Alpha Strategy for Stripping Beta Returns for Pure Bond Funds

Abstract

Contemporarily alpha strategy is favorable by investors and funders for its stable performances among volatility market. Although alpha strategy shows great extra returns, it might have great drawdown on account of the stochastic fluctuations of the market (e.g., hedge funds’ poor performance during COVID-19 early state including Bridge Water). Despite from stocks and futures, the bond funds are rather a low volatility type underlying assets, hence the alpha strategy based on pure bond will be more favorable for risk aversion investors. By building a five-factor model, this paper dissolves the returns of pure bond funds to the five factors of level, slope, convex, credit and default, which are separated from each other, and Alpha, which is not directly explained by the factors, and verifies the effectiveness of this alpha factor for selecting pure bond funds. Taking 2019 to 2022 as the time interval, the group backtest results show that the alpha factor stripped of beta has a good effect on the selection of pure bond funds in China's public offering fund market, and the base selection ability is better than the Sharpe Ratio and other traditional risk-return factors. Overall, these results shed light on guiding further exploration of portfolio construction with high alpha based on bond funds.