Odd Lots - Why the True Price of a Bond Can Still Be Hard To Know

Episode Date: April 5, 2021

In the modern age, we expect to be able to turn on our computers, enter in a ticker, and know the actual price of a financial instrument, such as a stock or a bond. But this is easier said than done, especially with bonds, and especially with bonds that are infrequently traded. Sometimes, in fact, bond pricing is a matter of opinion. At least that's the contention of Maciej Kowara and Eric Jacobson, analysts at Morningstar, who published a report earlier this year titled “Bond Pricing: Agreeing To Disagree.” They explain why there can still be disagreements about what a bond is actually worth from one firm to another.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But on Vanguard, at Vanguard, institutional quality isn't a tagline. It's a big line. It's a lot. It's a firm. It's a few. commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio.

That's vanguard.com slash audio. All investing is subject to risk vanguard marketing corporation distributor. Hello and welcome to another episode of the Oddlots podcast. I'm Tracy Allaway. And I'm Joe Wisenthal. So Joe, I think equity markets have been getting all the attention lately. Yeah, for good reason, you know, the index level is extremely high, individual stocks, all kinds of wild stories. But I am aware that there's also some interesting stuff at credit markets. I may it's not getting as much attention but I'm kind of I'm aware that there's some stuff going on. Yeah, we're going to try to fix the imbalance of attention in this episode. We're going to get very, very technical and a little bit wonky and take a look at not just credit, as you mentioned, corporate bonds, but we'll also look at things like U.S. Treasuries, what's going on there.

So I should just say as we're recording this episode, I was just looking at the yield on the 30 year, and that's getting up to almost 2%, which is a nice round number that people like to focus on. But the question, of course, is when we talk about bond yields, when we talk about bond prices, what exactly are we talking about? None of these trade on an exchange. So where does that pricing information come from? Yeah, this is always a fascinating question. We've discussed it in various forms a few times with Chris White as well as others, which is just this idea that, okay, everyone can look up on their monitor and see a quote for, to say, you know, price of Microsoft shares. And we know where that comes from. And there's sort of like some sort of a central repository for that.

But in the world of fixed income, whether it's sort of credit or rates, pricing is at a minimum much more distributed across all different kinds of platforms, all different kinds of players. And the idea that they're just sort of like one agreed upon price is not as much of a thing at all. Yeah, that's exactly right. And it's the kind of thing that people don't tend to talk about unless something bad is happening. in the market, at which point suddenly everyone starts talking about bond pricing and what exactly the process is there. And we saw a little bit of that in 2020 during the big market sell-off, of course. We had a lot of turmoil in credit. We also had a lot of turmoil in the U.S. Treasury market. And that's when people started talking about discrepancies in bond prices, which is, it's never a good sign,

is it? No. It's like basically, you know, with all these things, it's like once you have to start learning, by the time you're learning about how something actually works, usually that means trouble is hit. Yeah, exactly. For most people. Okay.

Yes. So today we're going to be diving into the topic of bond pricing and we're going to be talking to the authors of a paper that came out in January, a really, really interesting. paper by Morningstar. It's called bond pricing agreeing to disagree. And basically, the authors on that crunched a bunch of numbers to really look at how different funds are pricing bonds and the discrepancies that are going on. So really interesting. So without further ado, then, let's bring on Eric Jacobson. He's a fixed income strategist at Morningstar, and we'll bring on his co-author as well, Matcha Choira. Thank you both for coming on.

on. Glad to be with you. Thanks for having us. So I guess first things first, but, you know, Joe and I were joking a bit about how people don't tend to look at the technicals of bond pricing unless things are going wrong. What prompted you to do the paper? Well, there are a few things. I think, you know, I hate to use the cliche that that crises are an opportunity. But when you're in the, when you look at bonds, bonds and bond funds, the most exciting stuff always happens when something goes wrong. And that's really what happened, as usual, in March of 2020. And we started thinking about what we might see in the data at that period of time. And there's a relatively new filing that is required by the SEC called N-Port, which is really an electronic version of a portfolio

