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For Portfolio Trading, Explosive 2020 Growth Could Be Just the Beginning

| Credit

This article orginally appeared on here.

Pandemic-era volatility has helped portfolio trading in corporate bonds quietly turn a corner in 2020 even as the fixed-income spotlight has fallen on the rise of bond ETFs and bond-market electronification more generally.

Ironically, those two trends figure to be key drivers of rapid growth in portfolio trading for years to come.

By the Numbers

Even before the pandemic, portfolio trading was booming. In January 2020 alone, Tradeweb logged more portfolio trading volume on its platform ($7.8B) than in the first five months of 2019 combined ($7.7B).

Portfolio trading built on those gains at the March height of the coronavirus crisis, when the number of securities traded via Tradeweb doubled relative to the first two months of the year.

The size of trades has also grown as traders become more comfortable with the trading protocol. The average number of securities in a portfolio trade has surged 22% from 89 to 109 in 2020 — a trend likely to boost portfolio trading volume in its own right.

The crisis underlined portfolio trading’s key benefits: certainty of execution; the capacity to trade numerous bonds quickly, at lower cost, and with minimal market-impact risks; the ability to circumvent illiquidity in individual bonds by bundling them with other, more liquid bonds; and, for trades executed electronically, OMS access to timestamps and audit trails for every bond traded.

Those benefits have helped portfolio trading extend its success beyond the initial coronavirus crisis. Tradeweb estimated portfolio trading market-wide hit a record $35B in October.

Growth in portfolio trading has even outstripped surging volumes more generally to comprise a progressively larger share of bond trading. At the start of 2019, portfolio trading accounted for 1% of all TRACE-reported market volume. The figure doubled to 2% by the start of 2020, 3% during the pandemic, and 4.5% in October.

That two-year-stretch of sustained gains leaves little doubt that portfolio trading has turned a corner.

Dark Matter

Moreover, incomplete data on portfolio trading means those gains may be understated. Tradeweb rival MarketAxess, for instance, doesn’t report its portfolio-trading data.

The accuracy of portfolio-trading data is also limited by the fact that portfolio trades are not tagged as such in TRACE, the US's consolidated tape of bond prices. Instead, analysts must infer portfolio trades from circumstantial evidence like numerous trades executed with the same timestamp.

And since TRACE excludes trade sizes above $5M for investment-grade bonds and $1M for high-yield bonds to minimize information leakage, portfolio-trading volume calculations assume an average size for large trades. Those figures may be underestimated — particularly with the average number of securities per portfolio trade on the rise.

TRACE developer FINRA is working to remedy those shortcomings after the Fixed Income Market Structure Advisory Committee recommended in February that TRACE explicitly identify portfolio trades based on formal criteria.

The push to tag portfolio trades could expose dark matter that reveals the true size of the portfolio-trading universe. By improving industry participants’ understanding of how and when portfolio trades are executed, it could also create a feedback loop that raises the media profile of portfolio trading, attracts more buy-side firms and dealers into the ecosystem, and helps trading platforms develop features to enhance the functionality’s appeal.

Bright Future

Those developments herald a bright future for portfolio trading. Still, with the extraordinary circumstances of 2020, even bond-trading platforms themselves have been quick to temper future expectations for portfolio trading.

After Tradeweb posted record monthly volume in October, head of US credit product Chris Bruner warned the firm shouldn’t “‘overstate the significance of a single month, because these are estimates and there’s risk the jump is for idiosyncratic reasons’” such as volatility ahead of early November’s US elections.

That was before Tradeweb broke its October record in November.

More broadly, there’s ample reason to be bullish on portfolio trading’s future. An overwhelming 96% of respondents to a Q2 WBR Insights and Jane Street survey of 100 buy-side fixed-income trading heads expressed interest in portfolio trading. 45% have executed portfolio trades (up from just 17% in 2019), and another 36% plan to do so in the coming year.

“A year ago, a portfolio trade was a rare event. Now it is an everyday occurrence,” Morgan Stanley head of Europe credit market structure Angela Lobo said.

The meteoric rise of bond ETFs in recent months could be the single biggest growth driver in portfolio trading over the medium term, since it provides a streamlined way for ETF issuers to rapidly execute trades to rebalance fund holdings as cash flows in and out.

To that end, the Fed’s decision to give bond ETFs its imprimatur by purchasing them to prop up bond markets during the coronavirus crisis may have been a key turning point for the trading protocol.

The promise of more debt issuance to come as corporations take advantage of low rates to finance growth during the pandemic recovery could likewise fuel the growth of portfolio trading. That issuance will continue to increase the breadth of corporate bond markets, creating pockets of illiquidity that portfolio trading can help clean up.

And, as with electronic bond trading more generally, market participants are likely to conduct larger and more frequent trades once they’ve crossed the portfolio-trading Rubicon.

Perhaps most importantly, bond-trading platforms will continue to develop features to broaden and enhance the appeal of portfolio trading. Respondents to the WBR Insights and Jane Street survey cited “increased workflow efficiencies such as straight-through processing” as the top advancement required to execute more portfolio trades.

Creation of additional tools aimed at the pre-trade processes of portfolio construction and basket creation would meanwhile streamline the portfolio-trading workflow by replacing emailed spreadsheets of bonds.

Uptake of portfolio trading will also improve as bond dealers continue to develop their own tools for quickly pricing baskets of bonds, speeding the process of receiving portfolio-trade quotes for buy-side traders.

Collectively, those dynamics figure to push portfolio trading to new heights in the months and years to come. “‘I believe that credit portfolio trading will have profound effects on market structure,’” Greenwich Associates senior market analyst Kenneth Monahan said.