The Top 4 Reasons for Bond Market Inefficiency
A potential level 3 question around fixed income could center on reasons both FOR a fixed income manager to trade positions on their portfolio and/or common reasons they might NOT trade.
In this post we talk about the four main reasons mangers might NOT trade. You can see our other post on the top 8 reasons managers do trade as well.
Reasons the Bond Market might be inefficient
Here are some of the reasons why this may be true:
- Portfolio Constraints
- Quality constraints: Such as restrictions on buying junk bonds or limits to exposure
- Floating rate requirements for commercial banks (they are prohibited from holding fixed rate securities unless converted via swaps)
- Lack of international mandate
- Story Disagreements
- Happens when there is a lack of buy side/sell-side consensus.
- Generally refers to friction and mismatch on demand/supply side in secondary market
- Accounting constraints around trading (i.e. not wanting to sell and acknowledge a loss of an asset held on the books at the purchase price) may lead to buy-and-hold
- Trading is seasonal in the bond markets and tends to slow at the end of each month