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How do equity and fixed income markets differ?

Quick Take on Fixed Income
September, 2015

Q: How do equity and fixed income markets differ?

A: Most people are familiar with the equity markets and how they work. After all, anyone can turn on the television and see traders scurrying around the floor of the New York Stock Exchange, filling orders for their clients. Over the past few decades, equity markets have become models of efficiency. This is partly due to major advances in technology but mainly because of how these markets are structured. Equities trade on exchanges, meaning all market participants must go to the same place to transact business. No matter if you are Goldman Sachs or John Q. Public, you have to go to the Nasdaq exchange to buy or sell shares of stock. Because everyone must go to the same place to transact business and because equities trade every business day, market pricing becomes efficient and transparent. Pricing transparency and readily available information mean a lower bid/ask spread and better execution for both institutional and retail investors.

Many people have the misperception that bond markets work in the same manner. Unlike equity markets, bonds do not trade on a centralized exchange but on an over-the-counter market that is made up of a loose network of thousands of broker/dealers throughout the world. Another key difference between the equity and fixed income markets is their trading frequency. Stocks, with a few exceptions, trade every day on their respective exchanges while bonds can go months, or even years, between trades. The double whammy of not having a centralized exchange and infrequent trading makes price discovery in the fixed income markets very difficult for retail investors who don’t have access to expensive fixed income tools such as a Bloomberg terminal.

Because price discovery is difficult, retail investors are frequently taken advantage of in fixed income markets in the form of large markups. A Wall Street Journal article from 2014 cited a study showing that individual investors in the municipal bond market experienced markups of roughly 1.73 percent, or $1,730 per $100,000 of bonds traded. By contrast, BAM’s fixed income desk, with whom our firm works, receives an average institutional markup of 0.20 percent, or $200 per $100,000 of bonds.

Clearly, there are significant differences between the equity and fixed income markets. Unfortunately, these differences in the fixed income markets allow retail investors to often be exploited by Wall Street, making it imperative to work with a separate account manager when using individual bonds.


Copyright © 2015, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.

 

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