USD Corporate Risk: Big Changes in Risk Profiles, Viewed Through the Lens of the Axioma Factor-based Fixed Income Risk Model

It’s no surprise that the risk of corporate portfolios has increased substantially in the past few weeks. The chart below shows the forecasted risk for liquid USD Investment Grade and High Yield internal benchmarks, calculated using the Axioma Factor-based Fixed Income Risk Model. High yield saw an almost fourfold increase in risk, while investment-grade posted a twofold increase.

Source: Axioma Factor-based Fixed Income Risk Model

The Axioma Factor-based Fixed Income Risk Model represents credit risk using cross-sectional factors that explain movements of issuer spreads, and uses Duration Times Spread (DTS) for responsive and accurate risk forecasts. Interest rate risk is captured using bootstrapped government and swap spread curves. The chart below shows the weighted-average option-adjusted spread and effective duration of the benchmarks. Clearly, spreads have risen dramatically leading to higher DTS exposures and higher forecasted risk. High yield effective duration posted a slight increase due to reduced probability that firms will exercise the option to call bonds. The following chart shows the weighted average DTS exposure for each benchmark, highlighting the relatively larger increase for high yield and, hence, bigger increase in risk.

Alongside this increase in DTS exposures, proportional spread returns have become more volatile, and interest-rate volatility has become higher following expansionary actions by central banks.

Source: Axioma Risk

How is this increased risk attributed across the risk factors of the factor risk model and has this changed over the last few weeks? The charts below show the risk attribution expressed as the percent of variance of each factor type, for both benchmarks. The risk attribution has changed markedly for investment grade: prior to the crisis, interest-rate risk dominated and credit risk had a small part to play. Recent risk-attribution results show a dramatic switch to leave credit risk dominating, including a significant contribution from the cross-sectional style factors (further broken down in a moment). Interest rates have become a diversifier due to flight-to-quality and rate cuts. For high yield, the comparison is less dramatic: the contribution from the credit market intercept increases, but there are also increases in sector and country factors, indicating some increased risk and exposure at this level.

Source: Axioma Factor-based Fixed Income Risk Model

Source: Axioma Factor-based Fixed Income Risk Model

Finally, we examine the style factor contributions to risk for investment grade. Drilling into the risk attribution, we see that the Beta, or Market Sensitivity, factor dominates. This indicates an increase in the Market Sensitivity of issuer spread curves, following the systemic global shock to credit spreads.

Source: Axioma Factor-based Fixed Income Risk Model

The Axioma Factor-based Fixed Income Risk Model provides a framework for intuitive and actionable risk attribution, with accurate risk forecasts powered by Axioma Fixed Income Spread Curves and Axioma Risk Entity issuer classification.

David Antonio

David joined Qontigo's Multi-Asset Class research team in 2016 and has primarily focused on the research and development of next-generation fixed-income solutions. In particular, he has worked to develop Axioma’s granular set of issuer credit curves and the new fixed-income factor model for risk and portfolio construction.