Speaker 1: Hello, and welcome to another episode of the Odd Thoughts Podcast.
Speaker 1: I'm Tracy Allaway and I'm Joe. WI isn't all so, Joe?
Speaker 1: I think equity markets have been um getting all the
Speaker 1: attention lately. Yeah, for good reason. Um, you know, the
Speaker 1: index level is extremely high, individual stocks all kinds of
Speaker 1: wild stories. But I am aware that there's also some
Speaker 1: interesting stuff in credit markets. I it's not getting as
Speaker 1: much attention, but I've kind of I'm aware that there's
Speaker 1: some stuff going on. Yeah, we're gonna try to fix
Speaker 1: the imbalance of of attention. In this episode. We're going
Speaker 1: to get very very um technical and a little bit
Speaker 1: wonky and take a look at not just credit as
Speaker 1: you mentioned, corporate bonds, but um, we'll also look at
Speaker 1: things like US treasuries. Um, what's going on there? So
Speaker 1: I should just say, as we're recording this episode, I
Speaker 1: was just looking at the yield on the thirty year
Speaker 1: and that's getting up to almost two per cent, which
Speaker 1: is a nice round number that people like to focus on.
Speaker 1: But the question, of course, is when we talk about
Speaker 1: bond yields, when we talk about bond prices, what exactly
Speaker 1: are we talking about. None of these trade on an exchange,
Speaker 1: So where does that pricing information come from? Yeah, this
Speaker 1: is always a fascinating question. We've discussed it in various
Speaker 1: forms a few times with Chris White as as well
Speaker 1: as others. Which is just this idea that Okay, everyone
Speaker 1: can look up on their monitor and see a quote
Speaker 1: for the say, um, you know, price of Microsoft shares,
Speaker 1: and we know where that comes from, and there's sort
Speaker 1: of like some sort of central repository for that. But
Speaker 1: in the world of fixed income, whether it's a sort
Speaker 1: of credit or rates, pricing is at a minimum much
Speaker 1: more distributed across all different kinds of platforms, all different
Speaker 1: kinds of players. In the idea that they're just sort
Speaker 1: of like one agreed upon price is um, it's not
Speaker 1: as much of a thing at all. Yeah, that's exactly right.
Speaker 1: And it's the kind of thing that people don't tend
Speaker 1: to talk about unless something bad is happening in the market,
Speaker 1: at which point suddenly everyone starts talking about bond pricing
Speaker 1: and what exactly, um, the process is there. And we
Speaker 1: saw a little bit of that in during the big
Speaker 1: market sell off. Of course, we had a lot of
Speaker 1: turmoil in credit. We also had a lot of turmoil
Speaker 1: in the U. S. Treasury market, and that's when people
Speaker 1: started talking about discrepancies in bond prices, which is it's
Speaker 1: never a good sign, is it. Uh No, it's like basically,
Speaker 1: you know, with all these things, it's like, once you
Speaker 1: have to start learning, by the time you're learning about
Speaker 1: how something actually works, usually that means trouble him. Yeah, exactly.
Speaker 1: So okay, yes, So today, um, we're going to be
Speaker 1: diving into the topic of bond pricing and we're gonna
Speaker 1: be talking to the authors of a paper that came
Speaker 1: out in January, a really really interesting paper by morning Star.
Speaker 1: It's called Bond Pricing Agreeing to Disagree and uh basically
Speaker 1: the authors on that crunched a bunch of numbers to
Speaker 1: really look at how different funds are pricing bonds and
Speaker 1: the discrepancies that are going on. So really interesting. Um So,
Speaker 1: without further ado, then let's bring on Eric Jacobson. He's
Speaker 1: a fixed income strategist at morning Star, and we'll bring
Speaker 1: on his co author as well, match Up Kawara. Thank
Speaker 1: you both for coming on, glad to be with you,
Speaker 1: thanks for having us. So, I guess first things first,
Speaker 1: but you know, Joe and I were joking a bit
Speaker 1: about how people don't tend to look at the technicals
Speaker 1: of bond pricing unless things are going wrong. What prompted
Speaker 1: you to do the paper? Well, there are a few
Speaker 1: things I think, you know, I hate to use the
Speaker 1: cliche that that crises are an opportunity, but when you're
Speaker 1: in the when you when you look at bond bonds
Speaker 1: and bond funds, the most exciting stuff always happens when
Speaker 1: something goes wrong. And that's really what happened as usual
Speaker 1: in in March, and we started thinking about what we
Speaker 1: might see in the data at that period of time.
Speaker 1: And there's a relatively new filing that is required by
Speaker 1: the SEC called MPort, which is really an electronic version
Speaker 1: of a portfolio filing, essentially almost the same as an
Speaker 1: annual report UM, but for you know, reasons that most
Speaker 1: people wouldn't really care about. Having it digitized makes a
Speaker 1: huge difference in being able to deal with the data.
