Seth Bernstein, the CEO of US$622 billion AUM asset manager AllianceBernstein, has opened the Fixed Income Leaders’ Summit US today, with an analysis of the challenges facing bond investment management and the changes necessary to overcome those challenges.
“I am one of those people that does believe the diversifying role of fixed income in portfolios if not dead is in critical condition,” he said.
That is because fixed income generally – outside of certain sectors like high yield – does not provide much income for investors he noted.
“If all you are looking for is diversification you could just expand duration, and have a smaller amount of fixed income in your portfolio,” said Bernstein.
For active managers, that makes the business of finding ways to support investors more necessary and more challenging.
“We need to be able to expand the return streams available,” he said. “Mass customisation is a critical part of that.”
Looking at that notion of mass customisation, he observed that investors want solution tailored to their needs rather than generic solutions such as a market cap weighted index.
Asset managers also need to address the liquidity mismatch between accessible fixed income liquidity in the market and the daily dealing offered to investors, but he argued they could not do it alone.
“It will require regulatory changes as well at some point,” he said. “I don’t mean just in the US, although I think the issue is more pronounced in the US than in for example in Europe. Ultimately the liquidity imbalances can be addressed by the market participants but the challenge is really large and its awfully complex and it will take years to be resolved.”
The most fundamental of those liquidity imbalances is maturity transformation, he asserted.
“When you own a portfolio that has a duration of seven, and most of the bonds trade by appointment – when they trade – the notion that you can convert that to cash in the morning is farcical. And yet that is how the industry works today. we don’t have to have daily dealing, but we do [have it] and that may be something that requires regulatory change. You certainly need daily pricing – this is not a way to avoid transparency – it is just the recognition that liquidity isn’t always there.”
He noted that markets will increasingly become electronic, more efficient and more transparent, while access to them will be democratised over time and as a result, liquidity will improve.
“We’ve seen that already,” he said. “But the challenges are significant. We have inherent complexity in the variety of debt instruments – there is usually only one equity for a company and dozens of debt instruments. The importance of the new issue market to that liquidity, consequently, is much more important and that is never more clear to me than in the municipal market here is in the US, where if you don’t get [a bond] on the new issue it is very hard if not impossible to assemble a large position over time.”
He said that a select group of firms including AllianceBernstein are at the cutting edge of the effort to evolve the market, as evidenced by the technological innovations that the firm’s own fixed income team has introduced over the past ten years and the recognitions it has received from industry groups.
“What do we really need today? I think we need better data availability and integrity,” he said. “DTCC, Euroclear, Broadridge, supplementing TRACE, we need more insights, colour. Price discovery and understanding volume discovery is a part of core management. Liquidity aggregation, the consolidated tape in the spirit of the equity markets are hard to do, but frankly that is what we have been trying to do with our liquidity [aggregation] tool, ALFA. Understand those pools of assets and understand where and when they have traded.”
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