Is It Time to Switch from Bond Funds to Individual Bond Buying?

Abstract

This article revisits Dubil’s previous study of corporate bond bargains with new data and a new methodology. Since 2008, the corporate bond market has become more volatile. Dealers hold less inventory, while issues are concentrated in buy-and-hold portfolios of large asset managers. This has caused wild price swings, yet the bid–ask spreads have not increased. Bonds of identical issuers with identical credit ratings trade at different prices, offering individual investors opportunities to shop for bargains. Yields to maturity and prices between the best and the worst offers vary up to 1% and 10%, respectively. The author follows bonds of the same issuer over time throughout 2016–2017. He finds that prices on nearly identical bonds move in opposite directions or move by vastly different amounts. These movements are large (up to 10%) and not proportional to the modified duration. Some yields follow Treasuries, some yields do not. Thus, yields are subject to random variation unrelated to credit spread. Different issues at different times become expensive or trade at bargain prices. The author suggests that investors’ fixed-income allocations may be cost- and duration-optimized through buying individual bonds rather than through investing in active bond funds or index ETFs.

TOPICS: Fixed income and structured finance, portfolio construction, mutual funds/passive investing/indexing, performance measurement