filing, essentially almost the same as an annual report. But for reasons that most people wouldn't really care about. Having it digitized makes a huge difference in being able to deal with the data. And so it gave us an opportunity because obviously we collect that stuff across the industry. It gave us an opportunity to pull some of the data that we knew would be very clean or as as clean as we could imagine it to be given how it's submitted to the SEC and look at how different firms price their bonds at the end of a particular day, which, you know, it's been possible to do that in the past, but as I just sort of alluded about the filing issue, it was a lot more difficult and a lot more difficult to do knowing for sure that the data was going to be filed consistently. So,

you know, unfortunately, a very bad time in the market for a lot of people third quarter at the end of the first quarter, 2020, but not a terrible time to do research. So what was your most striking finding in terms of the different prices that can emerge on the same security, the same bond, and the different approaches that different holders took in their pricing? Sure. So, you know, the first thing I would say is that we did not expect to see prices sort of on top of each other perfectly aligned for some of the reasons I think that you guys alluded to. But, you know, some of it is just sort of structural in the sense of when when bond portfolios are marked, they're marked at the end of the day, and it's handled in slightly

different ways depending on the firm that's doing it and some of the decisions that they make about pricing. So one of them is simply what time a day. And you can price bond portfolios at either three o'clock or four o'clock. It seems that there's a lot more consistent than there used to be a lot more firms are doing it at the three o'clock hour, but there is some diversity in that. They also have the option of choosing to price either at the bid or the ask or the mid. And so that's just another layer of difference there. And most firms are also, well, pretty much all the firms that we know of all use third-party pricing services.

And so then you add to the fact that there are a multitude, not a huge number, but there are different services. So once you get through all three of those lenses, it's certainly possible. for prices to be somewhat different. And, you know, I think the key issue here, I think you guys are talking before about the end-of-day price for a stock. Part of the reason for this, that we have this issue is that even if you are able to observe a price, you know, at 2 o'clock in the afternoon for a particular bond, and it's recorded

by FINRA, the regulator, and it's disseminated through trace, which is a reporting system, If that's not the price, if that trade doesn't happen anywhere near the close of the market, then somebody has to look at what that bond and say, well, this is what the price should have been at the end of the day, because the market shifted between the last trade and now, and we really need to change the price to reflect that. And that's part of where you get all this difference. Of course, as we mentioned in the paper, there are lots of bonds that don't trade at all in a single day either. So that complicates things as well. Finally, I would say there's always a possibility that the asset manager can challenge the price that comes from a pricing service.

So that adds another layer of complexity. You know, they may think that they know the real value of that bond better than the pricing agency, which is quite conceivably true. one manager challenges the bond and another firm doesn't, then, you know, prices might look different for that reason as well. Can you talk a little bit more about the third-party pricing services? Because I think this is sort of, whenever people hear about this for the first time, I think it's difficult for a lot of people to get their heads around, that there are actually companies out there whose job is to kind of,

of triangulate the price of a corporate bond. Sure. So it's interesting because, you know, people will sometimes ask, well, you know, why wouldn't you just price the bond yourself if you're a manager? And as Machet just alluded, maybe the, in some cases, a bond that's not widely held. Maybe the manager knows even more about it, the pricing service. You know, the truth is, is that we've evolved into this system because the goal is to have a third party or an arm's length party, if you will, making those pricing determinations to

sort of remove the manager a step away from that decision since the decision that the decision that's made on that price can affect the performance of an account that a manager is running and so forth. And it's the kind of thing that has evolved over the years. I haven't been involved in bond pricing directly. So it's, you know, I don't have the full history of the industry at my fingertips, but I can tell you that pricing has historically, a lot of that information has come from broker dealers themselves. And even today, the pricing services do talk to the broker dealers. And there are pricing services that are associated in some cases with broker dealers as well. So it's kind of a mix there. But, you know, the idea is that when you have a

portfolio of, you know, 150 different bonds or maybe 1,000 when you're talking about more, mortgages or a very large mutual fund, you need to be able to gather market information very, very quickly in order to do that kind of pricing. So it makes sense to have a third-party do it. And one of the advantages of having an agency that's sort of independent is that they can be in touch with multiple dealers. They can take in all the data feeds. And they also have systems in place so that if there isn't any really fresh information, but they have a signpost of some kind to work off of. For example, you know that the bond has this level of maturity, you know that it has this credit rating, it's in this sector, et cetera. You can sort of triangulate a price, as I think