Speaker 1: And so it gave us an opportunity, because obviously we
Speaker 1: collect that stuff across the industry. UM, it gave us
Speaker 1: an opportunity to pull some of the data that was
Speaker 1: that we knew would be very clean or as clean
Speaker 1: as we could imagine it to be given how it's
Speaker 1: submitted to the SEC and look at how different firms
Speaker 1: price their bonds at the end of a particular day,
Speaker 1: which you know, it's been possible to do that in
Speaker 1: the past, but as I just sort of alluded about
Speaker 1: the filing issue, it would have been it was a
Speaker 1: lot more difficult and a lot more difficult to do
Speaker 1: knowing for sure that the that the data was going
Speaker 1: to be filed consistently. So, uh, you know, unfortunately a
Speaker 1: very bad time in the market for a lot of people,
Speaker 1: third quarter at the end of the first quarter, but
Speaker 1: not a terrible time to do research. So what was
Speaker 1: your most striking finding in terms of the different prices
Speaker 1: that can emerge on the same security, the same bond,
Speaker 1: and the different approaches that a different holder took in
Speaker 1: their prices. Sure, so, you know, the first thing I
Speaker 1: would say is that we did not expect to see
Speaker 1: prices sort of on top of each other perfectly aligned.
Speaker 1: For some of the is I think that that you
Speaker 1: guys alluded to, But you know, some of it is
Speaker 1: just sort of structural in the sense of when when
Speaker 1: bond portfolios are marked, they're marked at the end of
Speaker 1: the day, and it's handled in slightly different ways depending
Speaker 1: on the firm that's doing it and some of the
Speaker 1: decisions that they make about pricing. So one of them
Speaker 1: is simply what time of day, and you can price
Speaker 1: bond portfolios that either three o'clock or flour o'clock. It
Speaker 1: seems that there's a lot more consistently, and there used
Speaker 1: to be a lot more firms are doing at three
Speaker 1: o'clock hour, but there is some diversity in that they
Speaker 1: also have the option of choosing to price either at
Speaker 1: the bid or the ask or the mid and so
Speaker 1: that's just another layer of difference there. And most firms
Speaker 1: are also, well pretty much all the firms that we
Speaker 1: know of a all use third party pricing services. And
Speaker 1: so then you add to add to the fact that
Speaker 1: there are a multitude, not not a huge number, but
Speaker 1: there are different services. So once you get through all
Speaker 1: three of those lenses, it's certainly posible for prices to
Speaker 1: be somewhat different. And you know, I think that the
Speaker 1: key issue here, I think you guys were talking before
Speaker 1: about the end of day price for a stock. Part
Speaker 1: of the reason for this that we have this issue
Speaker 1: is that um even if you are able to observe
Speaker 1: a price, you know, at two o'clock in the afternoon
Speaker 1: for a particular bond, and it's recorded by FINNRA, that's
Speaker 1: the regulator, and it's disseminated through trace, which is a
Speaker 1: reporting system. If that's not the price, if if that
Speaker 1: trade doesn't happen anywhere near the close of the market,
Speaker 1: then the somebody has to look at what that bond
Speaker 1: and say, well, this is what the price should have
Speaker 1: been at the end of the day, because the market
Speaker 1: shifted between the last trade and now, and we really
Speaker 1: need to change the price to reflect that. And that's
Speaker 1: part of you know, where you get all this difference.
Speaker 1: Of course, as we mentioned in the paper, there are
Speaker 1: lots of bonds that don't trade at all in a
Speaker 1: single day either, so that complicates things as well. Finally,
Speaker 1: I would say there's always a possibility that that the
Speaker 1: asset amount you can challenge the price that comes from
Speaker 1: from pricing service. So that's that as another layer of complexity.
Speaker 1: You know that they they may think that they know
Speaker 1: the real value of that bond better than the pricing agency,
Speaker 1: which which is quite conceivably true. If one manager challenges
Speaker 1: the bond and another firm doesn't, then you know, prices
Speaker 1: might look different for that reason as well. Can you
Speaker 1: talk a little bit more about the third party pricing services,
Speaker 1: because I think this is sort of whenever people hear
Speaker 1: about this UM for the first time, I think it's
Speaker 1: difficult for a lot of people to get their heads
Speaker 1: around that there are actually companies out there whose job
Speaker 1: is to kind of triangulate the price of a corporate bond. Sure,
Speaker 1: so it's interesting because you know, people will sometimes ask,
Speaker 1: you know, why wouldn't you just price the bond yourself
Speaker 1: if you're a manager, and as much it just eluded
Speaker 1: maybe in some cases a bond that's not widely held,
Speaker 1: maybe the manager it knows even more about it. The
Speaker 1: pricing service. You know that the truth is is that
Speaker 1: we've evolved into this system because the goal is to
Speaker 1: have a third party or an arms length party, if
Speaker 1: you will, UM making those pricing determinations, to sort of
Speaker 1: remove the manager a step away from that decision. Since
Speaker 1: the decision that the manager, the decision that's made on
Speaker 1: that price can affect the performance of an account that
Speaker 1: a manager is running, and so forth. And it's the
Speaker 1: kind of thing that has evolved over the years. Um,
Speaker 1: I haven't been involved in bond pricing directly, so it's uh,
Speaker 1: you know, I don't have the full history of the
Speaker 1: industry at my fingertips, but I can tell you that
Speaker 1: pricing has historically a lot of that information has come
Speaker 1: from broker dealers themselves, so uh, and even today, the
Speaker 1: pricing services do talk to the broke dealers, and there
Speaker 1: are pricing services that are associated on some cases with
Speaker 1: broker dealers as well, so it's kind of a mix there.
