Accelerating fixed income’s risk‑on rise

Jason Waight at MarketAxess reveals how advances in data and technology are enabling faster, more agile risk-on trading strategies in today’s fixed income markets

Earlier this summer, a speaker at a Goldman Sachs virtual panel proclaimed that “speed is becoming alpha” for fixed income in 2020. The early months of the Covid‑19 pandemic – characterised by pricing collapses, extreme volatility and infusions of trillions of dollars in emergency funding from central banks – had thrown this trend into sharp relief, he said. Today’s leading fixed income desks, he argued, are already “going to market with a view as to what the trade-offs are – as prices change – to your existing portfolio construction.”

Such prophecies are far from new, but there are a couple of aspects that make this one notable. For one, the speaker was neither a technologist nor a vendor, but Ashish Shah, the co-chief information officer (CIO) of global fixed income and liquidity solutions at Goldman Sachs Asset Management (GSAM). That the likes of GSAM would see fixed income – once viewed as slow-moving and voice-predominant – as a space for technological experimentation is certainly a change. On the front end, this can be attributed to electronic trading venues broadening the liquidity pool and allowing algorithms to take charge of execution in some more liquid segments of the market. It also owes to greater and more accurate pricing data availability. Clearly, there are opportunities for new competitive edges.

Shah also highlighted the development of buy-side firms becoming smarter about how risk tolerances or, as he described them, “trade-offs”, should inform their business throughout the trading day – including the rising trading of entire fixed income portfolios. Buy-side firms are seeking to integrate these tolerances more directly into their risk and portfolio management functions without human intervention as they take a more active, risk-on approach. Many firms have spent years and millions of dollars on transformation projects for the chief risk office, opening up opportunities to achieve sophistication and speed – faster decision-making paired with faster choices for execution. 

Jason Waight, head of regulatory affairs for Europe at MarketAxess, discusses these dynamics, and presents a few of the technologies and tools that are making this new source of alpha a reality.

2020 has seen fixed income roiled by markets full of uncertainty and extremes, but what technical progress and opportunities have arisen as a result?

Jason Waight: With a diversity of instruments, investing purposes and risk profiles, fixed income is attracting greater attention amid this year’s volatile landscape. The question is how to build the foundation and push the boundaries.

The drivers are clear. Suffering fee compression, buy-side firms need to do more with less capital, achieve intraday visibility into risk exposure across asset classes, help clients hedge more effectively and keep up with – as well as benefit from – evolving market infrastructure. These are ambitious goals. 

Coupled with these goals are new, game-changing risk tools, ranging from newfangled analytics and auto-pricing to beefier data infrastructure and revamped development operations platforms. All of this transformation is being built with speed on fixed income desks in mind and being increasingly plugged into the front office, providing intelligence to be deployed pre-trade order and with as much leverage for onboarding risk as possible.

 

Even before the pandemic, fixed income was heating up – will that trend continue through the rest of 2020?

Jason Waight: Yes. The time when fixed income was a sleepy corner of the market is long gone, and we’ve seen two trading trends accelerate during Covid-19 as investors continue to hunt for yield. These include a marked increase in automated trading adoption and the growing popularity of all-to-all trading platforms. 

Many firms have adopted new remote operating frameworks, leaning more heavily into automation and, at the same time, they have identified new opportunities in the post-pandemic environment to generate returns. In pursuit of these goals, they are now searching for new sources of liquidity and flocking to venues where they can act as price-makers as well as takers.

 

These types of changes would be easy to adapt to for asset classes such as equities or foreign exchange, because the element that binds risk and trading together – readily available price discovery and pricing data – already exists, while most of the technology is commoditised, liquidity risk is low and firms can move on to new second-order transaction cost and risk analysis with relative ease. Why is this is not the case with fixed income – particularly in the corporate bonds market?

Jason Waight: It begins with data. For corporates and emerging market sovereign debt, pricing is piecemeal. No central data source or national exchange feed exists because there are far more instruments than there is trading volume. Historically, supply doesn’t always give rise to the interest required to operate an exchange. Bonds will trade at issuance and on relevant news, but too episodically, if at all, and these instruments are often held to redemption, especially as passive portfolio management strategies have become more popular. And today there is an additional wrinkle: most corporate debt inventory sits with the buy side. For firms looking to take advantage of the trends mentioned – rather than fall victim to them – there is much to sort out.

What are the components that will enable buy-side risk desks to take a more risk-on approach?

Jason Waight: It’s about automating as much of the work pre-trade as one can; solving for the pricing conundrum lays the foundation. Improved risk technology allows investment managers to dabble with their pricing models more flexibly. Because there is no consolidated tape or exchange feeds, investment managers will use a variable mix of data to ascertain where a bond should be trading: published trade prices if available, evaluated pricing services using benchmarks and comparable bonds, credit default swaps pricing, and even exchange-traded fund signals. Dealers also publish bulletins detailing indications and inventory. 

