Buy side gains edge in bond trading by turning data on banks
Long before Carl James completes a bond trade, he’s already got a pretty good idea of whether he’ll get a fair shake.
His confidence comes from having analyzed more than 100,000 debt transactions made by Pictet Asset Management, the $165 billion investment firm he works for as global head of fixed-income trading. James used the data to create profiles of banks, helping his firm avoid dealers that are expensive or difficult to trade with and instead prioritize those that are likely to give the best prices.
“Information is power,” said James, who evaluated counterparties using two years of bond trades. “When a bank says, ‘we love you and are really looking after you,’ buy side firms didn’t use to be able to do much more than just listen. Now we can analyze the information and give a much more forensic view of the relationship.”
AllianceBernstein Holding LP, Candriam and Union Investment are among other investors that are crunching data as they seek to cut trading costs in an increasingly illiquid bond market. The strategy also underscores how investment firms are seeking an upper hand in debt dealings as banks pull back from making markets amid tougher regulation.
AllianceBernstein, which oversees $498 billion, created a proprietary trading system in 2015 that other investors are looking to license this year, according to Tim Morbelli, a senior trader in New York.
The tool — called Automated Liquidity Filtering & Analytics, or Alfa — gathers bid and offer prices from dealers and electronic trading venues. It’s allowed AllianceBernstein to step in as a trading partner for other investors as well as dealers, and helped save an average of 4.5 basis points in trading investment-grade bonds, Morbelli said.
“We’re not trying to disintermediate the dealers,” he said, noting that most of the firm’s trades are still executed through banks. “We’re here to protect our clients and this gives us the best information possible to protect our clients.”
Union Investment is building a system that helps its traders decide which bank to approach and which platform to use for a transaction, said Christoph Hock, the Frankfurt-based head of multi-asset trading. By targeting an individual dealer rather than canvasing many, the 292 billion euro ($314 billion) firm can prevent information from leaking to other market participants and affecting prices, he said.
“As a buy side firm, being proactive and innovative is really key these days,” Hock said. “We’re not leaning back and waiting to see what development the market brings us. We’re having an impact on market structure on our own to benefit investors.”
Sell side firms are also trying to adapt to the changing dynamics in credit markets. ING Groep NV analyzes its own data to evaluate which bonds it can readily trade with investors, according to Stephane Malrait, global head of e-commerce for financial markets in London.
“Ten years ago we’d say to clients: ask us a price on any bond and we’ll get back to you,” Malrait said. “Now we focus on sectors where we know we’re strong.”
Investors in Europe are also getting ahead of a wide-ranging overhaul of European Union trading rules known as the Markets in Financial Instruments Directive, which comes into force in January.
Among new requirements, investors will have to prove to regulators that they’re getting the best prices for bond trades. That will encourage more investment firms to develop strategies to review counterparties and gain an edge with dealers, said Chris Perryman, senior vice president of fixed-income trading at PineBridge Investments.
PineBridge, which oversees about $83 billion, hired two traders last year with quantitative backgrounds to help model trading data for the firm’s in-house system, he said.
“Quant skills are coming into every element of trading,” London-based Perryman said. “The buy side has to make sure they’re using all the tools available.”
Fabien Oreve, the global head of trading at Candriam in Brussels, evaluated three years of trades at the 102 billion-euro firm to measure the ease of buying and selling various bond categories with different counterparties.
Pictet’s James said such analysis can improve trading relationships by giving investment firms greater access to information and control over costs. His ongoing study started last year and covers debt trades including government bonds and high-yield notes.
“Once dealers know you’re watching them, you’re able to better engage with them,” James said. “Today the onus is on the buy side to make things happen.”