Speaker 1: But you know, the idea is that, um, when you
Speaker 1: have a portfolio of you know, a hundred and fifty
Speaker 1: different bonds or maybe a thousand when you're talking about
Speaker 1: mortgages are a very large mutual fund, you need to
Speaker 1: be able to gather market information very very quickly in
Speaker 1: order to that kind of pricing. So it makes sense
Speaker 1: to have a third party do it. And one of
Speaker 1: the advantages of having an agency that's that's sort of
Speaker 1: independent is that they can be in touch with multiple dealers,
Speaker 1: they can take in all the data feeds, and they
Speaker 1: also have systems in place so that, um, if there
Speaker 1: isn't any really fresh information, but they have a signpost
Speaker 1: of some kind to work off of for example, you
Speaker 1: know that the bond has this level of maturity, you
Speaker 1: know that it has this credit rating, it's in this sector,
Speaker 1: and etcetera. You can sort of triangulate a prices. I
Speaker 1: think someone said, um, they use a lot of different
Speaker 1: tools for that. Some of them are now they're starting
Speaker 1: to use AI for some of that stuff. But the
Speaker 1: idea of fundamentally is to try and get that to
Speaker 1: be as dispassionate as as decision as possible. UM. And
Speaker 1: you know, one of the things that we talked about
Speaker 1: in the paper is one of the reasons that you
Speaker 1: have some differentiation aside from the other factors, is that
Speaker 1: there are a good handful of pricing services, and some
Speaker 1: firms may use a single service for everything, but most
Speaker 1: of the larger mutual fund managers that most people are
Speaker 1: invested with, UH pick and choose among the services depending
Speaker 1: on the asset class that they're that they're using. And
Speaker 1: then UH and so, for example, you know, if they
Speaker 1: are looking at one particular kind of mortgage bond for
Speaker 1: a private mortgage security, the kind that blew up during
Speaker 1: a crisis, they may use a single pricing service just
Speaker 1: for that and use somebody else for for all the
Speaker 1: other sectors, So you know, this comes up every once
Speaker 1: in a while. Obviously, Q one of last year was
Speaker 1: one time, I forget, what is it, tracy, when were
Speaker 1: we talking about like energy bonds in the junk bond
Speaker 1: E t F like years ago. I feel like that
Speaker 1: was late, I want to say, although, yeah, I think
Speaker 1: it happened. No, I think, but I want so yeah, yeah,
Speaker 1: I think it was late. And I know there's like
Speaker 1: a bunch there's like an oil crash or a bunch
Speaker 1: of junk bond E t F got dislocated. Hasn't really
Speaker 1: been a problem yet, this question of ambiguous bond pricing
Speaker 1: of instruments that don't trade, because I know there's all
Speaker 1: these questions that emerge about the sort of liquidity mismatch
Speaker 1: where the bonds don't really move, but the E t
Speaker 1: F that or the funds that own the bonds have
Speaker 1: to provide daily prices or even intramarket daily liquidity. How
Speaker 1: big of an issue is this because so far it
Speaker 1: seems like mostly the infrastructure has work. Yeah, I think.
Speaker 1: You know, one of the benefits of the mutual fund
Speaker 1: structure in particular is that you know a lot of
Speaker 1: these differences get kind of washed out on a large portfolio.
Speaker 1: So even in a mutual fund that you know that
Speaker 1: has truly billions and billions of dollars, even if there
Speaker 1: are a good handful of bonds where the pricing seems
Speaker 1: to be all over the map, you know, when you
Speaker 1: when you add all that up and average it out,
Speaker 1: they turn out to be kind of rounding errors in
Speaker 1: a lot of cases. UM we still have some research
Speaker 1: to do on that, because we haven't gone through the
Speaker 1: entire universe and done it at the fund by fund level,
Speaker 1: but that seems to be the case for the most part.
Speaker 1: You know. The big problem, as you alluded though, is
Speaker 1: when you wind up in a big crisis situation, and
Speaker 1: the more concentrated a portfolio, and the worst the crisis
Speaker 1: and the longer at last, the bigger problem that can be.
Speaker 1: And of course you know this isn't exclusive to bonds.
Speaker 1: It doesn't happen, you don't notice it nearly as often
Speaker 1: with equities, but that you alluded to earlier, you know,
Speaker 1: if you have private placements in a mutual fund or
Speaker 1: you know, very very large slugs of a of a
Speaker 1: private company that's spread around UM, and and that happens
Speaker 1: you know, often with with young uh startup companies, where
Speaker 1: small cap funds get involved, why to put big tech names?
Speaker 1: There can be disagreements about things like that too. Usually
Speaker 1: it's not that big a deal to small investors when
Speaker 1: you have diversified funds um But as I said, crisis
Speaker 1: last lasts long enough, or you have a concentrated enough portfolio,
Speaker 1: that's when it really starts to make a difference. So
Speaker 1: can we talk about that a little bit more in
Speaker 1: your paper? What exactly what was the difference in bond
Speaker 1: pricing differences in normal times versus something like the first
Speaker 1: quarter of twenty twenty, because I think your study looked
Speaker 1: at late which was a relatively calm period in markets,
Speaker 1: and then the end of March. So what was the
Speaker 1: difference between those two periods? Sure, so, as you alluded,
Speaker 1: we we started in September, and just to clarify, you know,
Speaker 1: we used quarter end data and so this was essentially
Speaker 1: data on the last day of the quarter, at the
Speaker 1: end of the day and looked across funds and across
Speaker 1: bonds that were appearing in more than one fund. Well,
Speaker 1: this is kind of a nuanced in and of itself.