someone said. They use a lot of different tools for that. Some of them are, now they're starting to use AI for some of that stuff. But the idea fundamentally is to try and get that to be as dispassionate as decision as possible. And, you know, one of the things that we talk about in the paper one of the reasons that you have some differentiation aside from the other factors is that there are a good handful of pricing services. And some firms may use a single service for everything, but most of the larger mutual fund managers that most people are invested with pick and choose among the services depending on the asset class that they're using. And so, for example, if they are looking at one particular kind of mortgage bond, private mortgage security,

that flew up during the crisis, they may use a single pricing service just for that and use somebody else for all the other sectors. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But on Vanguard.

At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio. That's vanguard.com slash audio, all investing in subject to risk vanguard marketing corporation distributor.

So, you know, this comes up every once in a while. Obviously, Q1 of last year was one time. I forget, what is it? 2016, Tracy, when were we talking about, like, energy bonds in the junk bond ETF, like years ago? Oh, man. I feel like that was late 2015, I want to say. Although, I think it happened twice, but I want to say 2015.

So, yeah, yeah, I think it was late 2015. And I know there was like a bunch of, there's like an oil. and a bunch of junk bond, ETFs got dislocated. Has it really been a problem yet, this question of ambiguous bond pricing of instruments that don't trade because I know there's all these questions

that emerge about the sort of liquidity mismatch where the bonds don't really move, but the ETFs that or the funds that own the bonds have to provide daily prices or even intramarket daily liquidity. How big of an issue is this? Because so far it seems like mostly the infrastructure is worth. Yeah, I think, you know, one of the benefits of the mutual fund structure in particular is that, you know, a lot of these differences get kind of washed out on a large portfolio.

So even in a mutual fund that, you know, that has truly, you know, billions and billions of dollars, even if there are a good handful of bonds where the pricing seems to be all over the map, you know, when you add all that up and average it out, they turn out to be kind of rounding errors in a lot of cases. We still have some research to do on that because we haven't gone through the entire universe and done it at the fund-by-fund level. But that seems to be the case for the most part. You know, the big problem, as you alluded, though, is when you wind up in a big crisis situation. And the more concentrated a portfolio and the worst of the crisis and the longer it lasts, the bigger problem that can be. And of course, you know, this isn't exclusive to bonds. It doesn't happen. You don't notice it nearly as often with equities, but that you alluded to earlier.

you know, if you have private placements in a mutual fund or, you know, very, very large slugs of a, of a private company that's spread around. And that happens, you know, often with young startup companies where small cap funds get involved and find it with big tech names. There can be disagreements about things like that, too. Usually it's not that big a deal to small investors when you have diversified funds. But as I said, crisis lands. last long enough or you have a concentrated enough portfolio, that's when it really starts to make a difference. So can we talk about that a little bit more? In your paper, what exactly, what was the difference in bond pricing differences in normal times versus something like the first quarter of 2020? Because I think your study looked at late 2019, which was a relatively calm period in markets, and then the end of March in 2020. So what was the difference between those two periods?

Sure. So as you alluded, we started in September of 2019. And just to clarify, you know, we used quarter-end data. And so this was essentially data on the last day of the quarter at the end of the day and looked across funds and across bonds that were appearing in more than one fund. That's cool. Well, this is kind of a nuance in and of itself, but when I say more than one, what I really mean is more than one firm's funds. Because each firm, no matter how many funds they have, if they own the same bond across multiple funds, the structure is to price them all at the same price.

So when we talk about this, we talk about how many firms priced the bond and that appear in the portfolios we looked at. But when you go back to September of 2019, for example, as you asked, if you take corporate, high quality corporate bronze, but corporate bronze in general essentially, the differences in price were fairly narrow. We use a term that we call the price spread percentage, where we took the lowest price and the highest price that we found, and then we took that, the difference between those two, and we divided it by the mean average, and that gave us this price spread percentage. And so if you look at AAA and double A bonds at the end of September 2019, that number was very small. It was only about 30 basis points for double and triple A.

