Active Bond - Explained
What is an Active Bond?
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Table of ContentsWhat is an Active Bond?How Does an Active Bond Work?Academic Research on Active Bonds
What is an Active Bond?
An active bond refers to either a corporate bond or other fixed-income security which is often traded in largely on the New York Stock Exchange (NYSE). This isn't to be mistaken for actively managed bond investment techniques.
How Does an Active Bond Work?
Active bond crowds trade active bonds and they are traders who engage in the buying and selling of bonds which are often traded. Active bond orders are usually filled quickly as a result of higher demand presence from investors, and generally, they have lesser bid-ask spreads. Because active bonds have higher liquidity, active bond traders dictate prices better. This is entirely different from infrequently traded bonds which inactive bond crowd trade. An inactive bond crowd refers to an exchange members' group who engage in the purchase and sale of infrequently traded bonds. Due to the lack of frequent trading, it may take a longer time to fill limit orders placed by an inactive bond crowd. Another name for the inactive bond crowd is the cabinet crowd. Before the invention of electronic trading, orders placed by members of the inactive bond crowd usually were kept in cabinets off to the side of the general trading floor. This brought about the cabinet crowd nickname. All else being equal, bigger trades are usually less costly than smaller ones; unlike large institutions, small institutions pay more to trade; and there is the likelihood of small bond dealers For some investors, active bonds can be a good choice in that, as fixed-income securities, the bonds' price is usually unaffected by their high trade volume. Furthermore, active bonds are rated higher by agencies like Moody's and Standard & Poor's. Combining these features, investors frequently use active bonds to diversify portfolio or as a safe investment during market volatility periods. A daily chart is published by many financial publications. This chart shows the ten most actively traded securities which are based on the total face value traded, in each of the three sectors of the corporate bond market: high-yield, convertibles, and investment grade. Investors can utilize this data for comparing the market value of the corporate bonds they are either thinking of buying or the bonds they own. As noted by SIFMA, higher volumes of trade for a specific security typically means better order execution, higher liquidity, and highly active market for buyer and caller connection. The most actively traded corporate bonds of the day might show where the bond investors get the biggest opportunities, as well as, risks in terms of both issuers and industries.
Academic Research on Active Bonds
- Gains from active bond portfolio management strategies, Boyd, N. E., & Mercer, J. M. (2010). Gains from active bond portfolio management strategies. Journal of Fixed Income, 19(4). The belief that excess returns can be achieved by correctly timing changes in yields and/or yield spreads motivates active bond portfolio management strategies. Given the rich literature linking yield spread patterns to both the business cycle and changes in short-term interest rates, we motivate and demonstrate the efficacy of simple spread-trading strategies tied to both. Using thirty-four years of fixed income returns, we demonstrate that straightforward rules would have led to superior risk-adjusted performance relative to standard fixed-income benchmarks. Furthermore, the strategies tied to short-maturity interest rates are based on the use of past information only.
- Active management, fund size, and bond mutual fund returns, Philpot, J., Hearth, D., Rimbey, J. N., & Schulman, C. T. (1998). Active management, fund size, and bond mutual fund returns. Financial Review, 33(2), 115-125. Conventional wisdom holds that bonds are relatively homogenous investments compared to equities. Consequently, factors that explain variation in returns among bond mutual funds may differ in magnitude from those for equity mutual funds. In this study, a timeseries crosssectional analysis is employed to investigate the relationship between a bond fund's riskadjusted return and specific fund attributes. Results indicate that a bond fund's past performance does not predict future performance and that bond fund managers are generally ineffective at increasing riskadjusted returns. However, unlike equity mutual funds, bond mutual funds do appear to enjoy economies of scale.
- The performance of active Australian bond funds, Gallagher, D. R., & Jarnecic, E. (2002). The performance of active Australian bond funds. Australian journal of management, 27(2), 163-185. This paper examines the investment performance of active Australian bond funds and the impact of investor fund flows on portfolio returns. Security selection and market timing performance are evaluated using both unconditional models and conditional-performance evaluation techniques that account for public information and the time variation in risk. Overall, the results of this paper are consistent with the US and international evidence, documenting that performance is consistent with an efficient market. While actively managed institutional funds perform broadly in line with the index before expenses, the paper documents significant underperformance for retail Australian bond funds after fees. The study also documents that retail fund flows negatively impact on market timing coefficients.
- Forecasting Interest Rates: Key to Active Bond Management, Meyer, K. R. (1978). Forecasting Interest Rates: Key to Active Bond Management. Financial Analysts Journal, 34(6), 58-63.
- Active bond strategies: What link between forecasting ability, excess return and performance?, de La Bruslerie, H. (2004). Active bond strategies: What link between forecasting ability, excess return and performance?. Journal of Asset Management, 5(2), 105-119. The active management of a portfolio should not be appreciated only in terms of excess profitability vis--vis a reference benchmark. It is part of a complete process where a manager's superior expertise is supposed to exist upstream. This paper aims to analyse the tie between forecasting ability and excess performance in active management. It limits itself to bond portfolio management, but takes into account the international environment. A simulation of choices of maturity and choices of market in an environment with four currencies will show a link between forecasting ability and the expectation of excess return. The opening of the international environment shows a superior potential for gain in comparison with domestic active management, but introduces a strong complexity.
- The Dividends from Active Bond Management, Meyer, K. R. (1975). The Dividends from Active Bond Management. The Journal of Portfolio Management, 1(3), 18-22.
- Developing of a model to determine the default bond spreads of African countries in the absence of active bond markets, Roux, K. C. (2010). Developing of a model to determine the default bond spreads of African countries in the absence of active bond markets (Doctoral dissertation, Stellenbosch: Stellenbosch University).