Why is it more challenging to construct and monitor a fixed income portfolio which attempts to closely match a bond index than an equity index?
This seems me counterintuitive, since bond indexes are composed of fixed income securities and it should be easy to match using assets similar to its components. I would appreciate if someone could help me digest this part.
Source - Reading 22: Introduction to Fixed-income portfolio management, 3.2 Total return mandates, 2nd paragraph, last sentence.
FI is illiquid compared to equities. Some bonds have no trades in a single year! How many bonds have you ever traded? how many stocks have you traded?
Pricing a bond with matrix pricing becomes inaccurate
Also, many issuers have multiple bond issues and new bond issues make obsolete the old ones.
Because replicating a bond index will only require a few trillion dollars, which let’s face it, you don’t have.
these indexes have 20,000 issues in them. And you can’t just go buy a single bond. When I used to work in ops, we would have to tell advisors constantly that we can’t just raise 2k in cash from their clients muni account - since they only trade in blocks of 5. So, not only are there an ASBURD amount of bonds in these indexes, but they also trade in large blocks.
Long story short- you’re not going to be able to match a bond index via full replication . . . Ever.
I see. Thank you guys for explanations.