And it got, you know, triple B was 0.37. So pretty small. Those numbers are still meaningful in the framework of, you know, a market where returns for a whole year, you know, the yield on bonds, as you just mentioned earlier, the 30 year, not quite even 2%. That's a meaningful number, but it's within the realm of expectations, given all the things that we said earlier about prices. And then they do tend to get a little bit wider, the thinner the market, lower the quality, the smaller the range of values and the bonds. Pardon me, what I mean to say is, you know, the high yield market is many times smaller, for example, than investment grade corporate market. And so you expect more dispersion there, and that's what you saw. at that point.

And then, of course, by contrast, when we looked at the end of the first quarter of 2020, those numbers were, in some cases, multiples. So I mentioned earlier 30 basis points for the price-bred percentage for AAA corporates. At the end of March 2020, that was 1.93%. And then the number for triple B bonds was 2.72%. So literally multiples of what we saw at that point, just another snapshot in time. Maja, your thoughts on the sort of significance of these figures or what they imply?

As Eric said, especially in the crisis modes, these differences were way bigger than we expected. One thing that I would maybe want to mention is that, you know, I remember that. this old paper that Fisher Black of the famous, you know, Black and Charles formula. He wrote this paper at some point, I forget when exactly in the 70s, called Noise. And this is kind of what we are dealing with here a little bit. You know, the bond prices are noisy. You know, they are not perfect. We don't know for sure what a given bond is worth, and that's what we are seeing here.

So on the positive side, Fisher Black asked the question, when would you say that the market is efficient? And the answer was if there is some kind of a true value, which we don't know about, but let's assume that it is there, Fisher Black said that the market will be efficient if the market is efficient,

if it'll assign a price within the factor of two of the real, unobservable, true value. So if something, let's say, is, there is an instrument whose true values, let's say, 100, then Fisher Black would say that the market is efficient if it assigns it a value somewhere between 50 and 200. That was his definition. So what we see here, you know, this is, these are these are fractions of, of what Fisher Black thought might still constitute an efficient market. So in that sense, we are not seeing anything critical here.

On the other hand, as I mentioned, if you see a 10 percentage point price differential between, between bonds, that can well be like two years worth of yield for some even for high yield issue, right? So that is a potential, you know, point of concern. I'm not sure what the solution to this problem might be. Nothing obvious comes to mind. We don't want to end up with just one pricing service. we don't probably want the government to dictate what that price is.

So I think we are stuck with the system that we have here. Let's just hope it continues to function reasonably well. One thing that Eric probably didn't highlight, so our sample that we are dealing with, we are only dealing with bonds that had at least two different firms pricing it. Now, it turns out that this is, in many cases, the minority of all the bonds. Most of the bonds that we are dealing with in these sectors, and especially in the municipal market, they are owned only by one firm. So we don't really know.

We can't, you know, you have only one price, but you can't talk about how spread out that price is, right? But that seems to be, that seems to be more of a norm than one would expect. So you're kind of dealing with these two issues. One is only one player owns a given bonds. And secondly, what Eric mentions, these bonds oftentimes go through long periods of not being traded at all. So how do you assign a price to an instrument like that? And I do remember we were talking to somebody who came from a big firm. And he was telling us that this.

was in the context of some emerging market paper. You know, they had to put a price on it. It says, this bond hasn't traded for seven years now. Who really knows what it's worth? So we are going to just say that it's worth $70 and be done with it. Wow. So I know we're talking about how, especially when you look at something like Munis or something like corporate bonds where they really aren't trading that regularly,

there's a tendency to say, well, the fact that there are pricing discrepancies isn't that worrying, and they tend to get sort of normalized in the long term and everything kind of works out. But one thing that was really surprising in your paper was that you also found price discrepancies in treasuries during the worst of the market sell-off in 2020. And this is supposed to be, you know, a huge and liquid and standardized market, and yet in March of last year, people seem to have difficulty agreeing what U.S. government debt was actually worth. Can you walk us through your findings and then also, I guess, your thoughts around this?

