Bond Portfolio Trading: How Innovative Technologies are Enabling Fixed Income Managers to Invest Efficiently

Key highlights:

• With portfolio trades, buy-side firms can greatly improve workflow efficiency and execution, and achieve better outcomes compared to trading bonds individually.
• Portfolio trades are a highly effective way to put new cash to work in a way that quickly replicates one or more portfolios’ existing structures.
• Portfolio trading improves liquidity, as bonds that may be illiquid individually can become more liquid as part of a “bundle.”
• With the right technology tools, institutional investment managers, bond mutual funds, and asset owners can construct, evaluate, and execute portfolio trades in under a day, realizing the many benefits that level of efficiency provides.

It’s an understatement to say that buying and selling bonds is not like buying or selling stocks. A quick comparison between the bond and stock markets helps to explain why bond trading is complicated (nothing new here…) – unlike equities, bonds do not trade on exchanges; the bond market has far more issuers and issues; the quantity and variety of terms and conditions data needed to describe a bond is enormous compared to what is needed for a stock; the analytical measures used in fixed income are simply in a different league, quantitatively, than the metrics used to describe equities, and so on.

This helps to explain why trading corporate bonds is so challenging and why the old-fashioned approach of arranging trades manually, over the phone, one at a time, still dominates. Although it is inefficient and often frustratingly slow, this hands-on, labor-intensive approach has been the only way to arrange all of the trades required to achieve a desired portfolio-level outcome. Large shifts to a strategy, such as raising or lowering overall credit quality, changing sector allocations, or adjusting duration targets could take months.

However, the situation is (finally) changing. Portfolio trades involving many corporate bonds in a single transaction are increasingly popular; some estimates say these trades range from approaching 5 to 10% of the market. Broker-dealers, sometimes via a third-party bond trading platform, are increasingly receptive to buying or selling bundles or portfolios of bonds, ranging from a fairly small number to 100+ individual issues. Buy-side firms are benefitting as portfolio trades require less manual effort, offer better liquidity, and allow portfolio managers to execute a group of trades all at once, over a short period.

Why portfolio trading, and why now?

As the name suggests, portfolio trading combines multiple bonds into a bundle to be sold or purchased together, as a single “all or none” package. A buy-side firm chooses the securities it wishes to buy or sell and sends the total order directly to one or more counterparties, or to trading platforms such as MarketAxess and TradeWeb. Based on the liquidity of the individual issues, whether they are likely to be included in ETFs, and the total transaction size, the recipient will quote a price that covers all of the bonds in the bundle.

Market forces are making bond portfolio trading more attractive and more feasible than in the past. The tremendous growth in fixed income ETFs makes portfolio trades more appealing to the sell-side than individual bond trades. A broker can use the bonds it purchases in a portfolio trade to create bundles that closely resemble an ETF’s holdings (especially when the portfolio is well diversified), then sell them to an authorized participant who will create new ETF shares. Or it can hedge the portfolio trade by shorting ETFs – which is significantly easier than shorting individual bonds – while taking the time to identify buyers for the bonds in the bundle.

The speed and certainty with which bundles of bonds can be traded, in one transaction, have made portfolio trades popular for fixed-income managers. According to a June 2023 global poll by Barclays, close to 12% of clients were trading a quarter or more of their flow through portfolio trading, The increased efficiency this approach offers allows firms to shift resources to other areas such as analysis, strategy, risk management, and client-focused activities.

A boost for liquidity

Ever since the global financial crisis of 2008, brokers have been far less willing to hold bonds in inventory than in the pre-crisis era, as higher capital requirements have greatly reduced the profitability of such risk-taking. Banks are reluctant to buy individual bonds that are difficult to hedge, and many of the proprietary trading desks at banks that used to be alternative sources of liquidity are now gone. It is an understatement to say that bond market liquidity has declined over the past decade or so.

While liquidity has suffered, issuance has boomed. During the years of ultra-low interest rates, borrowers across the credit spectrum issued new bonds to reduce their cost of capital. Then, the pandemic led companies to borrow more to increase cash reserves. And, as U.S. interest rates have risen, so has investor demand for fixed income. In short, there are many corporate bond issues to buy and sell, but few sources of liquidity to facilitate trading. It is as though farmers were producing bumper harvests of all types of crops, and consumers were hungry and had money to spend, but grocery stores were unwilling to stock their shelves unless they knew products could be sold in 24 hours or less.

