Trading US Corporate Bonds: It Pays to Be Flexible
- Corporate bonds exhibit sizable dispersion in trading costs due to less frequent trading.
- From 2013 to 2024, high-cost US corporate bonds underperformed low-cost substitutes over a three-month holding period by 20 bps on average, net of transaction costs.
- An investment approach that allows for flexible bond selection and cost-efficient trading can benefit investors in the long run.
Corporate bonds are a significant part of the fixed income opportunity set for investors. For example, over 8,000 corporate issues with a market value of nearly $7 trillion were included in the Bloomberg US Aggregate Bond Index as of December 2024. While corporate bonds can offer portfolio diversification and higher yields compared to government bonds, they tend to trade less frequently and at larger spreads.
In our recent paper,1 using 159 million trades across 29,032 US corporate bonds in the Bloomberg index universe, we find that while trading costs have fallen over time, sizable cost dispersion remains between similar bonds. This is good news for investors with flexibility: by substituting higher-cost bonds with lower-cost bonds of similar characteristics, they can improve net returns while achieving the desired exposures.
To quantify the benefit of flexible trading, we compared the returns of high-cost bonds to low-cost substitution portfolios, controlling for credit quality, duration, and gross expected return (mid-yield).2 From 2013 to 2024, low-cost substitutes outperformed high-cost bonds by an average of 20 bps net of transaction costs, over a three-month holding period, while their gross returns are similar. This pattern is consistent across different credit quality groups (AAA–AA, A, BBB, and BB), as shown in Exhibit 1.
These results suggest that the ability to substitute high-cost bonds with low-cost alternatives can help reduce transaction costs without impacting portfolio exposures. In contrast, a lack of flexibility in portfolio design and trading can increase costs.3 More broadly, an investment approach that allows for flexible bond selection and cost-efficient trading can benefit investors in the long run.
Three-Month Realized Gross (Mid-Price) Returns and Net Returns (%) of Substitutable High-Cost Bonds and Low-Cost Substitution Portfolios
June 2013–Dec 2024
Past performance, including hypothetical performance, is no guarantee of future results. Actual investment returns may be lower.
Footnotes
-
1. Aabbhas Garg and Samuel Wang, “Transaction Costs of US Corporate Bonds and Benefits of Flexible Trading” (research paper, Dimensional Fund Advisors, July 2026).
- 2. Transaction costs are estimated using the average effective spread over the past 10 days. For a bond on a given trading day, the effective spread is the difference between the trade quantity-weighted customer-buy price and the trade quantity-weighted customer-sell price, scaled by the midpoint of those two prices. For further details, refer to Figure 1.
- 3. Aabbhas Garg and Samuel Wang, “The Reconstitution Cost of US Corporate Bond Indexing” (research paper, Dimensional Fund Advisors, August 2026).
Glossary
Duration: Bond duration measures a bond’s price sensitivity to interest rates.
Gross expected return: Same as mid-yield.
Mid-yield: The midpoint yield between trade quantity-weighted customer-buy and customer-sell yields.
Mid-price: The midpoint price between trade quantity-weighted customer-buy and customer-sell prices.
Gross return: The gross return is the total return before accounting for transaction costs. This is computed using the mid-price of the bond between the buy and sell date.
Net return: The total return after accounting for transaction costs. This is calculated using the trade quantity-weighted buy price at buy date and the trade quantity-weighted sell price at sell date.
Market-value-weighted portfolio: A portfolio in which each bond’s share is determined by its total market value in comparison to the market value of all bonds in the portfolio.
TRACE: The Trade Reporting and Compliance Engine (TRACE) is the Financial Industry Regulatory Authority Inc. (FINRA) developed vehicle that facilitates the mandatory reporting of over-the-counter secondary market transactions in eligible fixed income securities. All broker-dealers who are FINRA member firms have an obligation to report transactions in corporate bonds to TRACE under a Securities and Exchange Commission (SEC) approved set of rules.
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Bloomberg data provided by Bloomberg. Credit ratings are based on index ratings from Bloomberg.
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