Speaker 1: But when I say more than one. What I really
Speaker 1: mean is more than one firms funds because each firm,
Speaker 1: no matter how many funds they have, if they own
Speaker 1: the same bond across multiple funds, the structure is to
Speaker 1: price them all at the same price. So when we
Speaker 1: talk about this, we talked about how many firms priced
Speaker 1: the bond, and that appear in the portfolios we looked
Speaker 1: at um. But when you go back to September, for example,
Speaker 1: as you asked, if you take corporate high quality, corporate bronze,
Speaker 1: but corporate brons in generalist, essentially, the differences in price
Speaker 1: were fairly narrow. We use a term that we call
Speaker 1: the price spread percentage, where we took the lowest price
Speaker 1: and the highest price that we found, and then we
Speaker 1: took that the difference between those two and we divided
Speaker 1: it by the mean average, and that gave us this
Speaker 1: price spread percentage. And so if you look at triple
Speaker 1: A and double A bonds at the end of September
Speaker 1: UM that number was very small. It was only about
Speaker 1: thirty basis points for double and triple A and it
Speaker 1: got you know, a triple B was point three seven,
Speaker 1: so pretty small. Those numbers are still meaningful in the
Speaker 1: in the framework of um. You know a market where
Speaker 1: returns for a whole year, you know, the yield on
Speaker 1: on bonds, as you just mentioned earlier, the thirty year
Speaker 1: not quite even two. That's a meaningful number, but it's
Speaker 1: it's within the realm of expectations given all the things
Speaker 1: that we said earlier about prices, and then they do
Speaker 1: tend to get a little bit wider. The the thinner
Speaker 1: the market, lower the quality, the smaller the range of
Speaker 1: values and the bonds part of me what I mean
Speaker 1: to say is, you know, the high yield market is
Speaker 1: many times smaller, for example, than the investment grade corporate market,
Speaker 1: and so you expect more dispersion there, and that's what
Speaker 1: you saw at that point. And then, of course, by contrast,
Speaker 1: when we looked at the end of the first quarter,
Speaker 1: of those numbers were in some cases multiples. So I
Speaker 1: mentioned earlier thirty basis points for the price fred percentage
Speaker 1: for triple A double A corporates at the end of
Speaker 1: March was one, and then the number for triple B
Speaker 1: bonds was two points seven two percent, so literally multiples
Speaker 1: of what we saw at that point. Just another snapshot
Speaker 1: in time. Your thoughts on this sort of significance of
Speaker 1: these figures are what they imply. As Eric said, especially
Speaker 1: in the in the in the crisis mode, these differences
Speaker 1: were way bigger than we expected. One thing that I
Speaker 1: would maybe want to mention is that, you know, I
Speaker 1: remember this old paper that Fisher Black of the famous
Speaker 1: um you know Black and shows formula. You wrote this
Speaker 1: paper at some point, I forget what exact name of
Speaker 1: seven is called noise, And this is kind of what
Speaker 1: we're dealing with here a little bit. You know, the
Speaker 1: bond prices are noisy. You know, they are not perfect.
Speaker 1: We don't know for sure what a given bond is
Speaker 1: it's worth, and that's what we see being here. So
Speaker 1: on the plot positive side, um, you know. Fisher Black
Speaker 1: asked the question, you know, when would you say that
Speaker 1: the market is efficient? And as the answer was, if
Speaker 1: if there is some kind of a true value which
Speaker 1: we don't know about, but let's assume that it is there.
Speaker 1: Fisher Black said that the market will be efficient if
Speaker 1: if the the market is efficient if it will assign
Speaker 1: a price within the factor of two of the real
Speaker 1: unobservable true value. So if if something is something let's
Speaker 1: say is is is there's an instrument who's true values
Speaker 1: let's say a hundred then Fisher Black would say that
Speaker 1: the market is efficient if if if it assigns at
Speaker 1: the value of somewhere between fifty and two hundred um.
Speaker 1: That was his definition. So what we see here, you
Speaker 1: know this is these are these are fractions of of
Speaker 1: what official Black thoughts might still constitute an efficient market.
Speaker 1: So in that sense, we are not seeing anything critical here.
