The secrets to unlocking alpha in fixed income trading

Erik Tham, head of private banking product, Market Axess

Electronic fixed income trading spiked over the course of 2021, thanks largely to the impact of the Covid-19 pandemic. Research by Coalition Greenwich estimates the average daily e-trading volume climbed to record highs of $10.6bn in January 2021, surpassing the previous $10.3bn record of May 2020.

Average daily trading volumes at US corporate bonds reached their highest levels since June 2020 at the start of 2021, with $29bn trading in investment grade and $12bn trading in high-yield, according to the analytics firm.

Rising trading activity has put increasing pressure on the execution desks at private banks and wealth management firms, which face different challenges compared with other market participants, according to Erik Tham, head of private banking product at MarketAxess, which provides an institutional e-trading platform, as well as market data and post-trade services.

“If you look at a classic execution trading desk at a private bank or wealth manager, there are three large differences between it and a classic asset manager role,” explains Mr Tham, who was previously a trader at UBS Wealth Management.

The first is the sheer number of different orders. “On a private banking desk, you typically have smaller order sizes, but many more orders, and you also have a very diverse order set,” he explains. “While asset managers have expert portfolio managers for specific product segments or asset classes, a private bank trading desk can receive a wide array of orders even within fixed income, which covers everything from government bonds through to exotic local emerging market bonds. The trader has to master all these different order types, assess thousands of orders and transform an investment decision that was taken a while ago, probably far away from the desk, into an actual investment, ideally also generating alpha for the client.”

This touches on the second difference: the fiduciary responsibility of private banks is to provide best execution and generate alpha for their end private clients. “The desk needs to generate alpha to get the best product in the market, not only to tick the MiFID best-execution boxes, but to provide a better execution than a competitor's execution desk,” Mr Tham continues.

The third difference, he says, is that the investment decision is decoupled from the actual trading activity. “There is a complex information flow between when an initial investment recommendation is given, then the actual investment decision is made between the client and their advisor and then when the trader finally receives an order to do the trade,” he says. And, unlike in equity trading, product pricing and liquidity applications for fixed income products are not readily available to market players and the wider public. Therefore, a successful trader requires expertise from deep within the market to drill down to good investment decisions.

It is a challenge to manage the intricate relationship between the private bank, the trading desk and the advisor seeking to secure the best deal for their client. “Information flows at private banks are very complex and a trading desk receives so many phone calls from client advisors asking about price, liquidity and putting in orders for their clients. Therefore, it is key that the information from experts, or from within the market, is transported as efficiently as possible to the advisor,” says Mr Tham.

Ordering orders

Achieving optimal efficiency and getting the entire order flow under control to quickly assess each order is vital. However, historically private banks have lacked the tools necessary to deal with the sheer volume of orders and the complexities that arise with such an innately diverse asset class as fixed income.

To address some of these pain points specifically for private banks, MarketAxess developed Axess IQ, an execution workflow solution for fixed income securities trading that makes the job of the modern trader far easier.

Axess IQ provides a range of functionalities for a fixed income trader, including smart ways of organising orders. The order management component of MarketAxess’ solution, for instance, allows traders on a private bank execution desk to efficiently manage orders in a large team of several execution traders. Multiple traders are able to work together in an accumulative order queue, which provides scalability.

Its built-in data aggregator, which pulls in data for every order, also solves another issue commonly found in among the trading profession. “In my experience as a trader, I used to spend a lot of time looking for the right data,” says Mr Tham. “Axess IQ compiles data so traders don’t have to search for data. Trader’s normally have an order on one screen, data on another, and perhaps a third screen for historic prints and activity from your desk. But Axess IQ combines everything, and it’s all one mouse click away, including the actual trade execution process, which is controlled from the very same screen in Axess IQ."

Efficiency gains

Nevertheless, for the modern trader, automation is key to efficiency, and can range from enabling fewer mouse clicks to fully automated, zero-touch workflow solutions.

“With Axess IQ, it is very easy to configure an automation engine, which allows for different levels of automation. Some of our most successful clients pump all the orders into the platform and use automation to auto-execute smaller orders and filter down the order list to those that require the attention of the trader, and that’s an enormous efficiency gain from the platform,” Mr Tham says.

Execution workflow solutions are also increasingly democratising the transaction process for the other market players involved. According to Mr Tham, advisors can now use Axess IQ to see their orders and the last best price achieved at the trading desk for that specific order.

“They obviously can’t interact with the market, but this transparency renders a lot of trader-advisor calls redundant because everyone can look up all the information in real-time,” he explains.

The trader can also log on to Axess IQ and review the entire order flow from one location, according to Mr Tham. Additionally, they are able to set up filters to efficiently zone in on specific asset classes, order sizes and characteristics.

Limit monitoring

Private bank execution desks often have to work with limit orders — something that asset managers typically do not do. Therefore, MarketAxess added integrated limit monitoring as another built-in feature of Axess IQ. It continuously assesses every limit order and benchmarks it with the market, giving an indication of whether the order is in the market or far off it.

“This allows the trader to simply filter down a list, of potentially several hundred orders, to those that are really executable now, with a limit which is in line with the market so they don’t have to waste time checking all the other hundreds of orders which could be far off the market,” Mr Tham says.

Desks that do not work with automatic electronic limit monitoring, he explains, periodically have to check all their orders. Because some limit orders can be valid until the end of the month, week, or even year, they can sit on the order book for a while, and traders can spend a lot of time and effort simply checking the limits. “Axess IQ does it all for them,” he adds.

Price prediction

Artificial intelligence also has role to play here, and limit monitoring and assessing liquidity levels of fixed income transactions can be aided by machine-learning predictive techniques. MarketAxess’s Composite+™  (CP+), for instance, is embedded in Axess IQ and enables machine predictive algorithms to identify where the next price point for a particular bond might happen.

The bond market is still very opaque, explains Mr Tham, and is challenging for non-experts and for non-traders to get an idea of where realistic price levels might be.

“In the context of private banks, for client advisors or end-clients who sit outside the market and are not in front of the trading desk, this product changes the way they can look at the fixed income asset class as a whole because it gives them a very good indication of where the market is,” he says.

This is underlined by a piece of data called relative liquidity score — a scale from one to 10 indicating how liquid a bond is in a normal market environment. “CP+, in combination with the relative liquidity score, is an extremely powerful tool to give to an investment advisor trying to find a bond that will be the best investment for their client,” says Mr Tham.

Data analytics and artificial intelligence are expected to continue to revolutionise the fixed income space in the coming years. Platforms like AxessIQ are already facilitating access to extensive amounts of data, which both drives alpha for clients and encourages a more transparent and open form of trading.