Every aspect of investment management revolves around accessing and processing information and incorporating it effectively into the decision-making process. Technological innovations in corporate bond trading rarely grab headlines, but advancements in electronic trading over the past decade have substantially changed how business is conducted in the fixed income markets. Electronic trading provides greater insight into pricing and liquidity data, as well as faster and more efficient access to market liquidity. The result of this recent innovation is an environment where a much larger number of trades are executed faster, easier, and cheaper than ever before.
When used as part of a comprehensive portfolio construction process, electronic trading helps improve efficiency, enhancing performance in client accounts while reducing account minimums and expanding customization options. However, there’s still a major role for fixed income professionals in unlocking additional value for bond investors.
What is electronic trading?
When investors think about a bond trade being executed, they probably imagine a trader haggling with a Wall Street broker over the phone, putting all their negotiation skills to use. In reality, trading desks now rely more on data than persuasion to transact a bond. When a trader receives an order from a portfolio manager, they first need to decide the most efficient way to execute the trade. For less liquid bonds, that may still entail knowing which of their dozens of counterparties is likely to make the best market and working the order over the phone. But for a growing segment of the bond market, traders turn to electronic trading platforms that are linked to their in-house order management system. These platforms, like MarketAxess, TradeWeb, and Trumid, consolidate bids and offers from both brokers and other investment managers. This greatly expands the number of potential interested counterparties, contributing to better prices and lower transaction costs.
There’s no question that electronic trading makes the process easier and more transparent. For bonds that meet certain liquidity thresholds, a trader can enter specific transaction parameters and efficiently execute the trade while their firm collects valuable market data. Traders work with their quantitative research team to develop an execution framework and define the trading parameters based on market conditions, trade size, and a bond’s liquidity assessments. They use this electronically generated data in post-execution trade cost analysis (TCA) to further refine the process.
Bond trading is one of the most tradition-minded areas of investing. As the bond business transitions to younger and more tech-savvy investment professionals, adoption of electronic trading will only become more widespread. As much as bond trading has evolved, fixed income managers have been slower to embrace electronic trading than their counterparts on the equity side due to the more fragmented and less liquid nature of the bond market. Even so, almost one-third of investment-grade corporate bond trades in 2020 have been executed on an electronic trading platform, up from 8% just seven years ago. While there’s still a role for one-on-one trading today, there’s no turning back to the phone-only past.
Share of corporate bonds traded electronically
Source: Greenwich Associates, 10/31/2020. For illustrative purposes only. Not a recommendation to buy or sell any security.