February 8, 2024

The Remix: Unwrapping the Fund

Jonathan Birnbaum

Founder of OpenYield

OpenYield is on a mission to make it cheap and easy for retail investors to invest in bonds. We often receive questions on why this matters in a world with myriad ETFs and mutual funds to access the asset class. To examine the value proposition, let’s take a step back and reflect on what funds represent, what investor goals are, and why direct ownership is compelling.


The fund is an OG capital markets innovation. Funds emerged in the 1890s delivering a killer benefit to smaller investors: diversification. A manager would pool securities in a single portfolio, issue shares and voila – a single share represented a cross-section of the entire pool. Ownership via funds also brought daily liquidity (for open-end funds), professional oversight and convenience. Originally equity only, fixed income mutual funds emerged post-WWII, fueled by investors seeking steady income with lower risk and today these funds boast $5T in assets.

Exchange-traded funds (ETFs) broke onto the scene in 1993 providing a tradeable variant of the mutual fund, with advantaged tax benefits to boot (realized capital gains can magically disappear via in-kind redemptions)[1]. It wasn’t long until the first fixed income ETF launched in 2002 with the iShares suite of LQD/SHY/IEF/TLT, and now the FI ETF industry surpasses $1.7T in assets, growing rapidly at 23% per annum – double the pace of FI mutual funds, and trebling the baseline bond market itself.[2] 

As FI ETFs have grown in size, they have fundamentally altered the secondary market by providing an observable intraday level for a tradeable cash basket. The FI world was accustomed to conversations with traders to ascertain the real price of bonds, so the ability to view an exchange-traded price was revolutionary. FI practitioners gawked at these ETF prices, crying wolf about disconnects between ETF liquidity and bond liquidity (see Matt Levine’s recurring “People Are Worried About Bond Market Liquidity” headline) – yet the mechanism has undoubtedly worked and currently enjoys widespread product market fit. As the ecosystem has flourished, issuers have flooded the market with tickers representing every slicing and dicing of risk that business strategists can contemplate. All told, US investors today can choose from 663 FI ETFs.[3]

Investor Goals

While philosophies and timeframes differ, the general goal of investors is to maximize net of tax wealth. Asset allocation strategies are widely used to dictate splits between equities, fixed income, and alternatives; an example is the classic 60/40 equity/bond portfolio that rebalances annually. There are multiple gateways to pursue your strategy: self-directed brokerages, robo-advisors, SMAs, mutual funds, hedge funds, etc. Even if you are not consciously pursuing a strategy, your assets (even cash) all exist somewhere, and this distribution is, technically, your current suboptimal strategy.

Jack Bogle shook up the industry in 1976 when he introduced the first low-cost index fund at Vanguard, which promised “average” returns. Notably, Wall Street laughed the idea out of the room, and it fell short of its IPO goal by 95%[4]. Fast forward to today and not only is this approach widely accepted as a default, but shifting to an active strategy is considered blasphemous by efficient market devotees. The index fund combined the trifecta of ease (single ticker), passivity (minimized churn and errors), and low fees. ETFs have further improved on these benefits with intraday liquidity and tax efficiency.

So have we achieved investor nirvana in 2024?

Customization at Scale

As a thought experiment, imagine if there were an omnipotent portfolio technology that could deliver any mix of securities to your portfolio in any size. What should investors own?

For your equity allocation, if you are a believer in a passive approach, you might choose to replicate a widely adopted index such as SPX500 or Nasdaq100. But rather than go about it exactly, you now have the flexibility to introduce tilts. As a stylized example, if you are a Microsoft employee, you might de-weight the index’s 7.3% exposure, as well as broadly reduce technology. If you are a values-based investor, you might overweight ESG names. Holding hundreds of names (versus a single fund ticker) gives you far more optionality to realize individual losses and temporarily shift cash to correlated assets, providing a boost to your net-of-tax return profile.

When managed by an asset manager, this direct approach is known as a Separately Managed Account (SMA), and specifically Direct Indexing. It not only exists today, but is the fastest-growing product in wealth management, surpassing ETFs[5]. Asset managers running large-scale operations with sophisticated portfolio technology are soaking up allocations for good reason: the approach offers empirically better outcomes than the ETF wrapper.[6]

Technology + Bonds Is the Holy Grail

For all the reasons SMAs are flourishing in equities compared to funds, the opportunity in the bond market is even more compelling.

If you were to unwrap popular bond funds, you’d find a staggering, dynamic collection of thousands of securities. The reason is that bond ETFs are geared for mass distribution and therefore must have stakes across many benchmark bonds that aren’t necessarily suitable for your specific needs. For example, LQD has 45 JPMorgan bonds – how many do you actually need?

Unlike equities, bonds offer rich selection across durations and yields. You can buy short-dated or long-dated bonds, hold to maturity or rebalance. You can run strategies optimized for current income or to just generally track the market. With our hypothetical omnipotent portfolio technology, the probability you’d want to independently replicate the mass market baskets delivered by funds to pursue your individual goals is nil.

While concentrating in equities introduces risk that you might miss out on big movers like the next Amazon, concentrating in bonds presents a fundamentally different tradeoff as you are worried about avoiding bad apples. The magnitude of this effect is extreme: the top 4% of stocks have driven all excess equity returns[7], whereas high-grade bonds average zero defaults per year.[8] Consequently, bond investors can practically diversify with fewer holdings than funds and generate total returns better aligned with their goals and risk preferences.

As in equities, direct ownership of bonds also enhances tax efficiency. Automatically realizing losses by swapping underwater bonds into similar issues is relatively straightforward – you can replace Bond A with Bond B from the same issuer. And for higher-income investors, the opportunity to take advantage of tax-exempt securities for your locale is one of the unique privileges of bond ownership.


The ideal investment engine takes into account your unique profile – your wealth, tax information, risk tolerance, goals, etc. – and generates and manages a strategy on your behalf through time. ETFs and funds have been the best vehicles for market exposure for the last few decades, but now that technology is able to cheaply and easily deliver customized portfolios at scale, SMAs are winning. 

We are still in the early innings of this transition as the wealth industry digitizes. Security certificates have been replaced by database updates at brokers, and price formation has been replaced by sophisticated market making algorithms – yet there are still legacy costs involved in the transaction lifecycle. Consequently, entry points for SMAs generally remain in the $100k+ range across asset managers. 

While the wealthy have benefited from directly managed bond portfolios for decades, technology is now replacing the expensive human capital historically required to manage and distribute bonds, opening up the floodgates for mass market access. Bonds are playing catchup compared to equities, but the direction of this market is inevitable due to the better portfolio outcomes afforded by direct ownership. A prerequisite for this coming generation of bond products is a marketplace powered with automated liquidity making it efficient to systematically trade small lot sizes – and that is what we have built at OpenYield.

The Bond Market Powering Retail

Our modern bond marketplace enables you to serve clients with modern technology, 100% firm quotes and aggressive pricing. This is the bond market you’ve been waiting for.

Reach out to us today.