This mix grows more complex and less exact for higher-yield and distressed debt that hasn’t traded in weeks or months, and the same is true of mortgage bonds and securitisations that have these instruments underlying. Of course, these are also some of the most sought-after instruments, so it’s down to maximising information availability, combined with a sound evaluation process.

 

Does that mean, as most suggest, a European consolidated tape is required? Is that a hope for the future of best execution? 

Jason Waight: As an industry, managing this challenge collectively is tricky. In the absence of exchanges, merely publishing a price is, in certain corners of the fixed income universe, an act of bravery. Predicting liquidity on a particular instrument remains an art form, and data providers must be careful to balance the desire for transparency – that is, how the price was formulated – against potential harm to liquidity providers in the market. 

In Europe, the weight of recent regulation has the industry dreaming big. On the back of the revised Markets in Financial Instruments Directive’s (Mifid II’s) approved publication arrangement (APA) reporting provisions, many in this market are now pinning their hopes on a pan-continental bond-pricing feed – a consolidated tape that is updated intraday but, unlike APAs, isn’t fragmented. 

An effective tape would need to cover the wide range of instruments in play across government, corporate and other issuances. It would need to offer core instrument details such as coupon, maturity and benchmark, as well as data on total trading volume, low- and high-pricing spreads, and execution time. It would also need to provide a rapid refresh of clean, consolidated and aggregated raw trade data.

MarketAxess has been providing its clients with a solution, Axess All, that already plays to this agenda, consolidating all relevant, unique trading data into one place, with prices refreshed every 60 seconds. Sourced from more than 31,000 verified voice and electronic transactions, AxessAll is the first intraday tape for the European market, providing near-real-time transparent pricing across a range of market sectors for buy- and sell-side participants.

 

Along with pricing, what other uncertainties must investment managers analyse as they look to go risk-on – whether via trades in individual instruments or broader bond portfolios?

Jason Waight: Investors are clamouring for yield but, for their asset managers, numerous risk vectors are crucial. Some of these are particular to a given trade, while others are contextual to the desk or institutional exposure. Liquidity, market and credit risk all come to the fore very quickly. For example: Is a corporate or emerging market bond’s rating stable? And is it priced to reflect that? What size is appropriate? How does adding or removing bond inventory from the balance sheet affect the firm’s overall exposure to a company, sector or country? Is that exposure sustainable or does it breach other considerations, such as an environmental, social and governance framework, and how easy is it to move on from the position? 

Today, to be confident enough to make markets or trade electronically, solutions are required to interpret every detail – and even dynamically evaluate how much any single data point should be weighted against others – right up to the point of trade execution. As Ashish Shah suggested, they must be able to make these decisions at speed, realising that mistakes in the new trading environment will be doubly punished – or worse. You need to know what you’re buying and where, your opinion on its price and how to hedge it, and then be willing to jump. As always, firms don’t want to find themselves stuck holding untradeable assets. But, in this environment, they also don’t want to miss opportunities. More than ever, it’s about achieving that balance.

 

What is the required technology stack for that purpose?

Jason Waight: Managers need the tools to harness automation – whether providing insights that can link up with risk considerations or affording them a free hour in the trading day. We’re seeing increasing amounts of the pre-trade activity getting filled with tech as more investment managers aim to become more active and stay ahead.

At MarketAxess we’ve built an algorithmic pricing engine that uses artificial intelligence to predict bids and offers for more than 25,000 bonds globally in near real time. This machine learning engine, Composite+, refreshes every 15 to 60 seconds and transforms unstructured data points into an unbiased two-way and mid-market predictive price.

There are also tools to help drive best execution for the more liquid (higher-grade) corners of the corporates market, such as Auto-Execution (Auto-X), which is also in our stable. For investment managers, this has worked particularly well for managing predictable, parameterised trades in places such as separately managed accounts and institutional bond portfolios. The idea here is simply to reduce the time fixed income teams spend on repeated tasks, freeing them up for more complicated trading opportunities and risk issues.

 

What do this year’s developments presage about the future for corporates and fixed income?

Jason Waight: In some ways, the fixed income market’s evolution towards technology has really been waiting on 2020. The opening up of volatility and a significant and cascading recalibration of corporate and sovereign fortunes worldwide has put new venues, platforms and assumptions about pricing data to the test. While some have dragged their heels, many are already taking advantage of technology solutions providing insight on fixed income pricing, liquidity and risk. Fixed income traders, portfolio managers – and now their risk teams – require signals they can use to navigate the markets, plug into much broader analytic processes and, ultimately, add risk for clients both aggressively and intelligently.

For them, the Covid-19 pandemic provided an unexpected and extremely chaotic opportunity, and it may not be long before more dislocation and volatility returns. With both the transition away from Libor and Brexit in the offing, they are looking to move faster and smarter in the coming years. Better data and technology tools will satisfy their – and their CIOs’ – growing need for speed.

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