Examining the Presence of Factor Premiums in South Africa's Local Curreny Soverign Bond Market

Abstract

While factor investing has gained prominence in recent decades – both in the academic literature and in its application to active, passive, and smart beta strategies in equity markets – it has a decidedly modest footprint in fixed income markets. This study contributes to the literature by examining the presence of factor premiums on the cross-section of South Africa’s sovereign bond market, assesses their contribution to return variation, and assesses whether such factors are unique or subsumed by other market factors. Established measures of value, carry, momentum, and reversion from the literature are explored in this study across long-only, long-short, and combination portfolios. These portfolios are constructed from on- the-run, sovereign-issued local currency bonds. This study finds statistically significant factor premiums for long-only value, carry, and reversion portfolios. Additionally, statistically significant factor premiums are identified across long-only and long-short combination portfolios. In many portfolio iterations, factor premiums are associated with improved risk efficiency and reduced return correlation relative to the sovereign bond benchmark. These findings lay further challenges to the EMH and the application of the CAPM in South Africa’s sovereign bond market.