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
  • Buy-and-Hold
    • 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
  • Seasonality
    • Trading is seasonal in the bond markets and tends to slow at the end of each month