When Factors Sleep and Wake: The Dynamic Nature of Factor Investing in US and European Investment-Grade Credit

We develop a synthetic factor framework for systematic portfolio management in the US and European investment-grade corporate bond markets that explicitly accounts for time-varying factor exposures. Unlike conventional approaches that model interest rate and credit risks separately or rely on equity-based factors, our framework integrates both sources of systematic risk through four bond-specific factors: level, steepness, spread, and momentum. Our results show that factor exposures vary over time rather than remaining constant. Interest rate factors dominate during rate-driven dislocations, spread risk becomes the primary driver during periods of credit stress, and momentum is most relevant in tranquil, trending markets. These factors explain a substantial share of credit sector returns. We also document structural differences between the two markets: Interest rate factors dominate European investment-grade credit, whereas spread dynamics play a larger role in US investment-grade credit. Using factor-based predictive regressions to estimate expected returns, we identify consistent patterns across European and US credit portfolios. Overall, our findings show that bond-specific factors add explanatory value for corporate bond returns and provide a useful framework for systematic credit portfolio construction.