Charting new paths

Uncovering the hidden alpha in treasuries

The U.S. Treasury market is the largest and most liquid bond market on the planet, so why do most investors turn to an index tracking strategy?

Many investors adhering to the efficient markets hypothesis believe there are minimal opportunities to generate alpha within a U.S. Treasury benchmark, thus defaulting to index-tracking strategies due to their low cost and stability. This can significantly limit opportunities for alpha generation. Conversely, a systematic approach seeks to offer risk-adjusted alpha without resorting to “out-of-benchmark” exposures or high-risk positions.

Figure 1 illustrates the difference between the fair value price and observed market prices within the U.S. Treasury universe. If all bonds were traded at the fair value level in-line with efficient markets theory, the average would be consistently zero. In contrast, we found the fair value difference oscillated between one and four basis points of yield through time. The highlighted area illustrates the opportunity set available to long-only mandates.

Seeking consistent, uncorrelated alpha over time

Many clients feel torn between indexing their government bonds or using active managers who may take out-of-benchmark bets. A systematic approach offers a compelling alternative — pursuing alpha while still allowing the allocation to play its desired role in the broader portfolio. As electronic trading evolves and market breadth expands, we believe systematic strategies are increasingly well-positioned to deliver consistent, risk-adjusted returns.