Speaker 1: On the other hand, as I mentioned, if you see
Speaker 1: attempt percentage point price differential between between bonds, that that
Speaker 1: can well be like two years worth a yield for
Speaker 1: some events, for high yield issue, right, so that is
Speaker 1: a potential, uh, you know, point of concern. Um, I'm
Speaker 1: not sure what solution to this problem might be. Nothing
Speaker 1: obvious count comes to mind. If we don't want to
Speaker 1: end up with just one pricing service, we don't probably
Speaker 1: want the government to dictate what that price is. So
Speaker 1: I think we are stuck with the system that that
Speaker 1: we have here. Let's just hope it continues to function
Speaker 1: reasonably well. One thing that Eric probably didn't highlight, so
Speaker 1: our sample that we are dealing with, we are only
Speaker 1: dealing with bonds that had at least two different firms
Speaker 1: pricing it. Now, it turns out that this is in
Speaker 1: many cases the minority of all the bonds. Most of
Speaker 1: the bonds that we are dealing with in these sectors
Speaker 1: and especially in the municipal market, they are owned only
Speaker 1: by one firm. So we don't really know. We can't
Speaker 1: you know, you have only one price that you can't
Speaker 1: talk about how spread out that price is, right, but
Speaker 1: that that seems to be that seems to be more
Speaker 1: of a norm than one would expect. So we're kind
Speaker 1: of dealing with these two issues. One is only one
Speaker 1: one player owns a given bonds and secondly, what Eric mentions,
Speaker 1: these bonds oftentimes go through long periods of not being
Speaker 1: traded at all, So so how do you a sign
Speaker 1: a price to what? Instruments like that? Though I don't remember,
Speaker 1: we were talking to somebody from a who came from
Speaker 1: a big firm, and he was telling us that this
Speaker 1: was in the context of of some emerging market paper.
Speaker 1: You know, they had to put a price on it.
Speaker 1: Says this bond hasn't traded for seven years. Now, who
Speaker 1: really knows what it's worth, So we're going to just
Speaker 1: say that it's worth seventy dollars and it's going to
Speaker 1: be done with it. Wow. So I know we're talking
Speaker 1: about how especially when when you look at something like
Speaker 1: new knees or something like corporate bonds where they really
Speaker 1: aren't trading that regularly, there's a tendency to say, well,
Speaker 1: this isn't the fact that there are pricing discrepancies, isn't
Speaker 1: that worrying? And they tend to get sort of normalized
Speaker 1: in the long term and everything kind of works out.
Speaker 1: But one thing that was really surprising in your paper
Speaker 1: was that you also found price discrepancies in treasuries during
Speaker 1: the worst of the market sell off in And this
Speaker 1: is supposed to be, you know, a huge and liquid
Speaker 1: and standardized market, and yet in March of last year,
Speaker 1: people seem to have difficulty agreeing what US government debt
Speaker 1: was actually worth. Um, can you walk us through your findings?
Speaker 1: And then also, I guess your thoughts around this, like,
Speaker 1: how could that possibly have happened? Sure, so what you
Speaker 1: said is right on. You know, we we when you
Speaker 1: look at the data for the end of the third
Speaker 1: quarter of UM, the differences were very very small. Um.
Speaker 1: You know, anyone looking at our charts, we'll see that
Speaker 1: there are cases where there are these outliers that show
Speaker 1: up in the data, and you know, we've audited a
Speaker 1: number them and found that it's the data. We the
Speaker 1: representation that we came up with its accurate. But there
Speaker 1: were certainly a handful of cases where we think that
Speaker 1: firms were actually reporting the information incorrectly, but you know,
Speaker 1: we didn't we didn't strip that out if we knew
Speaker 1: that the data that we were using the right data.
Speaker 1: But when you look down at the at the intercuartile
Speaker 1: ranges as we as we picked them out, So in
Speaker 1: other words, sort of the the concentration of bonds for
Speaker 1: the most part in the middle that it was a
Speaker 1: very very narrow band at the end of September. Then
Speaker 1: when you got to the end of the first quarter,
Speaker 1: there were pricing differences that went not quite to a
Speaker 1: full percentage point, but just under that. And as you said,
Speaker 1: that's that's pretty remarkable. Um. You know, the reasons for
Speaker 1: that are kind of all over the map a little
Speaker 1: bit in terms of um, you know, some of this
Speaker 1: was covered pretty widely in the press in terms of
Speaker 1: off the run securities and what have you. UM, But
Speaker 1: the bottom line I think is that it really it
Speaker 1: really made a strong case that it was important that
Speaker 1: that UM that the FED stepped in when they did
Speaker 1: and made the decision that did, because you can only imagine,
Speaker 1: you know, we saw much wider differences for other sectors. UM.
Speaker 1: You can only imagine how much worse it would have
Speaker 1: been and would have potentially gotten if they hadn't gotten.
Speaker 1: And I'm sorry much it where you're gonna add something, No,
Speaker 1: no, no no, no no, because the fact that I was
Speaker 1: just leading up to the same timp but you said
Speaker 1: it already. I mean, the Thud was really worried about
Speaker 1: what was happening, even in the you know, the treasuries
Speaker 1: are supposed to be the gold standard trading much and
Speaker 1: I don't trade bonds ourselves, but you know, we've definitely
Speaker 1: heard observations that there were certain bonds at certain times
Speaker 1: of the day during that period where people were seeing
Speaker 1: UM spreads that were unheard of from anything they had
Speaker 1: seen before. And as much as said that was that
Speaker 1: was you know, again, however you want to frame it,
Speaker 1: I mean, I think we were all very fortunate that
Speaker 1: the that was was awakened at the switch when that happened,
Speaker 1: because as bad as that is for the treasuring market.
Speaker 1: The implications down the way from that are just huge.
Speaker 1: I think hopefully the average person on the street that
Speaker 1: doesn't read, you know, the financial papers, probably didn't even
Speaker 1: notice it. But if it had gotten to that point,
Speaker 1: we really would have been in a real best trip.
