement from the spread compression.
Investors looking to generate alpha in their portfolios can benefit significantly from Katana’s insights. Detecting dislocations in relative value in a systematic way is the starting point for finding attractive relative value opportunities, but expert knowledge is required to separate mis-pricing from market forces that justify the dislocations. Katana enables portfolio managers to find trade ideas faster and spend more of their time analysing the most attractive ones. The understanding of fundamental and technical factors is critical to interpret the signals generated by Katana and uncover true investment opportunities.