Are Some Bond Fund Prices Stale?

I have long been skeptical of how fair bond fund prices are — or more accurately said, the potential ability for knowledgeable investors to “game” bond fund prices — in fixed income asset classes where liquidity isn’t great. Two asset classes that immediately come to mind are municipal bonds and high-yield corporate bonds. I finally got around to testing this proposition using daily returns data for a handful of different bond funds in these two asset classes. The findings confirm my suspicion.

If bond fund prices (or, equivalently, net asset values) were fair on a day-to-day basis, you should generally see that a prior day’s return for a fund tells you nothing about what today’s return will be. In other words, past returns shouldn’t predict future returns. The good news is that this is a testable proposition.

I pulled daily returns data for five different large bond funds from two different fund families. The first three funds have the majority of their portfolios invested in less liquid securities like municipal bonds and high-yield corporate bonds. The last two tend to own fixed income securities with better trading liquidity.

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