Like, how could that possibly have happened? Sure. So what you said is right on. You know, when you look at the data for the end of the third quarter of 2019, the differences were very, very small. You know, anyone looking at our charts, we'll see that there are cases where there are these outliers that show up in the data. And, you know, we've audited a number of them and found that the data we, the representation that we came up with is accurate. But there were certainly a handful of cases where we think that firms were actually reporting the information incorrectly.

But, you know, we didn't strip that out if we knew that the data, that we were using the right data. But when you look down at the interquartile ranges as we as we picked them out, so in other words, sort of the concentration of bonds for the most part in the middle, that was a very, very narrow band at the end of September 2019. Then when you got to the end of the first quarter 2020, there were pricing differences that went not quite to a full percentage point, but just under that. And as you said, that's pretty remarkable. You know, the reasons for that are kind of all over the map a little bit in terms of, you know, some of this was covered pretty widely in the press in terms of off the run securities and what have you. But the bottom line, I think, is that it really made a strong case that it was important that the Fed stepped in when they did and made the decisions that did. Because you can only imagine, you know, we saw much wide.

differences for other sectors, you can only imagine how much worse it would have been or would have potentially gotten if they hadn't gotten. I'm sorry, Machik, were you going to add something? No, no, no, no. No. Because the Fed was just leading up to the same cloud, but you said it already. I mean, the Fed was really worried about what was happening even in the, you know, the treasuries are supposed to be the gold standard for trading.

Yeah, Machi and I don't trade bonds ourselves, but, you know, we've definitely heard observations that there were certain bonds at certain times of the day during that period where people were seeing spreads that were unheard of from anything they had seen before. And as Macha said, that was, you know, again, however you want to frame it, I mean, I think we were all very fortunate that the Fed was awake and at the switch when that happened. because as bad as that is for the treasury market, the implications down the way from that are just huge. I think hopefully the average person on the street that doesn't read,

you know, the financial papers probably didn't even notice it. But if it had gotten to that point, we really would have been in a real best trend. One other thing that I maybe should have mentioned that it just occurred to me recently, that, you know, if given what we are seeing with these prices, what is the role of quantitative approaches in fixed income that kind of began to worry me a little bit. If you don't really know what the price is of something, then how you're trying to arbitrage some differences between these bonds.

So I'm sure that the people who do this have thought about it, but I haven't and I don't know how on dealing with it. But that does seem to, I mean, it is an interesting question. I mean, when you talk to sort of quants in the traditional equity space, you get the impression that they spend a lot of time on data quality, cleaning the data, making sure they have access to really high, you know, that the data is good. So when when thinking about porting some of these ideas to the bond space, if you can't even agree on what historical bond pricing data is, it does. seem harder to imagine that some of these strategies would be as effective. Yeah.

And you don't, yeah, you don't hear that much about those in the market. So I wonder if that's part of the reason. I don't know. I think that's one of the ultimate reasons why, you know, the conventional wisdom is that there is more, more to do in the fixed income space for active management than perhaps on the equity side. because there is so much structural inefficiency. One thing we haven't talked about is the fact that you're literally talking about millions of bonds. And not only are there several million bonds out there at this moment, but a month from now, those bonds will be different.

And over the course of a year, you know, that inventory, if you will, turn over because bonds are constantly maturing and their new bonds constantly coming out. The universe of U.S. domestic stocks is reasonably static. And that static is probably not the right word, but the number is a manageable number most of the time. You know, we're talking about several thousand. Once you get out into the millions, you've got to do a lot to keep that data clean and to even something as simple as getting a price, as you said. So it is a big, big lift for a lot of firms. And they spend a tremendous amount of money and time on it.

Yeah, the barriers to entry are very high in the fixed income. It's not like if you want to open an equity account, you still have to do all the kind of compliance and whatever stuff. But other than that, you can just do your research and construct a portfolio. You can't just walk off the street and start a bunch of that really there is no room. There is no room for small players here. I mean, the outlays of, you know, that you have to spend on data and analytics are just enormous, which kind of makes you wonder, makes you wonder what is what the future of this whole market is going to look like. Eating well shouldn't be complicated, but somehow it turns into recipes, prep, clean up, and half your Sunday gone.

