Let’s say a deal lands on a buy-side trader’s desk. It’s a billion-dollar, market-moving, large notional trade in aggregate consisting of a high number of bonds in various sizes, some illiquid and difficult to price. Where do you start?
Just a few years ago the go-to plan would be to trade each bond, or CUSIP, individually. The process would require finding the right counterparty, usually over the phone, and ensuring pricing is accurate, a task considered to be notoriously difficult, time consuming and downright tedious.
We’re talking hours of trawling through spreadsheets, dozens of phone calls, and a tonne of back-and-forth before the buy-side is able to fully complete the transaction.
You might consider request for quote (RFQ), but this trade is potentially market moving, so adopting the RFQ model to trade multiple bonds at once could materially impact price. Moreover, unless they are structured as a package trade, where risk can be mitigated across more liquid bonds, broker-dealers will find it almost impossible to price the illiquid bonds.
Purely from an efficiency standpoint, a portfolio trade for this type of transaction makes sense.
Tradeweb claims to be the first electronic trading platform to roll out portfolio trading functionality for institutional clients looking to streamline executions into fewer, larger trades to lessen both market impact and cost. The platform went live in January, with Tradeweb’s latest figures showing that as of August this year, more than $18 billion has been traded on the platform so far, accounting for 5.5% of TRACE volume.
Typically, a portfolio trade consists of a basket of between 10-100 bonds that can be either one or two-sided and executed in a single transaction with a single liquidity provider. More commonly recognised as basket or program trading, the protocol has been part of the landscape for a while, but with the electronification of global bond markets and a surge in fixed income exchange-traded funds (ETFs) – which in June surpassed $1 trillion in assets – portfolio trading is tipped to become one of the most efficient ways to deal with large, complex and multi-faceted bond transactions.
“Portfolio trading used to be laborious and complicated,” says Chris Bruner, managing director and head of US credit at Tradeweb. “Even if you wanted to do a portfolio trade with a single counterparty, it would require lots of back and forth with spreadsheets and phone include in the portfolio.”
Order routing, pricing and negotiation
There are various reasons why a portfolio trade could be on the cards for a buy-side trader. Perhaps large outflows in a fund has forced the need to raise cash quickly, or a transition management agenda means that you’re now selling investment grade and buying high-yield. Maybe a credit analyst has recently gone negative on a ticker, or a large portfolio of illiquid bonds are being asked to buy or sell.
Traders can complete a portfolio trade much like they would a regular RFQ on Tradeweb’s platform without changes to pre- and post-trade workflow, according to the vendor. When choosing a portfolio trade on the platform, orders are routed to the right person at a liquidity provider – such as a designated bank portfolio trader who will likely have more experience in the fixed income ETF ecosystem than a line trader – so that baskets of risk can be priced leveraging the create/redeem process.
Order routing is key here when it comes to pricing risk, and it can vary by each potential counterparty according to whether they distribute pricing across the whole desk or, in some cases, have a dedicated team of portfolio traders.
Once the trade is on the system and routed to a suitable liquidity provider, a bank portfolio trader prices the individual line items with aggregate basket portfolio- level statistics, which are displayed by Tradeweb to guide both sides towards the right price, and to provide pricing for the portfolio trade in its entirety, rather than at the individual CUSIP level.
The buy-side and dealers then negotiate and counter on individual bonds within the portfolio, and if it doesn’t suit, the buy-side trader can remove individual CUSIPs from the negotiation before executing the approved items all at once.
A new liquidity outlet
Tradeweb asserts that for the buy-side, the process means that traders can achieve faster execution and reduce information leakage on trades much like the billion-dollar trade we began with; large notional in aggregate and multiple CUSIPs which are difficult to price. Since the platform went live, Bruner says Tradeweb’s clients have been quick to adopt portfolio trading, even in their day-to-day trading activities.
“We’ve been surprised by how consistent the portfolio trading has become in such a short time frame,” he comments. “The nature of portfolio trading is that it can be big and chunky, which sometimes means it’s also sporadic. But now we have clients who do portfolio trading with us literally every day and the process has embedded itself as a new liquidity outlet.”