Speaker 1: H Well, one other thing that maybe should have mentioned
Speaker 1: that It just occurred to me recently that you know,
Speaker 1: I've given what we are seeing with these prices, what
Speaker 1: is the row of quantitative approaches and fixed income? That's
Speaker 1: kind of began to worry me a little bit. If
Speaker 1: you don't really know what the prices of something, how
Speaker 1: you're trying to arbitract some differences between these mombs. So
Speaker 1: I'm sure that people who do this have thought about it,
Speaker 1: but I haven't, and I don't know how they are
Speaker 1: dealing with it. But that does seem to I mean,
Speaker 1: it is an interesting question. I mean, when you talk
Speaker 1: to sort of quants in the traditional equity space, you
Speaker 1: get the impressure. They spend a lot of time on
Speaker 1: data quality, cleaning the data, making sure that they have
Speaker 1: access to really high you know that the data is good.
Speaker 1: So when we when thinking about poorting some of these
Speaker 1: ideas to the bond space, if you can't even agree
Speaker 1: on what historical bond pricing data is, it does seem
Speaker 1: harder to imagine that some of these strategies would be
Speaker 1: as effective. Yeah, and and you don't see I don't
Speaker 1: hear that much about those right in the market. So
Speaker 1: I wonder if that's part of the reason. I don't know.
Speaker 1: I think that's one of the ultimate reasons why. You know,
Speaker 1: the conventional wisdom is that there is more more to
Speaker 1: do in the fixed income space for active management um
Speaker 1: then perhaps on the equity side, because there is so
Speaker 1: much structural inefficiency. And one thing we haven't talked about
Speaker 1: is the fact that you're literally talking about millions of bonds,
Speaker 1: and not only are there several million bonds out there
Speaker 1: at this moment, but a month from now, those bonds
Speaker 1: will be different. And over the course of a year,
Speaker 1: you know that that inventory, if you will turn over
Speaker 1: because bonds are constantly maturing and their new bonds constantly
Speaker 1: coming out. The universe of US domestic stocks is reasonably static,
Speaker 1: and that statics probably not the right word, but the
Speaker 1: number is a manageable number most of the time. You know,
Speaker 1: we're talking about several thousand Once you get out into
Speaker 1: the millions. You've got to do a lot to keep
Speaker 1: that data clean and too, and to even something as
Speaker 1: simple as getting a price as as you said, So
Speaker 1: it is a it is a big, big lift for
Speaker 1: a lot of firms and they spend a tremendous amount
Speaker 1: of money and time on it. Yeah, the barriers to
Speaker 1: entry are very high in the extent income. It's not
Speaker 1: like if you want to open, uh, you know, an
Speaker 1: equity account, um, you still have to do all the
Speaker 1: kind of compliance and whatever stuff. But but other than that,
Speaker 1: you can just you know, do your research and a
Speaker 1: constructive portfolio with you can just walk off the street
Speaker 1: and then start a bunch of that that Really there
Speaker 1: is no room, there is no room for small players here.
Speaker 1: I mean the outlays of you know that you have
Speaker 1: to spend on on data and analytics are just just enormous,
Speaker 1: which kind of makes you wonder. It makes you wonder
Speaker 1: what is what the future of this of this whole
Speaker 1: market is going to look like. M Magic. You touched
Speaker 1: on the idea of what the solutions could be too
Speaker 1: these bond pricing issues, And for as long as I've
Speaker 1: covered bonds, especially in the corporate space, there's been talk
Speaker 1: about doing more electronic bond trading, UM, maybe moving it
Speaker 1: to something that resembles an exchange and something that might
Speaker 1: have more transparent pricing. But what are the prospects of
Speaker 1: that actually happening, because again, like I feel like the
Speaker 1: industry has been talking about it for years and years
Speaker 1: and years and it just never really seems to UM.
Speaker 1: I mean, there's been progress, but it certainly isn't anywhere
Speaker 1: near the level of something like stocks. Well. I mean one,
Speaker 1: I'll let Eric pick it up later. But but one
Speaker 1: thing that you know, whatever platform you you can think of,
Speaker 1: will not address as the fact that you know, some
Speaker 1: of these guys just not trade a sign how the
Speaker 1: US sign a price to something that last traded three
Speaker 1: weeks ago. So that that was our finding. I think
Speaker 1: that's about half of mombs, half of corporate bombs well
Speaker 1: and through at least a three week period when they
Speaker 1: were not traded. Yeah, I think the issue is really
Speaker 1: that it's always going to be a part of the market. UM.
Speaker 1: The there are a couple issues there. One is this
Speaker 1: issue a sort of critical mass, so you know, firms
Speaker 1: have definitely talked about and tried to take more of it.
Speaker 1: Electronic and that works better in places where there's going
Speaker 1: to be a lot of trading and a lot of
Speaker 1: supply and demand meeting. It's meeting halfway in the same spaces, right,
Speaker 1: And that's why there are some electronic trading platforms um
Speaker 1: that do some of the work. You know there there are,
Speaker 1: There is a lot of electronic trading in the treasury market.
Speaker 1: There even is quite a bit in the higher, higher
Speaker 1: quality corporate market. But that that is that works best
Speaker 1: when you're dealing with the high volume, high deal size bonds.
