A digital drawing of two people standing across from each other. On person is holding a giant muni bond, and the other a corporate bond.

Why a Talented Trading Desk Matters for Fixed Income SMA Investors

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Brian Barney, CFA

Managing Director, Institutional Portfolio Management and Trading

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We were thrilled to win Markets Media’s 2023 US Market Choice Award for Best Buy-Side Fixed Income Trading Desk. How did we do it? Speed, scale, and spirit. Find out how our trading technology supports all three.



Throughout most of 2023, interest rates saw volatility unseen since the 2008 global financial crisis. This presented particular challenges for fixed income trading desks. Sharp and sudden changes to yields can deter investors and market makers from taking risk, and liquidity comes under pressure as a result. The Bloomberg US Government Liquidity Index, which measures the average yield error across the universe of US Treasury trades relative to the Bloomberg fair-value curve, suggests liquidity is at its weakest point in 13 years.


In this environment, the role of a trading desk to help investors achieve positive investment results has never been more critical. We find that managers who embrace technology have the potential to make trading smoother. By leveraging technology, traders can quickly access and analyze market data, identify opportunities, and execute trades at great scale with precision and speed, even during volatile periods.



What’s the value of efficient trading in the corporate bond market?


In the US investment-grade (IG) corporate bond market, pretrade liquidity metrics allow traders to adjust input parameters to execute hundreds of trades in an automated and timely manner. RFQ post-trade stack analysis, as well as third-party liquidity scores and tradability metrics, assist portfolio managers and traders with the security selection process. This data is crucial for building portfolios that will trade in a timely fashion for both purchases and redemptions. 


A bond in a certain ticker complex may appear to be a few basis points cheaper, but that discount can quickly erode if the security-level liquidity is lacking. As we noted in a previous blog post, the electronification of the IG market has reduced liquidity costs by several orders of magnitude, allowing smaller lot sizes to achieve the same if not better execution than larger lot sizes. This execution accrues as a benefit to the individual separately managed account (SMA) client. Not only can it help save costs when our traders buy and sell smaller security sizes, it can also allow for a high level of strategy customization.


The explosion in popularity of fixed income ETFs has also helped produce more IG corporate bond trades on a daily basis. Many individual trades can occur as part of the create-and-redeem process.  The liquidity of certain bonds can change multiple times over the course of a single trading day. This phenomenon has also allowed authorized participants to inject liquidity and become relevant in day-to-day bond market-making. This means the desk could pass on an offering in the morning and buy those bonds cheaper later that day, or vice versa. We see this and track these outcomes daily. All these factors have helped to produce smaller trade sizes, more efficient pricing, and a higher amount of trades per day. Trading really does beget trading.   

 
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What’s the value of efficient trading in the municipal bond market?

Technology can help muni traders identify attractive opportunities across more than 60,000 daily offerings and auctions. Data analysis plays a key role here, since each of those offerings has unique attributes including state, coupon, maturity, or credit rating. This presents a very large and fragmented data set, which we enhance with the addition of historical trade prices and current offer or bid prices. 


Leveraging technology allows traders to narrow the opportunity set to identify a subgroup of offerings that best fit client needs. For example, a trader focused on buying AA-rated credits in California with eight- to 10-year final maturities can quickly find a handful of offerings that fit from a valuation perspective (yield or spread target) out of the thousands in the marketplace. As a result, our SMA clients may benefit from both stronger and faster execution.



What’s the value of efficient trading for SMA investors?


Parametric’s fixed income team, which manages municipals, corporates, and US government securities for our SMA strategies, traded a total of $90 billion in market value in 2022. This volume consisted of over 530,000 trades and 1.5 million separate account allocations, which equates to daily volumes of over 2,000 trades and $360 million in market value. These staggering trade volumes are possible due to the systems and trading workflows that our technology, operations, and investment teams have created and continue to refine over time.


This becomes especially important for taxable investors. Tax-loss harvesting in fixed income SMAs requires a number of steps: analyzing current positions, finding suitable replacement securities that adhere to portfolio guidelines and maintain similar risk characteristics, ensuring liquidity is adequate in those securities, avoiding wash-sale violations, and reducing cash drag. Sophisticated models can address these constraints and allow traders to execute tax-loss trading effectively at scale. This process helps investors capitalize on volatility and improve overall after-tax performance. Our team executed 300,000 loss-harvesting trades in 2022 for a total of $860 million in losses realized.*



The bottom line
Parametric’s fixed income trading desk has always embraced the latest quantitative tools and trade analytics to build scalable execution workflows. The desk has been an early adopter of electronic trading venues and new trading protocols such as auto-execution, striving to push the limits on trading technology and process efficiency. While Parametric has its own proprietary systems, there will likely always be a need for third-party systems. Incorporating new technology into our workflow and collaborating with vendors and counterparties on certain initiatives have been key in advancing electronic trading internally. We’re working together to develop tools that will help our clients and the industry as a whole.


* Source: Parametric, 12/31/2022. The information is provided for illustrative purposes only. Values are aggregated across all municipal laddered strategies, managed municipal strategies, and municipal total return strategies. Only client positions with unverified cost basis were excluded from calculations. Loss calculation is based on the amortized book price minus the sell price, represents historical information, and should not be construed as future results. Loss information illustrates the effect to a portfolio and is not representative of, and should not be construed as, performance. There is no assurance that tax-loss harvesting will continue in the future. There is no guarantee that any specific account may engage in tax-loss harvesting.   

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss. Prospective investors should consult with a tax or legal advisor before making any investment decision. Please refer to the Disclosure page on our website for important information about investments and risks.