Systematic investing has become a widely embraced approach in equities and other liquid asset classes, yet its adoption in fixed income – particularly in emerging market bonds – remains relatively limited. While discretionary strategies continue to dominate, Andra AP-fonden (AP2) is challenging that norm. Under the leadership of Kristian Hartelius, the quantitative team at AP2 has since 2015 extended its systematic investment approach to emerging market fixed-income bonds, building on its success in applying quantitative strategies to developed and emerging market equities.
“A systematic approach to investing is not the only path to success – one can manage all asset classes fundamentally and achieve excellent results – but it is far more labor-intensive,” says Hartelius. “We are a small team based in Gothenburg, and for us, a systematic approach works very well,” he adds, highlighting that around half of the pension fund’s SEK 460 billion in assets under management are allocated through systematic strategies.
“A systematic approach to investing is not the only path to success – one can manage all asset classes fundamentally and achieve excellent results – but it is far more labor-intensive.”
Kristian Hartelius, Head of Quantitative Dynamic Allocation at AP2.
“Once you choose an approach, it’s important to commit to it and trust the process,” Hartelius emphasizes. Beyond offering transparency, cost efficiency, and scalability, AP2’s systematic approach is also free from human bias and emotional interference. “The model provides an objective, unemotional assessment of value in a particular instrument or market segment—especially when fear dominates sentiment. Sticking to the program in those moments is key to capturing the long-term rewards.”
Balancing Quantitative Rigor with Qualitative Insight
Similar to the systematic approach used in equity markets, the investment process begins with an assessment of political risk and various aspects of governance at the country level. This includes evaluating factors such as the rule of law, government stability, democracy, external and internal conflicts, and human rights, among others. “We use a scorecard approach to determine which countries we invest in,” explains Hartelius. “Then, of course, we incorporate financial and macroeconomic variables to build models that estimate equilibrium or fair value risk premiums,” he elaborates. “We then compare these premiums to current market conditions and allocate capital to countries where the risk premium appears particularly attractive, based on historical data and model insights.”
Despite its quantitative backbone, the approach does not discount the value of on-the-ground insights. “We travel to emerging markets for macro surveillance,” Hartelius adds. “We meet with authorities, central banks, debt offices, and even companies to understand whether a country is undergoing abrupt changes or if its economic dynamics are likely to remain stable over the next decade or so.” Once the country selection process is complete – guided by a data-driven approach but not necessarily purely systematic – the systematic strategy is put into action.
Building a Systematic Fixed-Income Strategy
The foundation of AP2’s systematic fixed-income strategy lies in developing robust macro models for both hard currency and local currency government bonds in emerging markets. Although both instruments are government bonds, they differ significantly in structure. Hard currency debt, typically denominated in U.S. dollars, functions as a spread product relative to U.S. Treasuries. Hartelius, who developed the model for hard currency bonds, explains, “I did the hard currency part myself – it’s a bit more contained. You trade dollar bonds in established markets like London and New York.”
In contrast, local currency debt is primarily a rates product rather than a spread product. Its returns are influenced by multiple factors, including local inflation, monetary policy, and exchange rate fluctuations, making it more sensitive to domestic economic conditions. “In essence, it’s not fundamentally different from how we approach the Swedish rates market for government bonds. The key inputs remain macroeconomic data, national accounts, inflation statistics, budget deficits, and other economic indicators available,” explains Hartelius. “When we’re in local markets, we’re trading across time zones from Asia to Latin America, accounting for a far greater number of variables,” he adds. “This is where we can leverage a range of models – such as yield curve models and duration return models – to navigate these markets.”
“You collect macroeconomic data and build models to estimate spread returns for hard currency bonds and duration returns for local currency bonds. It’s essentially about using statistical models to forecast returns, whether it’s for equities, bonds, hard or local currency bonds.”
Kristian Hartelius, Head of Quantitative Dynamic Allocation at AP2.
However, the general approach is quite similar for both hard and local currency emerging market bonds. “You collect macroeconomic data and build models to estimate spread returns for hard currency bonds and duration returns for local currency bonds,” explains Hartelius. Ultimately, “it’s essentially about using statistical models to forecast returns, whether it’s for equities, bonds, hard or local currency bonds. The models may differ, and you’ll rely on different data, but the fundamental approach remains consistent.”
Overcoming Market Challenges
Systematic investing in emerging market bonds is not without its challenges. Liquidity risk and market fragmentation, particularly in an environment where most bond trading occurs over the counter, can complicate a rules-based approach. Hartelius explains that AP2’s systematic approach extends all the way down to selecting specific instruments. “We’ve constructed models all the way down to choosing instruments,” he says. However, most bond trading still occurs over-the-counter. “There’s some electronic trading in bonds, but most transactions still happen over-the-counter,” notes Hartelius. “We have a clear idea of what we want and why – specifically the duration and relative yield curves that we have identified as offering the best return relative to cost. We then go ahead and buy what we want over-the-counter.”
“We’ve constructed models all the way down to choosing instruments. We have a clear idea of what we want and why… We then go ahead and buy what we want over-the-counter.”
Kristian Hartelius, Head of Quantitative Dynamic Allocation at AP2.
From top-down macro correlations to the finer details of daily turnover and market impact, AP2’s approach is characterized by a chain of increasingly detailed models. “At the top, we assess long-term correlations between asset classes and the macro economy; at the bottom, we focus on market impact and trading costs, looking at things like average daily turnover,” Hartelius explains. “It’s a chain of models leading down to the instrument level.”
Trusting the Process, Yet Remaining Vigilant
Maintaining a systematic framework is crucial to AP2’s approach, yet Hartelius acknowledges the necessity of human oversight. “Our job is to develop robust models, ensure rigorous back-testing, control risk, and verify that our data is high quality. We monitor the mechanical aspects – from programming and server reliability to data integrity – so the process runs smoothly,” he emphasizes. Still, there are times when even the best models fall short. “For instance, during the market breakdown in Turkey in 2019-2020, our models couldn’t accurately capture the turmoil. In such cases, we recognized that it was not reasonable to take on risk,” Hartelius recalls.
AP2’s systematic approach to emerging market bonds illustrates how quantitative rigor, complemented by qualitative insights, can navigate the complexities of fixed-income investing in emerging markets. By trusting their models while remaining open to market realities, Hartelius and his team are advancing systematic investing in a space traditionally dominated by more conventional methods.
