Fundamental Inefficiencies in the Bond Market

Bonds are weird. Have you seen Bonds on Robinhood? The Fixed Income market is niche and relatively inaccessible to the average person. Some bonds are quite expensive. Only 11% of corporate debt issues are even traded on a daily basis (FINRA)!

All these bonds reside in a decentralised marketplace where they are sometimes traded by dealers, market-makers and buy-side managers. They are traded through over-the-counter platforms, where dealers and buyers need to go through the ‘requesting for quote’ process whenever they want to trade. A typical trade takes about 60–80 minutes, compared to the average amount of 2–5 minutes for equities.

There are clear inefficiencies in the market. Inefficiencies result in additional operational and logistical costs and the prerequisite of extensive human intervention. Even ‘systematic’ and ‘quantitative’ models are posed challenges due to the deeply regimented nature of the markets. Since the global financial crisis, regulations have dramatically squeezed dealer inventories of corporate bonds, causing a spike in the value of outstanding bonds and increasing the cost and inefficiency of creating portfolios with individual securities.

Fixed-income ETFs inevitably carry the baggage of the market on which they are based. How — investors may justifiably ask — can an ETF that trades throughout market hours like an equity own bonds that may not trade at all?