By Lynn Martin, President, ICE Fixed Income and Data Services
It’s a dynamic transforming bond markets: the ability to move large, multi-faceted bond portfolios fast and with precision. Portfolio trading now comprises nearly 5% of total bond market trading volumes, around three times the amount in previous years, according to TRACE estimates.
The momentum is clear. In the first quarter of 2021, over $4.2 billion in U.S.-based notional activity was executed at ICE, up from $1.9 billion in the fourth quarter of 2020, over double the volume of the prior quarter.
Where portfolio managers, traders and dealers once engaged in protracted spreadsheet exchanges lasting several hours, they can now price and move complex portfolios with a few keystrokes.
Portfolio trading refers to a transaction where thousands of bonds can be offered simultaneously by ICE in a single trade to one or several counterparties. The trade is executed in an all-or-none fashion, but can put multiple dealers in competition to price the entire portfolio.
The ability to move large parcels of risk with ease means the opportunity to execute fewer, larger trades to reduce market impact and cost. Already, many asset managers are regularly shifting blocks worth several hundred million to topping $1 billion. A process which used to be sporadic due to time and resources needed, is fast becoming part of the fixed income landscape as a way to tap liquidity.
In addition, a reduction in time needed to execute on portfolios means bond desks can reallocate resources. This means traders can spend more time with clients, conducting analysis or managing risk, instead of executing transactions. As a trading workflow which is fully automated - from staging the order to execution reports - portfolio auctions can also reduce operational risk, complemented by an audit trail of execution.
More broadly, the continued rise of passive and low-cost investing is supporting its use, with portfolio trading allowing exchange traded fund (ETF) issuers and other fund managers to automate their rebalancing process. As the volume of ETF creation/redemption activity has jumped - translating into larger volumes traded - transparency has increased, spinning off more data for pricing, which has fed greater confidence and liquidity in the market.
Similarly, portfolio trading improves pricing by allowing asset managers to trade an entire basket of bonds vs their pricing benchmark. The “all or none” execution style allows the winning bidder to essentially own the entire risk profile of the basket - so they may be more willing to provide better pricing for less liquid bonds when packaged with more liquid bonds.
Importantly, tracking error can be reduced by the ability to execute as close as possible to net asset value prices. Asset managers who want to build portfolios quickly, raise cash fast, or change positioning swiftly can also minimize information leakage with the faster execution of portfolio trades. This becomes increasingly critical as multimillion dollar bundles of risk change hands, and the volumes transacted in single trades rise.
In this way, portfolio trading supports a more nimble fixed income market - replacing traditional RFQ activity and playing a key role in ETF primary markets. And as billion dollar bundles change hands with increased momentum, it represents a critical edge in volume-hungry markets.