Speaker 1: The further down the ladder you go, the more um
Speaker 1: fragmented it gets, the less trading there is. Then it's
Speaker 1: a bigger lift to try and get everybody together. And
Speaker 1: the fact of the matter is is that for for
Speaker 1: anybody who's actively involved in the industry, whether that's the
Speaker 1: investment banks and dealers or even the large active managers,
Speaker 1: to some degree, there's an incentive too have some inefficiency
Speaker 1: in the trading, especially when it comes to the dealers,
Speaker 1: because they do make a lot more money on these
Speaker 1: structural inefficiencies in fixed income than they're able to in equities.
Speaker 1: It's inevitable that when there is inefficiency that you can
Speaker 1: ring out with technology. Somebody will eventually get there and
Speaker 1: be able to do it. It will take more time, um,
Speaker 1: you know, because it requires that sort of critical mass.
Speaker 1: You have to be able to bring enough buyers and
Speaker 1: sellers together. Um. And when you don't have a single
Speaker 1: point of exchange, that that's more difficult. But what we
Speaker 1: said earlier about the nature of the bond market, the
Speaker 1: fact that it is so fragmented and splintered, and there
Speaker 1: are you know, even even a single I mean, look
Speaker 1: at it this way. A single large company, a very
Speaker 1: very large mega cap company will still have one stock right,
Speaker 1: one share, common equity, maybe a couple of maybe they've
Speaker 1: got some prefers, what have you. But fundamentally, when you
Speaker 1: trade you know G E, you're trading G. They made.
Speaker 1: The same company may have literally hundreds of bonds, and
Speaker 1: the differences among them may have Sometimes it may be
Speaker 1: as simple as just the maturity. But once you spread
Speaker 1: that out, you've got different coupons, different maturities, and very
Speaker 1: large companies with subsidiaries and so forth, may issue bonds
Speaker 1: at every different level, so the underlying credit qualities slightly
Speaker 1: different because they have legal differences in one of them
Speaker 1: as well. Trying to standardize and commoditize those Um there
Speaker 1: there are certainly party of these parties that benefit from that,
Speaker 1: including the issuers themselves would But as long as you've
Speaker 1: got that much differentiation, you're always going to have a
Speaker 1: huge swath of the market that isn't going to trade
Speaker 1: quite that often. I do think that in some of
Speaker 1: it is a matter of time and some of it
Speaker 1: is a matter of sort of the socialization of the market,
Speaker 1: people sort of getting on the same page. But no
Speaker 1: matter how far down the road you go in terms
Speaker 1: of making it electronic, UM, you're still gonna have inefficiency
Speaker 1: people trying. You know, the bottom line is traders still
Speaker 1: get on the phone and haggle over prices for bonds.
Speaker 1: That's always going to happen to some degree, the less
Speaker 1: standardized and the smaller the bond is. So one other
Speaker 1: thing to add to to this, Uh, what we are
Speaker 1: hearing is that pricing agencies, pricing services now apparently look
Speaker 1: at at e t F prices because whoever is creating
Speaker 1: the E t F units, um, they are implicit like
Speaker 1: putting some price on these on these things, whether they
Speaker 1: have been traded or not. So that might be a
Speaker 1: potentially interesting having you to to get around that problem.
Speaker 1: Although it's it's clearly not perfect, but but it tells
Speaker 1: you something. It's kind of crazy when the like liquid
Speaker 1: wrapper that you put around the stuff that doesn't trade
Speaker 1: very much becomes the reference point for pricing because it
Speaker 1: doesn't trade much. It's weird. Yeah, I think that that's definitely,
Speaker 1: definitely an important, interesting thing that's that the market is
Speaker 1: starting to absorb and learn about. I would point out though,
Speaker 1: that you're still dealing with a subset of the market.
Speaker 1: Usually when you have a corporate bond e t F
Speaker 1: that has a hundred bonds in it, that will certainly
Speaker 1: affect the liquidity of those one bonds and bonds that
Speaker 1: are similar in nature to it UM, but you wind
Speaker 1: up getting concentration liquidity in those in that area as well,
Speaker 1: So that kind of things. Certainly there's no question that
Speaker 1: that should have an effect of creating better efficiency in
Speaker 1: parts of the market where those et f s live UM,
Speaker 1: But to the degree that they have that bonds are
Speaker 1: not concentrated inside those et f s, you're still going
Speaker 1: to be dealing quite a bit with with this issue.
Speaker 1: Look that it's still an analogy, it's not doesn't fit entirely.
Speaker 1: But you know, when we talk about companies being a
Speaker 1: part of our not being a part of the SMP
Speaker 1: five hundred, it makes a difference. If you're not in
Speaker 1: that s your the demand for your stock is not
Speaker 1: going to be the same. So it is kind of
Speaker 1: a somewhat paradoxical situation where you know, fixed income is
Speaker 1: supposed to be this safe and kind of boring asset,
Speaker 1: but we don't really to some extent now what these
Speaker 1: prices are, at least much less clearly than than we
Speaker 1: do four equities. That to me that was a little paradoxical,
Speaker 1: and that sends fixed income is a little closer to
Speaker 1: like private equa to you or something of that nature.
