One of the most entertaining sessions at the Fixed Income Leaders Summit in Nice last week was a debate with a serious point. Discussing the veracity of the statement ‘This house believes it is time to challenge traditional ways of paying for balance sheet access’, Mike Poole, head of fixed income dealing at Jupiter Asset Management duelled with Jasper Livingsmith, director and head of G7 portfolio management for the EBRD Treasury, while refereed by the excellent FILS chairperson, David Bullen, director & founder of consultancy Lorgwood. The starting point was 79% in favour of the house’s view.
The pair debated how and if the current market making model needed to be replaced, based upon the inability to the lack of transparency in determining true trading costs for spread products, and the current weakness of dealers in being able to support risk taking.
Poole, whose firm is purely an active management house operating a high touch trading desk, said, “I find our ability to ascertain how much we pay for balance sheet can be curtailed by the sporadic nature of our trading, so we’re not flow house. We don’t have to buy and sell securities we do so when the price is right and the opportunity presents itself.”
Noting that opportunity costs in a fragmented marketplace have for so long been the “silent killer of investment returns”, Poole advocated an enhanced ability to both make prices and better inform buy-side / sell-side conversations with data and analytics tools alongside a new way to price trades that is less implicit.
“It’s vital as we approach a new transparency and liquidity paradigm in fixed income especially spread products,” he said. “So I am here to explain not only why it is necessary but we have a fiduciary duty to shine a light on how much we as investors are paying to access to balance sheet and to think about how we improve the value proposition for both parties in a trade”
Livingsmith fought back with the famous ‘jaws of death’ chart which shows bank inventory of bonds vs bond fund outstandings.
“There is no way for banks to intermediate any event in the bond market,” he said.
He noted that banks needed to change the costs of supporting a trade for this very reason, in order to bridge the gap at any one time.
“The sands beneath you are constantly shifting,” he said. “It’s a repeated game, that no one should be incentivised to win big on anything. But having said that, transparency for a trade is quite difficult.”
However, argued Poole, for investors that needed to trade based on opportunity rather than supplying a constant flow of liquidity to the sell side, creating better opportunities for the end investor.
“As active Alpha generative fund managers we are looking for that dislocation on the curve, we are looking for the ISIN which is slightly under owned or something that has alpha attached to it,” he said. “Now, for me to get that particular ISIN, chances are banks will have to warehouse risk and use balance sheet and that’s going to cost money. We need to smooth out that revenue stream.”
Being a seasoned FILS debater Poole delivered rhetorical flourish after flourish, fighting hard for making liquidity a “tree that would bend in the storm and not be broken” and arguing “[the industry] continues finding ourselves in Blockbuster video at nine o’clock on a Friday night, scrambling around for that film we all we want but ultimately going home with a Romcom everyone’s already seen,” when instead investment firms should move to a Netflix model, “having paid a consistent and fair revenue stream to allow us to access the content that we want when we want to play it – claiming the proper provision of liquidity.”
Nevertheless, Livingsmith’s excellent case won the audience over, leading to a twenty-point swing against the house’s position by the end of the debate.
©Markets Media Europe 2022
