Sep 3, 2021 - Economy & Business

Algorithms have arrived in the bond market

Illustration of a dollar bill and binary code.
Illustration: Sarah Grillo/Axios

The corporate bond market has always lagged equities — by a lot — in electronic trading. But recent innovations in pricing algorithms have helped grease the wheels for a relatively new way of moving a basket of bonds.

What's happening: That process, called portfolio trading, started picking up steam in 2019 — and is similar in concept to program trading for equities.

  • The pandemic-era push to experiment with workflow has helped accelerate portfolio trading activity, which has grown to a 5% share of total corporate bond trades, up from just 2% in January 2020, according to Tradeweb.

Why it matters: Liquidity has always been a pain point in the bond market. Portfolio trading helps address that by allowing asset managers to move large baskets of investment-grade or high-yield bonds in a single trade in a matter of hours.

  • Moving the same basket the old-fashioned way might take days — and loads of phone calls — leading to more information leakage about the trade and sending prices south.
  • Portfolio trading also helps investors sell illiquid bonds that they may otherwise not be able to find a bid for. Put one of those bonds into a portfolio of otherwise fairly common names and it’ll usually sail through in the basket trade, sources tell Axios.

Where it stands: Asset managers drove the initial portfolio trading activity, but that's expanded to insurance companies and even hedge funds, says Chris Bruner, head of U.S. institutional fixed income at Tradeweb.

  • Overall activity is expected to continue growing, he adds.

How it works: A trading desk runs an algorithm that spits out a clearing price for a basket of dozens or even hundreds of individual bonds. These portfolios can be anywhere from $100 million to over $1 billion in size, says Bob Summers, portfolio manager and senior trader at Neuberger Berman.

  • Why this process didn’t develop earlier has to do with the sheer size and variety of the bond market. There are 100,000 individual corporate bonds compared to less than 5,000 public equities in the U.S.

State of play: Fund managers use the portfolio trading technique to quickly put large inflows to work — or to create the liquidity to fund large withdrawals.

  • “If we get $100 million in from a client, this is a very easy way to get that $100 million invested right away,” says Summers.

Piggy-backing off of exchange-traded funds helps. Because ETFs are buying and selling assets every day, the more a portfolio trade lines up with an ETF’s assets, the easier it is for trading desks to move the inventory, Bruner says.

The bottom line: Portfolio trading is a still small portion of the overall market — but the train has left the station.

Go deeper: A bond market peak

This post has been updated to specify that portfolio trades were 2% of trading volume in January 2020.

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