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

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:16)

And I'm Joe Weisenthal.

Tracy Alloway (0:17)

So Joe, I think equity markets have been getting all the attention lately.

Joe Weisenthal (0:23)

Yeah, for good reason.

The index level is extremely high, individual stocks, all kinds of wild stories. But I am aware that there's also some interesting stuff in credit markets. It's not getting as much attention, but I'm aware that there's some stuff going on.

Tracy Alloway (0:41)

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 US 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?

Joe Weisenthal (1:28)

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 the say 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 degree upon price is not as much of a thing at all.

Tracy Alloway (2:13)

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 US. Treasury market.

And that's when people started talking about discrepancies in bond prices, which is, it's never a good sign, is it?

Joe Weisenthal (2:48)

No, it's like basically, 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.

Tracy Alloway (3:01)

Yeah, exactly. For most people. So, okay.

Yes.

So today, we're going to be diving into the topic of bond pricing, and we're gonna 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, Maciej Kowara. Thank you both for coming on.

Eric Jacobson (3:47)

Glad to be with you. Thanks for having us.

Tracy Alloway (3:49)

So I guess first things first, but 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?

Eric Jacobson (4:01)

Well, there are a few things. I think, you know, I hate to use the cliche that crises are an opportunity, but when you look at 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 Endport, 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 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 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 gonna be filed consistently. So, unfortunately, a very bad time in the market for a lot of people at the end of the first quarter, 2020, but not a terrible time to do research.