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Fixed On Bonds

It’s good to talk!

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So the dream was always to work from home. I’d heard about those traders sitting in a villa on a beach executing orders with a Pina colada in hand. Well now the dream turned into reality, albeit for reasons that I would have never imagined or wanted. I was at my desk, my screens were set up, my daughter was screaming in the background and I was ready to go, would my WIFI rise up to the challenge!…….It’s now been quite a few months at home and my desk is as messy as it was in the office. I’m an expert in setting up funky zoom backgrounds and I spent a disproportionate time thinking about toilet rolls at the beginning of it all. However, what has really come out of this period is that I’ve learnt some very important lessons about the job I do during one of the most volatile periods in recent history.

When COVID started to take full effect in the economy, spreads started to widen significantly in the European corporate bond markets. Credit markets sold off and according to Marketaxess, in price terms, there was an approximate +190% rise in GBP IG spreads and +377% in EUR IG spreads from February to March. Bonds became difficult to absorb by the banks and in some cases bid-less as many investors scrambled for the door. The prices which buy side dealers normally had to try and rely on often became stale and in some cases were completely irrelevant to the prices being traded at in the market.

Once central banks intervened and started supporting the markets, there was a strong recovery in the stock market and spreads began to tighten and in some cases are close to or tighter than February 2020 levels. Since spreads were impacted differently (depending on the bond characteristics such as currency, sector, maturity and seniority) it highlighted even more the importance of understanding the liquidity of the bonds in the portfolio. To summarise the markets have been volatile!

So what did I learn over this year….I learnt it’s good to talk!

It’s good to talk to your counterparties!

On a practical level, during the initial COVID volatility, trading became extremely difficult across certain asset classes with a large number of banks unable to price bonds with any consistency. As a result, when trading by voice or electronically it became even more important to show trades to relevant and trusted counterparties especially to prevent information leakage.

What this re-emphasised was that it’s important to talk to and analyse your trading counterparties and maintain strong relationships, understanding how each of them are effective for your funds. As we know there has been a reduction in banks’ balance sheets due to regulation and although they are still critical to the functioning of the market they are no longer a one stop shop. It is important to know to which markets they have allocated capital to and who is consistent in their pricing, providing liquidity in both times of stress and stability. As a result, non-bank liquidity providers have also stepped into the market to try and fill the void but also face challenges of consistent pricing in stressed scenarios.

It’s good to talk all things Tech!

In the last few years, the use of technology and different trading protocols have swept into the credit markets. Every other virtual knock on the door has been from a technology provider claiming to solve my liquidity problems. There has been an acceptance that with the less liquid nature of the market the use of technology will help to alleviate some of the liquidity issues and create efficiency.

Over the past year, access to pre-trade bond inventory tools has been extremely useful in often less liquid markets. Away from the traditional request for quote (RFQ) protocol, being able execute orders anonymously with other buy-side firms and alternative liquidity providers through a variety of trading protocols widened the pool of liquidity. Overall, the increased use of portfolio trading, auction based trading, streaming bank algorithms as well smart auto routing of orders show how the ecosystem for fixed income trading is continually changing. Not all systems and protocols will have a role to play as every portfolio is different but it is important to challenge both the incumbent and new trading platforms in developing relevant and practical solutions.

It’s good to talk to the team!

As we left the office in March the one fear I had was that I would lose all the interaction with the credit team as we sat within touching and talking distance of each other in the office. Apart from not being able to listen to Simon’s terrible jokes, how would I continue to keep the PMs aware of the movements in the markets, discuss trading opportunities, suggest alternative bonds, understand motivations for trades and talk about live trades and prices as they happened.

Luckily I didn’t need to fear! Yes the joyful atmosphere of the office and the rush for the fruit bowls can’t be fully replicated but the use of Instant Bloomberg Messaging and especially the use of video conferencing has allowed us to continue the close team dynamics. Credit dealing is an integral part of the investment process and it was key to replicate the lines of communications at home with the PMs. Daily calls on the state of the credit markets, new issue announcements and trading updates can still take place.

So my working from home dream came true, not a Pina Colada in sight. It has come with challenges but surprisingly better than expected. As I write this Blog, Joe Biden is coming into power and there are now COVID vaccines being rolled out to the world. The market is now caught between rising optimism post vaccines and the worry of a rise in yield curves. It is clear, as an active investor, the need to navigate the markets with a substantial toolkit of execution methods and systems which take advantage of capturing liquidity is now more important than ever.

Anish Shah

Risks

Government and corporate bonds generally offer a fixed level of interest to investors, so their value can be affected by changes in interest rates. When central bank interest rates fall, investors may be prepared to pay more for bonds and bond prices tend to rise. If interest rates rise, bonds may be less valuable to investors and their prices can fall.

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For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within this document.

Whilst every effort has been made to ensure the accuracy of the information contained within this document, we regret that we cannot accept responsibility for any omissions or errors. The information given and opinions expressed are subject to change and should not be interpreted as investment advice. Reference to any particular stock does not constitute a recommendation to buy or sell the stock.

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