Active bond investors seeing hope from electronic venues

Fixed-income trading volumes have skyrocketed since the Nov. 8 U.S. election, particularly on electronic venues, providing opportunities for active bond investors that have recently struggled with low returns to find alpha.

“We're finally getting volatility back into the market,” said Richard Schiffman, open trading product manager, MarketAxess Holdings Inc., New York. “It's tougher to generate alpha with low volatility and tighter spreads. Now that there's some movement, people can take action.”

Added Constantinos Antoniades, global head of fixed income, Liquidnet Inc., New York: “Overall, post-election has been positive for the corporate bond market. The higher volume makes it easier to pick bonds. Changes we've seen in the last few weeks in terms of volume have created added opportunities for alpha. Macro changes like the election create an appetite for more trading.”

One electronic fixed-income trading venue, Tradeweb Markets, had record volume of $7.9 trillion in November, the most active month of trading across its platforms since the 2008-2009 financial crisis. While the majority of securities that traded that month were mortgage-backed securities, government bonds and interest-rate derivatives, U.S. investment-grade fixed income saw volume highs for 2016, according to Tradeweb.

Such rising volumes have been a boon to electronic trading venues, which still have a smaller share of overall fixed-income execution volume — some say as little as 20%. Said Mark Monahan, CEO of MTS Markets International Inc., New York, “The corporate bond market can be so illiquid, when things get busy, even people that don't (normally) trade electronically will call and ask for their password.”

“Overall, higher volumes and volatility generally mean more opportunity,” said Colm Murtagh, managing director, head of U.S. institutional rates, Tradeweb, New York. “And we're seeing that across our platform with dramatic increases in volume since the election.”

Mr. Murtagh said the heightened volume points not only to a short-term rise in bond trading, but possibly a more long-term trend spurred by fundamental changes in the market, such as an expected increase in interest rates by the Federal Reserve.

“There may be a fundamental shift in many markets, including interest rates,” Mr. Murtagh said. “Usually, volume growth following a jump in volatility would come mostly from delta hedging by market participants with large options strategies. This recent increase in volume was much broader. The initial market reaction to the Trump victory felt like it might be temporary. But stepping back and looking collectively at the move in interest rates, the change in inflation expectations and the potential for more uncertainty surrounding the Fed, it all suggests a fundamentally different investment outlook.”

“We have seen every type of buy-side institution increase their volumes, both for volatility and fundamental reasons,” Mr. Murtagh added.

Liquidnet's Mr. Antoniades said volume increases post-election might have been spurred in large part by a sell-off in the U.S. Treasury market, but the corporate bond market “has been very different. You don't see signs of a sell-off there. Yields are higher, and there's more appetite for corporates now.”

Mr. Antoniades said any changes in the Dodd-Frank Wall Street Reform and Consumer Protection Act that would reduce capital requirements for banks holding bond inventory would have a greater impact on Treasuries and swaps than on corporate bonds. “If banks go back to proprietary trading, that would be no different than a new hedge fund being set up,” he said. “But banks creating an internal prop desk creates more problems than it solves.”

Mr. Murtagh at Tradeweb said that while it remains to be seen whether the higher volumes are signaling more long-term opportunities for institutional fixed-income investors, “there are enough changes from a macro perspective to think that this higher volatility and increased trading activity could continue.”

At Nuveen Asset Management, Minneapolis, Timothy A. Palmer, managing director, portfolio manager and head of global interest rates and governments, and emerging markets sector teams, said investor flows and market activity have remained fairly orderly and two-way during the recent spike in bond yields, with some strategies seeing inflows. “That said, we have certainly seen periods of challenged bond market liquidity in recent quarters, and it's likely to exhibit bouts of thin liquidity going forward, given low capital commitment from dealers, investors' concentrations and large one-way flows across markets,” Mr. Palmer added.

However, Mr. Palmer said market volatility driven by liquidity swings “can be created by flows in and out of passive products, so as an active manager we look to take advantage of the misalignment that can occur, on both up and down moves. Certainly fixed-income returns have been made more volatile as a result of changes in the market, including lower liquidity. We think it argues for active vs. passive management and more flexible mandates, particularly for longer term investors in need of income.”

Nuveen Asset Management managed $17 billion in active fixed income as of Sept. 30.

The increased volumes on electronic venues are being closely watched by asset owners like the C$63 billion ($46.6 billion) Healthcare of Ontario Pension Plan, Toronto. Fixed income is in HOOPP's liability hedging portfolio, which provides 62% of the pension fund's investment income.

Ray Tanveer, HOOPP assistant vice president-interest rates, said the recent sell-off in bonds “has, in fact, increased electronic volumes due to a) old long positions being cut, b) new positions being accumulated and c) money being put to work at much better yields. ... I think we are looking at intermediate-term deterioration of bond prices due to a recalibration of higher U.S. (gross domestic product) expectations on the back of an all-Republican Washington trying to stimulate via fiscal policy. In other words, more U.S. Treasury supply in 2017.” n