Liquidity crunch elevates bond traders

FT_Traders_FinalV2.jpg©Joe Waldron

Falling liquidity in fixed income markets has created a new sphere of influence at some of the world’s largest investment houses: the trading desk.

Over the past 18 months, large fund houses have hired more bond traders, overhauled the technology their traders use and encouraged those responsible for executing deals to work more closely with portfolio managers.

In some cases, traders have even begun to influence investment decisions, according to several asset management executives.

These changes are a big departure from the days when traders simply executed the buy and sell orders placed by fund managers, with little interaction between the two teams.

But highly skilled traders are now seen as a vital source of information for portfolio managers, in an environment where it has become increasingly difficult to find suitable buyers or sellers at the opposite end of complex fixed income trades.
The liquidity crunch has come about because banks and other counterparties, the traditional middlemen in fixed income trading, have significantly reduced their bond inventories because of stricter regulations. Asset managers say this has made it harder for them to offload bonds quickly and made the trading environment more difficult.

Deutsche Asset Management, Nordea Asset Management, Amundi, Pioneer and Jupiter, which collectively oversee more than $2.3tn of assets, have increased the size of their bond trading desks over the past 18 months as a result.

Deutsche Asset Management opened a trading desk in London last November, and plans to open another one in Hong Kong in the coming months, in addition to existing teams in Frankfurt and New York.

Nordea AM has increased the size of its trading desk by a fifth, to 24, since 2014 and hired a new head of trading last year. Amundi, which oversees €600bn of fixed income assets, has increased the size of its Paris-based dealing desk from seven traders to 10 over the same period.

Both Jupiter and Pioneer have added one trader to existing teams over the past 12 months.

The consensus among these groups is that having more traders who specialise in a wider range of fixed income asset classes will help them to combat the growing difficulty of identifying suitable trades.

The head of trading at a large European asset manager, who requested anonymity, says:
Traders work more closely with portfolio managers now than ever before. Specialised traders come to portfolio manager meetings, analyst meetings and portfolio construction team meetings.

“We give [fund managers] a reality check quite often, and they come to us for a reality check.

We look for the most liquid opportunities ahead of any order coming to us. This absolutely influences asset managers’ decisions.

“Not all portfolio managers are willing to take our advice as not all traders have the same reputation with the portfolio managers. But there is more awareness of the importance of the [trading] role and the liquidity challenge. Bond markets are not a supermarket any more.”

Christian Hyldahl, chief executive of Nordea Asset Management, the Swedish investment group, agrees the trend of traders suggesting trades to fund managers has become “increasingly common” in his group’s fixed income team.

Alastair Sewell, senior director at Fitch, the rating agency, adds: “We have seen fund managers restructure their trading desks so that traders propose trades to portfolio managers. There are specific examples we are explicitly aware of.”

Asset managers are keen to avoid swamping the market with one large trade that could alarm potential buyers or sellers in the market. They are instead bringing a series of smaller trades to the market, which is a more labour-intensive process.

Eric Brard, head of fixed income at Amundi, says: “It is now easier to trade 10 small [tranches of a bond], rather than one big order of €10m. This puts more pressure on the dealing desk because this is more work. We also have a more complex universe of securities in fixed income portfolios, with more high yield and convertible debt, which puts pressure on the dealing desk.

“In the old days when a portfolio manager wanted to buy or sell something, he asked his dealer to trade in the market and speak to the counterparties. This sequence has changed over the past two years, with much more integration between the portfolio manager and the dealing desk.”

A spokesperson for Jupiter adds: “Liquidity in fixed income has become more difficult to source now the major brokers are not allowed to hold inventory on their balance sheets. As a result we have to work harder to find the other side of the trade we are trying to execute. All this takes time, with increased phone calls [and] checking bid and offer lists.”

There is a big divergence in the tools asset managers want their traders to use in order to overcome liquidity problems. Some are choosing cutting-edge technology, while others are returning to more traditional techniques.

Deutsche AM adopted technology 18 months ago that enables the company to bypass human traders altogether when carrying out simple trades in liquid areas, such as certain European government bonds.

Juan Landazabal, head of fixed income trading at Deutsche AM, says: “It is not just about throwing more resources at the trading desk — we are cost constrained. There is an important element of technology and how we organise ourselves.”

Mr Hyldahl agrees: “There is no silver bullet to solve the liquidity challenge. What makes it difficult is that, under normal circumstances, fixed income markets work pretty well, but in times of stress [they don’t].

“We have hired 20 per cent more [traders] over the past three years, [but] at the same time we seek to automate. You want as much [trading] as possible to be fully automated.”

By contrast, Axa Investment Managers, which oversees €432bn of fixed income assets, is in some cases turning away from automated technology in favour of human interaction.

Paul Squires, head of trading at the French asset manager, says: “We generally execute 93 per cent of our fixed income orders in a day, and we have not seen that figure drop in quite testing markets. But we have become more discriminate in how we execute our orders.

“Where it is difficult to execute, the expertise of the traders and the sensitivity around giving information to the market is more important. That is why more orders are being given by voice rather than electronically.”

The number of traders at Axa IM has fallen by one in the past year, to 24, as a result of a reorganisation of the dealing desk, but Mr Squires says the company “may need to reverse that decision” and add to its headcount, given the challenging market environment.

Many other asset management companies are also likely to boost trader headcount in the coming months, according to Huw van Steenis, an analyst at Morgan Stanley, the bank.

The analyst, who has met several heads of trading and investment bosses at fund companies representing $10tn of assets since December, says: “Every asset manager we met was concerned about accessing bond market liquidity. They are learning to live with less liquidity, and this requires some material operational changes. Trading desks are typically the starting point.

“Many asset managers ran their portfolios assuming vast and deep liquidity is a given. They are now having to optimise portfolios for a much more stressed liquidity environment and need market intelligence on what is readily available to sell.

“It is not necessarily that the power is shifting [towards traders], but [investment companies] need to have a clear fire-drill plan that is done collaboratively between fund managers, the trading desk and the risk management team.”

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