The strategy uses 5-year CDS contracts from emerging market entities, ranking them based on momentum factors (CDS, FX, and equity returns). The portfolio is beta-neutral, scaled to 10% volatility, and rebalanced monthly.
ASSET CLASS: swaps | REGION: Emerging Markets | FREQUENCY:
Monthly | MARKET: bonds | KEYWORD: Momentum
I. STRATEGY IN A NUTSHELL
The strategy trades 5-year CDS contracts on USD-denominated emerging market entities from the J.P. Morgan Global EMBI+ index. Each month, entities are ranked by momentum using 6-month trailing returns of CDS, FX, and country equities. The portfolio goes long on top performers and short on bottom performers, maintaining beta neutrality via an asset-by-asset variance-covariance matrix. Positions are scaled to a 10% volatility target and rebalanced monthly.
II. ECONOMIC RATIONALE
5-year CDS contracts provide standardized, liquid exposure to emerging market credit risk, serving as insurance against bond default. The strategy leverages momentum across credit, FX, and equity markets for emerging countries in Asia, Latin America, and EMEA, capturing mispricings while managing beta risk in a long/short framework.
III. SOURCE PAPER
(Systematic) Investing in Emerging Market Debt [Click to Open PDF]
J. Brooks, S. Richardson, Z. Xu, AQR Capital Management LLC, AQR Capital Management LLC, London Business School, AQR Capital Management LLC
<Abstract>
We extend the analysis of systematic investment approaches to emerging market (EM) fixed income. We focus on hard currency bonds issued by emerging sovereign and quasi-sovereign entities. We find that systematic exposures linked to carry, defensive, momentum and valuation themes are well compensated and lowly correlated in EM markets. A transaction-cost and liquidity aware long-only portfolio generates an Information Ratio above 1. We further show that excess of benchmark returns for a broad set of EM managers are (i) largely explained by passive exposures to EM corporate credit excess returns and EM local currency returns, and (ii) have non-trivial macroeconomic exposures (growth, inflation, volatility and liquidity). A systematic approach to EM debt may be a powerful diversifier.
IV. BACKTEST PERFORMANCE
| Annualised Return | 5.4% |
| Volatility | 8.5% |
| Beta | N/A |
| Sharpe Ratio | 0.64 |
| Sortino Ratio | N/A |
| Maximum Drawdown | -17.7% |
| Win Rate | N/A |