Volatility is also a challenge to liquidity when trading corporate bonds. If a one-off trade involves a sector, credit rating, or individual issuer that is out of favor, sellers are often forced to accept an unattractive price to get it done. However, when groups of bonds are packaged into portfolio trades, even “unattractive” bonds can find buyers because there are ETFs that cover every corporate bond sector as well as the entire quality spectrum. Investment managers find they can do a portfolio trade that provides a price for every bond, in a single day, rather than having to spread the trade out over multiple days.

Bond portfolio trading depends on technology

Technology innovations have also contributed to the growth in portfolio trading. Technology providers are making it easy for buy-side firms to submit portfolio trades, and for the sell-side to respond with quotes for an entire bundle. Automating workflows from trade order to execution reduces risk and costs.

Regulations (such as MiFID II) that emphasize post-trade transparency and require investment managers to show proof of best execution, make portfolio trading via innovative technology platforms even more appealing. Chioma Okoye, a European credit product manager at Tradeweb, explained that on their platform an asset manager can ask up to three dealers to quote a package price for a portfolio. “All quoted prices, for the package and per bond, are shown on Tradeweb, making it easy to prove best execution to clients,” she said. This level of transparency can also help with transaction cost analysis.

One major hurdle for the buy-side is selecting which bonds to include to optimize their portfolio trades. A portfolio trade may consist of anywhere from 10 to 100 bonds (or more), and selecting which ones to sell across accounts or strategies or evaluating a bundle of bonds a dealer is offering as a portfolio trade requires the right technology tools. It’s cumbersome when shifting portfolio strategy, such as extending duration or going down in credit quality to pick up yield. In other words, firms need systems that are designed for this.

How IMTC technology optimizes the portfolio trading experience

Instead of spending days or weeks to build a portfolio trade manually, bond managers are using IMTC’s powerful optimizer and compliance tools to determine which bonds to buy or sell. This streamlines the tedious process of figuring out which bonds to include in portfolio trade that will accomplish a range of objectives across accounts or in a diversified fund.

How does IMTC help portfolio managers to execute portfolio trades?

• Specify goals for portfolios: Portfolio managers can codify objectives based on a model portfolio’s structure and/or investment policy guidelines, as a percent of the overall portfolio or relative to a benchmark. This ability to specify targets helps to determine trades needed to achieve desired exposures while remaining in compliance.
• Filter portfolios to identify which ones require adjustments: Instead of manually reviewing accounts one by one to determine where adjustments are needed, IMTC’s filtering capabilities quickly highlight those that are over or under certain targets, have excess cash or unrealized gains/losses (for harvesting), or meet any criteria you specify to easily construct a portfolio trade.
• Develop buy lists: Analysts can create buy lists based on brokers’ available inventory, recently traded bonds, or approved names that can be used in optimization scenarios. This streamlines the approach to choosing securities to buy and sell in a portfolio trade.
• Collaborate across the desk: IMTC’s cloud-based platform allows teams in various locations to collaborate by working with the same information simultaneously to build portfolio trades. Team members can specify changes to sector weights, duration, credit quality, curve positioning, and more to achieve desired portfolio results.
• Optimize portfolio trades to meet goals: IMTC’s Optimization tool identifies bonds to buy or sell based on an overlying objective (e.g., maximize yield), subject to a wide range of constraints – from duration and sector allocations to gains and losses. Turnover can be restricted, and individual bonds can be tagged to retain as part of the solution. The system can also check to ensure proposed trades would not violate any investment policy statements specified on the platform. The result: a list of bonds and par values to submit as a portfolio trade to accomplish objectives across one or more strategies or accounts.
• Facilitate the trade order and execution processes: Optimizing a portfolio trade is critical, but executing it makes it a reality. IMTC allows you to stage portfolio trade orders, send them to the trade blotter, connect to trade execution systems, and receive trade confirmations.
• Streamline post-trade allocation: After the portfolio trade is completed, IMTC offers a methodological approach to allocating bonds across accounts. Bonds purchased in a portfolio trade can be allocated based on criteria you specify, to holistically achieve unbiased allocations.

Taken together, the tools IMTC offers make portfolio trades easy to build and execute. By optimizing the bonds to trade to achieve portfolio-level goals, facilitating collaboration across teams, and facilitating execution, IMTC saves a tremendous amount of valuable time. Fixed income portfolio trading is expected to keep growing as technology solutions make the process easy for buy-side managers to embrace.

Want to see how IMTC can simplify generating your portfolio trades? Schedule time to talk with our team.

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