Active trading and non-comp trading
For active funds, high touch trading still dominates, with buy-side desks on average trading using voice/messaging for 37% of their activity, either over the phone or typically by using email of Bloomberg messaging/IB chat (see Figure 1).
Electronic request-for-quote (RFQ), which is typically accessed via an electronic trading platform such as Bloomberg, MarketAxess, Tradeweb, Trumid and UBS Bond Port amongst others, was the most commonly used protocol for active portfolios, at 42% of activity.
While both typically were used by placing dealers in competition, non-comp trading in which a single dealer was approached amounted to 14% of activity for voice/messaging, plus 5% of block-trading and 1% of portfolio trading, up to an average of 20% of activity that might be placed directly with a single dealer.
The value of non-comp trading is found in sell-side dealers knowing that their buying or selling of the bonds is not visible to the rest of the market and therefore they will not get picked off when trying to trade out of their position. Consequently, they can offer a better price to their client as they do not have to price in this risk. However, the buy-side trader must be sure that the dealer will have the inventory or appetite to sell or buy the bonds in question pre-trade.
In-comp trading pushes the dealers to offer a better price to compete with their peers but increases their risk in trading out of the position.
More structured trading protocols, such as block trading, portfolio trading and auto-execution are less used when trading active portfolios.
Block trading in-comp is on average 3% of activity and non-comp is 5% of activity for buy-side traders on active funds. Portfolio trading is 4% in-comp and 1% non-comp. Just 1% of activity is auto-executed with dealers from a directly streamed price, and 5% via a platform from a directly streamed price.
Although these single figure levels of activity may seem low given the noise around electronic trading this year, adoption of new ways to trade across the entire market can take time.
“Adoption of new trading protocols has always been slow by the buy-side. For example, Liquidnet took many years to establish themselves as a strong business. This has been the same for other platforms such as, MarketAxess, Tradeweb etc.” says Carl James, global head of fixed income trading at Pictet Asset Management. “With the plethora of trading platforms – latest count 150 – how do you sort the wheat from the chaff? There has to be a compelling reason to change, if your senior management only wants you to not mess it up, then you are likely to stick with the status quo.”
Passive portfolios see greater competition
Interestingly, passive portfolios see a similar proportion of trading activity across the same trading methods used for active portfolios (see Figure 2). However, the trading methods used on an individual desk basis were quite different.
For example, firms who had passive portfolios typically used a smaller range of trading protocols to execute trading in those funds than for active funds. Five firms used a single protocol to trade for passive funds – either voice/messenger in comp, electronic RFQ all-to-all or auto-execution (auto-ex).
“How you determine the execution for a passive fund depends on the type of fund you have, its size and the size of trades that you are executing,” says Louise Drummond, global head of execution at Aberdeen Standard. “We will usually auto-execute a lot of it, but it has to be within certain parameters as it is being measured against an index, and it is key to get pricing as close to the index as possible to minimise cost and therefore tracking error.”
Many other asset managers clearly share that model, as 18% of trading for passive funds is auto-executed on a platform from a streamed price; significantly more than the 5% seen for active portfolios. Auto-execution direct with dealers was just 1% across both passive and active funds.
At the same time non-comp trading, which was used in block and voice/messaging for active portfolios was only 4% of trading activity overall, compared to 20% overall for active fund trading.
James noted that the discretionary aspect of trading was far lower for passive funds than it was for active funds, which could account for the effect on both auto-ex and non-comp trading.
“Active and passive portfolio strategies have widely differing catalysts to trade,” he says. “At a broad level active managed funds are opportunistic to market (macro and micro) conditions, whereas passive funds are more rule-based.”
“We are starting to think more about the use of portfolio trades for our passive funds so that the whole program is executed at once,” says Drummond. “You can get a couple of names that are not so liquid and this will ensure we have executed all the trades at the same time, we will have to do our homework pre-trade on each program though, to see which is the most cost- and tracking-effective way to deliver the best outcome for the client.”
Drawing conclusions
Taking a look ahead, this data suggests that if asset management continues to grow the passive management and shrink active management the two greatest industry changes from a trading perspective will be a far greater level of auto-execution, and a far smaller level of non-comp trading to dealers.
James is cautious about extrapolating much further based on the data, as it did not capture the size of activity.
“One fund manager that only trades a small amount of passive, versus an investment firm that trades almost entirely passive may have very different ways of executing,” he says. He observes that trading protocols need to fit the firm, not simply the type of fund.
“Buy-side traders first of all have to have the willingness to evaluate portfolio trading (PT), and then see if PT has any relevance to their flow.”
Gilles Martins, head of business development and executive committee member at Natixis TradEx Solutions says, “I think the future of fixed income is program trading. Not trading individual bonds, but trading via multiple bonds simultaneously via a program. It might be new in fixed income compared to the equity trading.”
Drummond adds, “I will say that our use of portfolio trades across fixed income has increased dramatically this year. I was sceptical when this new protocol was first launched, but it has given us more choice on how we choose to execute our trades.”
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