Speaker 1: Not maybe to the same degree, but nature, I think
Speaker 1: it's closer in terms of pricing. I love the idea
Speaker 1: that we think of bonds is really boring, as you said,
Speaker 1: but like below the surface, maybe you know someone an
Speaker 1: asset manager and a pricing service provider are having like
Speaker 1: this raging debate about how much the bond is actually worth,
Speaker 1: But we don't get to see that most of the time.
Speaker 1: You know, Marchick mentioned earlier about the fact that such
Speaker 1: a huge proportion of municipal bonds that we observed were
Speaker 1: only being held in the funds of a single firm each.
Speaker 1: That's that's what's particularly interesting when you said about below
Speaker 1: the surface. You know, that's where that kind of argument
Speaker 1: may really come in when a manager may be the
Speaker 1: only large investor holding that bond, and that that means
Speaker 1: that the pricing service itself isn't necessarily seeing in anybody
Speaker 1: else's port olio either. Um, They're gonna sign a price
Speaker 1: based on some formula, some matrix or or artificial intelligence.
Speaker 1: And that's a case where the manager may know something
Speaker 1: about the you know, it's if it's a few million
Speaker 1: dollar bond of a small, you know, nursing home in
Speaker 1: West Texas, that's where that argument may come. But it's
Speaker 1: as you said, it's all it's all under the surface,
Speaker 1: and we'll never see anything about that. So there was
Speaker 1: more though bonds all right, Well, Um, Matcha and Eric.
Speaker 1: That was that was really interesting, um, and really good
Speaker 1: fun to dive beneath the surface of an otherwise boring
Speaker 1: fixed income market. So thank you so much for coming on.
Speaker 1: Really appreciate it. Thank you, it's our pleasure. Thanks. That
Speaker 1: was great, So Joe, I actually feel kind of bad
Speaker 1: for calling the fixed income market boring because I don't
Speaker 1: think it is. But I do think that there is
Speaker 1: this big portion of it in terms of the market
Speaker 1: structure that doesn't get as much attention as it should
Speaker 1: in my mind, and the pricing of a lot of
Speaker 1: bonds is one of them. No, I think it's super
Speaker 1: one of those things. Interesting. My big takeaway is that
Speaker 1: I feel like if I were going to start some
Speaker 1: sort of like asset manager, or if I were going
Speaker 1: to get into trading or something like that, I feel
Speaker 1: like I would definitely go into the bond space, just
Speaker 1: because you know, listening to that after all, you know,
Speaker 1: it still feels like it's come up in some of
Speaker 1: our conversations. There are so many I guess inefficiencies or
Speaker 1: sources of friction might be a better way to characterize
Speaker 1: it in the space, whereas with equities there are very few,
Speaker 1: And as such, I suspect that there are you know,
Speaker 1: risk premium out there yet still to be harvested by
Speaker 1: the enterprising bond manager the more they understand this stuff.
Speaker 1: I was worried for a second when when you talked
Speaker 1: about starting something that you were going to start like
Speaker 1: the team the electronic bond trading platform. Um, but no,
Speaker 1: in a different direction. Okay, I take advantage, take advantage
Speaker 1: of all all the fragmented bond trading platforms to find inefficiencies. Yes, Um.
Speaker 1: The other thing, I mean, there's a lot to unpack
Speaker 1: in that discussion. Um. The description of the treasury pricing
Speaker 1: discrepancies is still really remarkable to me, um, and I
Speaker 1: would love to hear more about that. But the other
Speaker 1: thing that stuck out was this idea of e t
Speaker 1: s kind of becoming um the reference price for the
Speaker 1: bonds they're actually wrapped around. UM. And I've heard that
Speaker 1: before from people in the market, and I can understand why,
Speaker 1: but it just seems so circular to me and sort
Speaker 1: of like intuitively odd when when that came up, like
Speaker 1: I literally got in my head that image of the
Speaker 1: snake eating its tail. So say it's exactly like It's like, okay,
Speaker 1: so it doesn't sound right. It sounds problematic, Like I
Speaker 1: don't know how it would become a problem, but it
Speaker 1: doesn't sound great if the instrument designed to hold the
Speaker 1: bonds can't be priced easily because the bonds are a
Speaker 1: liquid and so you end up pricing the bonds based
Speaker 1: on where the et F trade. It does not sound great,
Speaker 1: but maybe it's fine. I don't know. We'll have to
Speaker 1: wait to a crisis and then will say, oh, yes,
Speaker 1: that was a big deal. Well, I mean, to some extent,
Speaker 1: we we kind of had, um the credit crisis in
Speaker 1: and the e t f s performed reasonably well. But
Speaker 1: you could imagine a scenario where um, because the e
Speaker 1: t f s are sort of influencing the underlying and
Speaker 1: vice versa, maybe you get a cascade effect of some sort.
Speaker 1: But anyway, um, your your image of the snake eating
Speaker 1: its own tail is it's gonna stick with me. Okay,
Speaker 1: should we leave it there? Let's leave it there? All right?
Speaker 1: This has been another episode of the All Thoughts podcast.
Speaker 1: I'm Tracy Alloway. You can follow me on Twitter at
Speaker 1: Tracy Alloway and I'm Joe wi Isn't though. You could
Speaker 1: follow me on Twitter at the Stalwart. Follow our producer
Speaker 1: Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg
Speaker 1: head of podcast Francesca Levi at Francesca Today, and check
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Speaker 1: at podcasts. Thanks for listening,