Investors eager to load up on corporate bonds at the start of the year have increasingly been turning to technology to get the job done.
Banks’ portfolio trading desks, where computers price hundreds of securities in a matter of minutes, have enjoyed a busy start to 2023 as institutional investors have piled into investment-grade debt. US portfolio trades increased 45% to US$84bn in the first two months of the year from the same period in 2022, according to estimates from bond platform Tradeweb, outstripping the 22% growth in corporate debt trading volumes in the wider market over that time.
Many believe the upswing in portfolio trading is further confirmation of the shift towards a more equity-style trading regime for corporate bonds amid greater electronification of these markets.
“Real money investors are using portfolio trading to trade investment-grade credit now in significant size,” said Rehan Latif, co-head of global credit at Morgan Stanley. “This is a new thing and I think it’s the most fascinating evolution of the credit market.”
Portfolio trading has grown rapidly in recent years, with many investors seeing it as a handy way to buy or sell sizeable amounts of corporate bonds quickly. These transactions involve trading desks using algorithms to price hundreds of securities in the space of an hour, sometimes totalling as much as US$2bn. As well as being speedy, portfolio trades often end up a cheaper alternative to executing a series of individual transactions over several days.
Many credit experts believe this increased electronification of corporate debt trading is helping to address longstanding concerns over liquidity – or the ease with which investors can manoeuvre in and out of the market in large size without unduly affecting prices. They note that portfolio trades and other forms of electronic activity helped record volumes pass through credit markets at the outbreak of the pandemic in 2020 when asset prices whipsawed.
Quick adjustments
Portfolio trades accounted for about 5% of US corporate bond volumes last year compared with roughly 2% in early 2019, according to Tradeweb estimates. Ketan Shah, a credit trader at Aviva Investors, said the benefits of this approach included efficiency, timeliness and certainty of execution.
It “is a useful addition to any desk’s toolkit”, Shah said. “Instead of trading one hundred-plus line items, it can be done in one go, allowing you to adjust risk quickly within a narrowly defined window of time.”
While concerns over market liquidity have tended to focus on investors' ability to sell bonds in a hurry, portfolio trades are also proving their worth as a way for money managers to deploy the material influx of cash flowing into credit.
Investors poured US$3.8bn into investment-grade credit funds in the week ended March 8, according to a report from Bank of America citing EPFR data, marking the 11th straight week of inflows. That comes on the heels of a strong rally in credit markets in late 2022 and early 2023, as higher yield levels have increased the appeal of fixed-income investments.
Putting that money to work in large size can be easier said than done, though. New issuance markets have had a typically busy start to the year, providing investors with one avenue to purchase securities. But buying in bulk can still prove challenging in secondary markets for those wanting greater freedom to pick and choose their investments. That is particularly true when prices are moving in one direction, traders say, due to banks’ reluctance to hold large stocks of bonds on their books.
“Due to market dynamics, investors can sometimes struggle to source large volumes of paper through traditional routes because of a lack of inventory, whereas portfolio trading allows them to do so in one go,” said Latif.
Maturing market
Many banks have invested heavily to grab a larger share of portfolio trading in recent years. While that competition initially succeeded in driving down portfolio trading prices for clients, it ultimately caused some dealers to pull back somewhat last year and charge more for these services during what proved to be a tougher period for corporate bond markets.
Even during this time, though, traders point to several signs that the market for portfolio trading continued to mature. Tradeweb said the number of line items in portfolio trades on its platform increased 40% in 2022 from a year earlier and in January it said it processed a transaction with a record of nearly 2,000 line items. Meanwhile, the average time to price and trade dropped to below an hour from closer to 90 minutes in early 2021.
“We still expect portfolio trading to become a higher percentage of the business over time,” said Izzy Conlin, head of US institutional credit at Tradeweb. “We’ve noticed that clients keep trading electronically, but they will pivot between different trading protocols such as portfolio trading or RFQs [request for quotes] depending on where they think they’re going to get the best pricing. They don’t go back to not trading electronically, they just shift the protocol they’re using.”
Tradeweb is majority owned by the London Stock Exchange Group, which also owns IFR.