As bid-ask spreads begin to widen on both sides of the Atlantic, buy-side credit traders need to reassess how to best manage the crunch on their liquidity costs. Bond markets have not seen the sale level of trading activity as equity markets, by implied volatility has been rising considerably as the US begins its long awaited trade war, and costs for entering and exiting the US market rise by double figure percentages for many commodities and goods, between large markets.
While credit spreads in the corporate bond market are tight, making opportunities for value harder to find, and bid ask spreads are widening, making liquidity more expensive without any notable increase in volumes, it is getting more expensive to add value to a credit portfolio.
If portfolio managers are finding it harder to spot value, traders will be integral in supporting them spot opportunities. Reading the market for chance to improve the pricing and liquidity for a portfolio will be constructive for the PM and for the end investor.
The potential value add could be affected by the level of active control that the combined trading desk and portfolio managers can express over orders, reflected via the level of agency that a PM and traders can collectively express.
In this current environment, working with PMs to closely find the point of return needed for a strategy vs. the costs to trade will require the trading desk to tap into pre-trade data, and keep close contact with their dealers to understand current available liquidity.
Building pre-trade analytics using both proprietary and commercially available data can be invaluable for the trading team, so that they can minimise the level of information leakage they create when exploring a trade idea with potential counterparties.
That plays into another crucial factor, the use of the right trading protocol to execute an order. While there is no one path to execute a given trade, given the interplay of market activity, counterparty availability, the portfolio manager’s priorities and the ISIN/CUSIP in question, some trading protocols are better at managing specific risks than others.
Automated trading held up well in the rates market recently during the Bund sell-off, which suggests that it can be better support trades – typically smaller in size – even in more directional markets, than ever before.
Portfolio trading, now reckoned to be around 25% of the US credit market, is also enabling a major transfer of risk in such a way that timing issues, such as implementation shortfall, are reduced. This has key advantage in that less liquid bonds can still be exchanged alongside more liquid bonds to support a better net transfer of risk.
Taking stock, the cost of liquidity is still relatively low, but climbing. With value harder to find, the cumulative cost of delivering returns for investors is rising. However, with the right data, and a careful use of trading protocol, the credit desk can still help the portfolios it serves to outpace the market.
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