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People who needs space. Matchett, you touched on the idea of what the solutions could be to these bond pricing issues. And for as long as I've covered bonds, especially in the corporate space, there's been talk about doing more electronic bond trading, maybe move. moving it to something that resembles an exchange and something that might have more transparent pricing. But what are the prospects of that actually happening? Because, again, like, I feel like the industry has been talking about it for years and

years and years and it just never really seems to. I mean, there's been progress, but it certainly isn't anywhere near the level of something like stocks. Well, I mean, I'll let Eric pick it up later, but one thing that, whatever platform you can think of will not address is the fact that some of these guys just don't trade. How do you assign a price to something that last traded three weeks ago? So that was our finding, I think. That's about half of bonds. Half of corporate bonds went through at least a three-week period when they were not traded. Yeah, I think the issue is really that

it's always going to be a part of the market. There are a couple issues. One is this issue of critical mass. So firms have definitely talked about and tried to take more of it electronic. And that works better in places where there's going to be a lot of trading and a lot of supply and demand meeting, it's meeting halfway in the same spaces, right? And that's why there are some electronic trading platforms that do some of the work. You know, there are, there is a lot of electronic trading in the treasury market. There even is quite a bit in the higher, higher quality corporate market. But that is, that works best when you're dealing with the high volume, high deal-sized bonds. The further down the ladder you go, the more fragmented it gets,

the less trading there is, then it's a bigger lift to try and get everybody together. And the fact of the matter is, is that for anybody who's actively involved in the industry, whether that's the investment banks and dealers or even the large active managers to some degree, there's an incentive to have some inefficiency in the trading, especially when it comes to the dealers, because they do make a lot more money on these structural inefficiencies in fixed income than they're able to in equities. It's inevitable that when there is inefficiency that you can ring out with technology, somebody will eventually get there and be able to do it. It will take more time because it requires that sort of critical mass. You have to be able to bring enough buyers and sellers together.

And when you don't have a single point of exchange, that that's more difficult. But what we said earlier about the nature of the bond market, the fact that it is so fragmented and splintered. And there are even a single, I mean, look at it this way. A single large company, a very, very large mega cap company will still have one stock, right? One share of common equity. Maybe a couple of, maybe they've got some prefers or what have. have you, but fundamentally, when you trade, you know, GE, you're trading GE. They may, the same company may have literally hundreds of bonds. And the differences among them may have, sometimes it may be

as simple as just the maturity. But once you spread that out, you've got different coupons, different maturities, and very large companies with subsidiaries and so forth may issue bonds at every different level. So the underlying credit quality is slightly different because they have legal differences among them as well. Trying to standardize and commoditize those, there are certainly parties that benefit from that, including the issuers themselves would. But as long as you've got that much differentiation, you're always going to have a huge swath of the market that isn't going to trade quite that often. I do think that in some of it is a matter of time and some of it is a matter of sort of the socialization of the market, people

sort of getting on the same page. But no matter how far down the road you go in terms of making it electronic, you're still going to have inefficiency with people's time. The bottom line is traders still get on the phone and haggle over prices for bonds. That's always going to happen to some degree the less standardized and the smaller the bond is. So one other thing to add to this, what we are hearing is that pricing agencies or pricing services now apparently look at at ETF prices because

whoever is creating the ETF units they are implicitly putting some price on these things whether they have been traded or not so that might be a potentially interesting avenue to get around that

problem although it's clearly not perfect but it tells you something. It's kind of crazy when the like liquid wrapper that you put around the stuff that doesn't trade very much becomes the reference point for pricing because it doesn't trade much. It's weird. Yeah, I think that that's definitely, definitely an important, interesting thing that the market is starting to absorb and learn about. I would point out, though, that you're still dealing with a subset of the market usually.

When you have a corporate bond ETF that has 100 bonds in it, that will certainly affect the liquidity of those 100 bonds and bonds that are similar in nature to it. But you wind up getting concentration of liquidity in those in that area as well. So that kind of thing certainly, there's no question that that should have an effect of creating better efficiency in parts of the market where those ETFs live. But to the degree that they have, that bonds are not concentrated inside those ETFs, you're still going to be dealing quite a bit with this issue. look, it's still an analogy. It doesn't fit entirely.

