Understanding the effect of exchange-traded funds ETFs in supporting liquidity for fixed income is crucial, since it has become an integral part of the market.
“In European investment grade (IG), the tickets of around €1 million have been increasing in number quite dramatically,” said Ramon Baljé, head of fixed income EMEA at Flow Traders. “That is at the expense of larger size tickets. A 2020 study by ICMA showed that the buy and sell side unanimously believe the ETF ecosystem is a big driver of new liquidity in fixed income markets.
The prediction for algorithmic trading in European investment grade is really interesting because it not only shows that 50% of volumes will be processes in an automated, algorithmic way but also if you compare it to other asset classes, especially ETFs, that we know very well have much higher percentages this has been driving a lot of innovation in the system.”
This dynamic, in concert with electronic market makers such as Flow Traders, has enabled greater electronification of bond markets helping systematic investment firms like Dimensional Advisors. “It’s been a fantastic development for depth of liquidity of the market,” says Odin Costa, senior fixed income trader at Dimensional Fund Advisors. “I 100% agree with the trend described. We’ve seen the eruption of smaller sized tickets of under €1 million, even down to €100k-€200k.” “The [predicted growth of the ETF market] is a very realistic prediction, we’ve also seen a lot of new ETFs that are focused on green bonds,” said Jasper Jansen head of fixed income trading EMEA at Flow Traders. “The other thing we’ve seen in ETF markets is that they are not only being used by the buy side to buy and hold, they’re also used by more fast money to try to quickly get -in-and-out, and some buy an ETF until end of month when they convert the ETF into the single bonds.”
Costa noted that this allows traders to tackle broader parts of a curve rather than focusing on a single ISIN or issuer. “If you’re looking at, two years tenor, and you have a range of 100 to 150 bonds you can sell or purchase on a given day, it allows you the flexibility so that if you plan to spend €50 million, you can spend €1 million on one ticket, €100 or €200k here, and only €5 million with another counterparty, to build up all of that liquidity at once,” he said.
The potential for adding further liquidity to the market is increased because as an ETF creator, the Dimensional could potentially support price making in the future as electronification expands. “We as a systematic trading firm are on the path to developing our own algo pricing,” Costa said. “We would love, in the next year or so, to be able to provide liquidity back to the street, via MarketAxess or Tradeweb, as a buy-side firm providing liquidity in portfolio trading for example, if a buy-side firm were to put a cross in a dark pool. I would be more than happy to do things like that.”
©Markets Media Europe 2023
