The MSIM Quantitative Duration Strategy Model: A Factor-Based Approach to Managing Interest Rates

Our proprietary MSIM Quantitative Duration Strategy (QDS) model advises us on tactical duration risk positioning in developed government bond markets. The model is based on five signals, which reflect factors we think are important:

1. Market Technicals
2. Risk Sentiment
3. Business Cycle
4. Carry
5. Valuation

These signals incorporate both fundamental and technical inputs based on the following criteria:

1. There is evidence that relationship has worked in the past.
2. Academic literature supports the idea of these inputs.
3. The relationship has a plausible fundamental or behavioural explanation.
4. Data is timely and readily available.
5. Signals have been additive to the performance of the strategy.

Individually, these signals have limited success in predicting bond returns vs cash (i.e., excess bond returns, which is the return one gets from taking duration risk), but when combined together they have created a more successful and reliable signal. This makes intuitive sense: by looking at a broader range of relevant data, one gets a better picture of the appropriate risk to take.

This strategy has generated attractive Sharpe ratios, resilient performances during periods of market stress and few significant drawdowns (before taking transaction costs into account). However, returns can be modest over extended periods, so the model should not be relied upon to deliver attractive results in all market conditions. QDS remains an important component of our investment process, but it is only one of several inputs we consider.

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^{Risk Considerations
Diversification does not eliminate the risk of loss. The value of investments held by the portfolio may increase or decrease in response to economic, and financial events (whether real, expected or perceived) in the U.S. and global markets. As interest rates rise, the value of certain income investments is likely to decline. Investments in debt instruments may be affected by changes in the creditworthiness of the issuer and are subject to the risk of non-payment of principal and interest. The value of income securities also may decline because of real or perceived concerns about the issuer’s ability to make principal and interest payments. U.S. Treasury securities generally have a lower return than other obligations because of their higher credit quality and market liquidity. While certain U.S. Government-sponsored agencies may be chartered or sponsored by acts of Congress, their securities are neither issued nor guaranteed by the U.S. Treasury. Investments rated below investment grade (sometimes referred to as “junk”) are typically subject to greater price volatility and illiquidity than higher rated investments. Investments in foreign instruments or currencies can involve greater risk and volatility than U.S. investments because of adverse market, economic, political, regulatory, geopolitical, currency exchange rates or other conditions. In the event of a default by a sovereign entity, there are typically no assets to be seized or cash flows to be attached. The portfolio is exposed to liquidity risk when trading volume, lack of a market maker or trading partner, large position size, market conditions, or legal restrictions impair its ability to sell particular investments or to sell them at advantageous market prices.}

^{There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.}