But, you know, when we talk about companies being a part of or not being a part of the S&P 500, it makes a difference. If you're not in that S&P 500, the demand for your stock is not going to be the same. So it is kind of a somewhat paradoxical situation where, you know, fixed income is supposed to be this safe and kind of boring asset, but we don't really, to some extent, know what these prices are.

at least much less clearly than we do for equities. To me, that was a little paradoxical. In that sense, fixed income is a little closer to private equity or something of that nature. Not maybe to the same degree, but in nature, I think, it's closer in terms of pricing. I love the idea that we think of bonds as really boring, as you said, but below the surface maybe, you know, someone, an asset manager and a pricing service provider are having like this raging debate about how much the bond is actually worth. But we don't get to see that most of the time. You know, Machik mentioned earlier about the fact that such a huge proportion of municipal bonds

that we observed were only being held in the funds of a single firm each. That's what's particularly interesting when you said about below the surface. You know, that's where that kind of argument may really come in when a manager may be the only large investor holding that bond and that that means that the pricing service itself isn't necessarily seeing it in anybody else's portfolio either they're going to sign a price based on some formula some matrix or or you know artificial intelligence and that's a case where the manager may know something about you know if it's a few million dollar bond of a small, you know, nursing home in West Texas, that's where that argument may come. But it's, as you said, it's all, it's all under the surface and we'll never see anything

about that. So there is more two bonds than meets the eye. All right. Well, Matcha and Eric, that was really interesting and really good fun to dive beneath the surface of an otherwise boring fixed income market. So thank you so much for coming on. Really appreciate it. Thank you. It's our pleasure. Thanks. That was great. So Joe, I actually feel kind of bad for calling the fixed income market boring because I don't think it is. But I do think that there is this big portion of it in terms of the market structure that doesn't get as much attention as it should in my mind. And the pricing of a lot of bonds is one of them. No, I think it's super one of those things. Interesting. My big takeaway is that I feel like if I were going to start some sort of like asset manager or

if I were going to like get into trading or something like that, I feel like I would definitely go into the bonus space. Just because, you know, listening to that after all, you know, it still feels like it's come up in some of our conversations. There are so many, I guess, inefficiencies or sources of friction might be a better way to characterize it in the space. Whereas with equities, there are very few. And as such, I suspect that there are, you know,

risk premium out there yet still to be harvested by the enterprising bond manager, the more they understand this stuff. I was worried for a second when you talked about starting something that you were going to start, like, the um, team, the electronic bond trading platform. But no, you went in a different direction. Okay. Take advantage of all the fragmented bond trading platforms to find inefficiencies in the market. Yes. The other thing, I mean, there is a lot to unpack in that discussion. the description of the treasury pricing discrepancies is still really remarkable to me.

And I would love to hear more about that. But the other thing that stuck out was this idea of ETFs kind of becoming the reference price for the bonds. They're actually wrapped around. And I've heard that before from people in the market. And I can understand why. But it just seems so circular to me and sort of like intuitive. odd. When that came up, like, I literally got in my head that image of the snake eating its tail. So when you say, it's exactly, like, it's like, okay, so it doesn't sound right. It sounds problematic.

Like, I don't know how it would become a problem, but it doesn't sound great if the instrument designed to hold the bonds can't be priced easily because the bonds are illiquid and so you end pricing of the bonds based on where the ETF trades. It does not sound great, but maybe it's fine. I don't know. We'll have to wait to a crisis that we'll say, oh, yes, that was a big deal. Well, I mean, to some extent, we kind of had the credit crisis in 2020 and the ETFs performed reasonably well, but you could imagine a scenario where because the ETFs are sort of influencing the underlying and vice versa, maybe you get a cascade effect of some sort. But anyway, your image of the snake eating its own tail is going to stick with me.

Okay, should we leave it there? Let's leave it there. All right. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Allaway. And I'm Joe Wisenthal. You can follow me on Twitter at the stalwart.

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