Abstract/Summary

Which factor model do investors in corporate bonds use? We examine this question by tracking investors’ decisions to invest in actively managed corporate bond mutual funds with a revealed preference approach. Our main result is that all bond factor models are dominated by the simple Sharpe ratio and Morningstar ratings. For all major corporate bond mutual fund styles, the Sharpe ratio explains fund flows better than alphas from bond factor models. Since the Sharpe ratio (and to some extent also Morningstar ratings) can be easily manipulated in bond markets, our findings have potentially severe implications for all market participants.