The pandemic has accelerated an evolution in bond trading, and it is already making a difference for investors—if bond managers have embraced tech-enabled trading. Here’s what’s happening, and what we expect to see more of down the road.
Trading in the Time of COVID-19
In the bond market, time is money. That’s why new technologies that combine proprietary credit research, market liquidity surveillance and portfolio information in one comprehensive tool can boost trading speed and investors’ bottom line.
This tech edge is even more imperative in the midst of a pandemic. Instantly, teams went from sitting next to each other to working remotely. Markets didn’t slow down for anyone—speed became even more of the essence, and technology enabled it. For example, our traders processed 60% more trades in March 2020 than in March 2019, despite being remote. And as shutdowns changed market and credit outlooks overnight, speed again was key. Our US credit analysts updated over 90% of their ratings in March—critical information that instantly fed into decision-making.
Pandemic or not, technology can help bond managers scan the market in real time and, based on market opportunities and current portfolio needs, suggest potential trades to its human overlord—the fixed-income portfolio manager, who can easily view how the trade would affect portfolio risk and return. Then, with the push of a button, the portfolio manager can approve that trade for a large number of accounts. The trades are built out in seconds, a task that used to take humans 20 to 30 minutes at best and included the potential for costly human error.
This same technology helps invest new portfolios more quickly. Three years ago, it took an average of 35 days to get a new portfolio 90% invested. Today, it can be accomplished in half the time—if bond managers have mastered the tech revolution. Every extra day those assets are invested equals more interest earned. Lastly, cutting-edge tech allows traders to cut through the noise of the fixed-income market, where thousands of bonds are trading at any given time, to find opportunities and source liquidity.
Better Sourcing of Liquidity
Liquidity doesn’t just appear in today’s bond markets—it needs to be found.
Liquidity is a measure of how easy it is to complete a trade without substantial change to the asset’s price. It used to be readily available through proprietary trading desks or hedge funds that were willing to take the other side of an asset manager’s trade.
But today, many of those proprietary trading desks and hedge funds are gone, and regulated broker-dealers are reluctant to bid on large individual bond trades that carry very specific and individualized risks that may be difficult to hedge. They are, however, quite willing to buy and sell large, diversified portfolios of bonds, as they can then turn around and hedge the positions using exchange-traded funds (ETFs). The more closely the portfolio trade resembles an ETF, the better the chances of favorable pricing.
Consequently, having the ability to create portfolio trades and to quickly assess offered portfolio trades is imperative. But putting together a portfolio trade of anywhere from 10 to 200 bonds isn’t for the faint of heart or the technologically challenged. It requires integrated portfolio management and risk management systems.
Better Compensation for Providing Liquidity
This same technology—properly harnessed—can sift through market noise to find hidden gems.
For example, in March 2020, liquidity pressure and investor sentiment caused trading in some sectors to detach from fundamentals, as investors needing cash sold what they could. Linked credit research and trading systems enabled the flagging of abnormally high trading volume in mispriced sectors—and allowed traders to quickly sift through hundreds of available bonds in those sectors to find issues that met investment criteria.
The result? Traders bought investment-grade bonds at higher-than-expected yields while providing market liquidity—and market liquidity is well compensated in times of market stress.
Market Connectivity and Price Transparency
While there are many electronic trading platforms and alternative trading solutions, fixed-income asset managers that trade through just one platform miss out on other potential sources of liquidity. (For municipal bonds, that’s a staggering 90% of managers.) Unfortunately, trading on segregated proprietary platforms hinders market liquidity and best execution and adds unnecessary costs.
So how does a trader know where to go for the best price? Today, they don’t always know. That’s why technology is critical in allowing managers to ask for bids from multiple platforms simultaneously. While that benefits clients, more market transparency is needed for all traders.
Execution management systems (EMS) can help with this. EMS act as trading conduits, connecting traders to market participants. They allow traders to engage liquidity in the marketplace—any place, any time—through alternative trade systems, directly with dealers, or via all-to-all anonymous trading platforms, to achieve the best execution.
Perhaps the biggest benefit of an EMS is that it allows managers to be more systematic in nature, trading more bonds in an automated low-touch or no-touch style. This frees traders to focus on more complex, high-touch opportunities that require human insight. The EMS also aggregates the data back to the user for further analysis.
In short, we imagine a future fixed-income trading world that resembles the national highway grid, with every trading platform connected to every other.
Know Your Manager
Bond managers know that they must build or buy the bond-trading technology of the future—or be left in the dust. Here are some questions to ask your manager to ensure they’re up to speed:
How much of your organization’s fixed-income trading is done electronically and how many platforms do you use?
In the last five years, how, specifically, has technology changed the way you do business? What changes are you contemplating for the next five years?
Can you describe your organization’s culture and attitude toward technology?
Do you see your tools as stand-alone improvements, or as part of a more holistic strategy?
Technology is changing the bond market for the better, and there’s still a lot of road ahead. As changes continue to roll along, ask the tough questions to make sure your bond manager is in the driver’s seat.
James Switzer is Global Head of Fixed Income Trading and Head of Municipal Bonds, Sasan Doroudian is a Trader in Credit Trading, and Erin Bigley is a Senior Investment Strategist for Fixed Income at AllianceBernstein (AB).
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.