Expectations of a borrowing deluge from corporates globally are turning bond market attention to a little-known tool that’s already helping smooth trading of illiquid debt the way exchange-traded funds (ETFs) did years ago.
The innovation, known as portfolio trading, involves bundling several bonds into a single package to trade. Once unwieldy and time-consuming, tech innovation is rapidly turning it mainstream.
More significantly, the strategy may have earned its stripes during the coronavirus-linked market mayhem.
During volatile times, trading in corporate bonds and other risky assets can dry up, forcing sellers to slash prices. But market participants have reported several instances when even debt from stricken hospitality and travel firms, packaged into bond portfolios, smoothly changed hands.
Cumulative portfolio trading volumes globally on bond trading platform Tradeweb topped $100 billion in June, rising from just over $2 billion when it launched portfolio trading for U.S. investment grade and high yield bonds in January 2019. The cumulative total was almost $51 billion in January 2020.
It executed 54 portfolio trades in Europe in March, versus 19 in February and 15 in January.
“We have been doing (portfolio trading) a lot more since March and that’s because it reduces the size of the outright risk associated with a one-way trade on a single bond,” said David Arnaud, a fixed income fund manager at Canada Life Investments.
In a portfolio trade, an asset manager picks a basket of securities to buy or sell, then analyses them on various metrics such as liquidity, inclusion in ETFs and transaction size.
Once constructed, an order is sent, either directly to counterparties or over trading platforms, which quote a price reflecting the value of all the securities the portfolio contains.
For some, this complements fixed-income ETFs which allow investors to trade baskets of securities simultaneously.
But a portfolio trade can make liquidity pools available to a wider array of bonds, even those not in ETFs. It can be useful for investors who want, for instance, to trade off a single factor such as duration or credit agency ratings.
The tool proved handy for Andrew Falco, global head of FX and fixed income trading at Fidelity International. Seeking higher exposure to longer-maturity debt, Falco’s team used it for a “very decent sized transaction”, he said.
TIME, COST, REGULATION
The trend is gathering speed in world corporate bond markets, worth more than $10 trillion. Robert Simnick, credit portfolio specialist at Invesco Asset Management, told a recent conference he had executed nearly 130 portfolio trades in the last two years, with about 100 bonds in each.
“There were a couple of guys doing this last year and now I have a whole portfolio trading chatroom dedicated to this kind of trading,” Simnick added.
A survey of 49 European investors by consultancy Greenwich Associates found 40% planned to execute portfolio trades in the coming year or had recently done so.
Technology has allowed the trend to gather speed by computerising a process that previously relied on spreadsheets and manually inputting data. In an electronic format, a portfolio trade becomes a much easier “workflow” for a dealer because the bonds are already in the system and can be grouped together more easily than was previously the case.
Mehmet Mazi, global head of debt trading and financing at HSBC, said pricing and transacting several hundred bonds now takes just a couple of minutes.
“The first portfolio trade we did a few years ago took three weeks because we didn’t have the technology, we had to do it manually,” Mazi said.
The strategy, like others, isn’t perfect. Some traders said it stalled at the height of the March turmoil, when even the highly liquid U.S. Treasury market and ETFs were seizing up.
But several factors may drive its growth.
For one, corporate borrowing is soaring, with companies likely to take on $1 trillion of new debt this year, Janus Henderson predicts.
Guy America, global head of credit trading at JP Morgan, expects the tool to grow with the underlying market.
Then there’s regulation, more specifically MiFID II rules requiring post-trade transparency and proof of best execution.
Chioma Okoye, European credit product manager at Tradeweb, said an asset manager can ask up to three dealers to quote a package price for their portfolio. All quoted prices, for the package and per bond, are shown on Tradeweb, making it easy to prove “best execution” to clients.
Finally, Kenneth Monahan, a senior market analyst at Greenwich Associates, said estimates suggest investors using portfolio trading can cut execution costs roughly in half. “I believe that credit portfolio trading will have profound effects on market structure,” he said.