Carl James, global head of fixed income trading at Pictet Asset Management, echoes Bruner, highlighting the move towards portfolio trading as being the ‘new norm’ for large credit trades like the one we started with. James says there isn’t a right or wrong way to execute such a trade, but portfolio trading gives buy-side traders the optionality to effect changes on a portfolio.
“Portfolio trading is quite a big trend in the industry at the moment, and there are several elements to this. A big driver has been the rise of ETFs, but we also know that the sell-side is under pressure in terms of margins, and by using technology, firms can view that risk in a much more efficient way,” James comments.
“A few years ago, executing an inflow through a portfolio trade was the less obvious choice. Nowadays, it’s normal to utilise portfolio trading, either on a bilateral basis where we engage to trade that risk on or off the portfolios, or we do it on various different platforms. It depends what you are looking for, but that’s your low-touch-type of methodology, and it’s a nice thing for the buy-side to do in terms of executing all of that business at the same time.”
There are other ways a trader could tackle the billion- dollar credit trade in question. It could be traded in block size shares in an ETF or via the credit index, or a trader could work the bonds within the portfolio individually on an all-to-all platform. But industry trends in the form of an explosion in fixed income ETF assets, the progression of market makers, and the rise of algorithmic trading, have contributed to buy-side houses seeking out portfolio trading to connect the dots on multiple credit instruments for execution.
Bond ETFs, which BlackRock predicts could top two trillion dollars in assets within the next five years, have played a crucial role in the evolution of portfolio trading in credit, and particularly for the electronification of credit trading in investment and high-yield bonds.
“Around five years ago, there weren’t many liquidity providers in credit that could algorithmically price thousands of bonds in real-time, but now – as a result of the explosion in ETF assets – there are, and their numbers have only grown,” explains Bruner. “As a result, there are portfolios being traded off the back of create/redeems of ETFs every single day. That means there’s now the ability to price any generic basket of credit bonds, and that service is now being deployed in its own right on behalf of the buy-side.”
The rise of fixed income ETFs has essentially been the gasoline on the fire accelerating the growth of portfolio trading by calculating a way to get the execution of the underlying bond sufficiently, so that the create/redeem process is simplified. The ETF vehicle has also facilitated more traditional list RFQ trading, often considered to be the precursor to portfolio trading.
When it comes to liquidity providers and market makers, ETFs have changed the way that firms which service the fixed income space operate. That, alongside the rise of algorithmic trading to facilitate pricing and the fact that liquidity providers share far more data with the buy-side now than ever before, has created a perfect storm for electronic trading platform providers to facilitate portfolio trading for clients.
More than electronification
Tradeweb may have been first off the mark, but it certainly won’t be the last firm to build out portfolio trading functionality for credit markets. In June, MarketAxess, a direct competitor of Tradeweb, confirmed plans to develop its own portfolio trading platform, also in response to client demand for increased basket trading activities.
Speaking to analysts on the company’s second quarter earnings call, MarketAxess’ president and chief operating officer, Chris Concannon, said the soon-to-launch portfolio trading protocol will leverage its list trading functionality with the ability to request prices from multiple dealers.
Tradeweb’s platform is currently bilateral, meaning that it is negotiated and risk is transferred with a single counterparty, but the firm is in the process of rolling out the ability for clients to deal with multiple liquidity providers*, similar to MarketAxess.
“We see portfolio trading happening in the market on an average trading day,” Concannon told analysts. “We continue to hear from our clients about how they are constructing portfolio trades and putting up portfolio trades. Right now, the efficiency of that process and the workflow is very difficult for both client and dealer, because it’s passing spreadsheets back and forth… Given the growth of the ETFs and fixed income ETF trading, we do think it will allow our clients to trade more portfolios that they are not currently trading.”
With MarketAxess and Tradeweb betting on the adoption of portfolio trading in credit, the trend appears to be more than just another shift towards electronification, but an opportunity for buy-side traders to create complex, multi-leg, large sized, billion-dollar credit trades that the market has never quite seen before. And that’s how you deal with a billion-dollar credit portfolio trade.
*On 8 October, Tradeweb announced it had expanded its portfolio trading platform to include multiple liquidity providers.