Corporate fixed-income investing is becoming a buy-and-hold market, as the reduction of traditional market makers and the resulting loss in inventory make active trading strategies more risky.
“The long term favors fundamentally biased fixed-income investors over those with very active trading strategies,” said Michael C. Buchanan, deputy chief investment officer, Western Asset Management Co., Pasadena, Calif. “It's getting the right price and owning the investment, not trading it.
“Some money managers are philosophically founded on active dynamic trading strategies, which can be highly volatile,” Mr. Buchanan added. “Adding value that way is going to be challenging going forward. Active managers who have a foundation of doing fundamental work and are investing for the long term, those yields will increase and my guess is that that will continue.”
Earlier this year, J.P. Morgan Chase & Co. became the latest investment bank to indicate it could cut back on its fixed-income trading desk because of regulatory requirements and capital costs, as Morgan Stanley and Credit Suisse Group have done. Separately, UBS AG last year outsourced most of its fixed-income trading platform to trading software providers Murex and Ion Trading.
In most corporate bond markets, trading has become highly concentrated in just a few liquid issues, and concentration appears to be increasing in some market segments, according to a March 18 report from the Bank for International Settlements.
A recent Western Asset white paper showed that just 44 of the 756 issuers of the more than 6,000 bonds in the Barclays Capital U.S. Corporate Credit Bond index account for a combined 50% of all investment-grade trading volume, while 529 issuers in total make up less than 10% of trading volume. “The market is becoming far more concentrated with a few issuers,” Mr. Buchanan said.
Yet, the volume of investment-grade bond trading has risen to $3.26 trillion as of Dec. 31, up 3.5% for 2014 and 64% above the volume at the end of 2008, according to TRACE data from the Financial Industry Regulatory Authority, Washington.
Gregory Davis, principal and global head of fixed income at Vanguard Group Inc., Valley Forge, Pa., said if there are fewer investment banks willing to act as market makers, trades will be tougher to get done, although he believes more diversification within a fixed-income portfolio could help. “The market taking longer to be able to move positions will ultimately harm performance,” Mr. Davis said. “That's why you need to be highly diversified. Concentration creates a challenge in terms of risk.”