An electronic trading revolution is finally coming to corporate bonds, years after reaching other financial markets.
That’s what Man Numeric, a quant investment arm of the world’s largest publicly listed hedge fund manager, believes. The firm is executing 90% of its high-yield and investment-grade trades through digital platforms, and expects to get to 100% within two years. A year ago, only about a third of its junk bond trades were electronic, with the rest happening on the telephone or a messaging platform.
The money manager’s shift shows how electronic platforms are making real inroads in a corporate bond market that has long been dominated by investors and banks calling one another to trade. Across the high-grade market, about 40% of trades are online, up from less than a tenth a decade ago, according to research firm Coalition Greenwich.
Man Numeric has noticed a key shift in electronic trading in just the last two years. Corporate bond traders have long clung to the telephone because most bonds change hands infrequently. An asset manager that needs to sell notes might call a dealer that in turn needs to find a buyer, and may have to telephone dozens of other firms to find one.
During times of turmoil, voice trading has often won out for the biggest trades, even as recently as the early part of the pandemic in 2020. But in the last few years, Man Numeric has noticed that trading volume on electronic platforms was growing in both bad times and in good, said Robert Lam, co-head of credit at Man Numeric. More investors seem comfortable using fully electronic trading, in part because they have more sophisticated pricing algorithms that can handle big market shifts.
“What’s really changed is that electronic trading continues to gain market share even through these periods of volatility, which means that this protocol has become time tested as well as volatility tested,” Lam said.
That growth opens the door to investors using more quantitative strategies in corporate bonds, such as using large language models to find underpriced securities, Lam said. Quant firms and their rapid trading can broadly add liquidity to the market.
Man Numeric views its edge as being in security selection. It’s generally looking for individual bonds or groups of securities that are underpriced, or for long-short trades.
The firm might use a large language model and alternative data sets to find companies that are exposed to artificial intelligence and whose bonds are therefore mis-valued, according to Lam. While this kind of analysis is common in equities markets, it’s still unusual in corporate debt, where many investors are often looking through individual companies’ balance sheets and income statements to evaluate their creditworthiness. Man Group overall had about $6.6 billion in systematic credit and convertibles strategies as of June 30.
About 30% of high-yield bond trading is electronic now, up from around 2% a decade ago. This kind of growth will probably only continue as online platforms figure out how to appeal to more types of investors, said Kevin McPartland, head of research for market structure and technology at Coalition Greenwich.
“We still believe this market has a lot of innovating to do,” McPartland wrote in a recent note. “Retail access to the bond market is still a decade or more behind the equity market.”
Bloomberg LP, the parent company of Bloomberg News, competes with electronic platforms to offer fixed-income trading, data and information to the financial services industry.
Liquidity Concentrates
Man Numeric, which had about $37 billion of total assets as of March 31, looks closely at both performance and liquidity data in trying to find good investments. The firm has found that liquidity for electronic trading can still be good during times of stress, but it tends to be concentrated in the most liquid securities, while liquidity in securities that are less commonly traded might get even thinner.
Not every money manager is convinced that electronic credit trading is robust enough for all their needs. T. Rowe Price’s fixed income trading unit is increasingly trading more of its credit flows electronically but doesn’t foresee this approach becoming the majority of its orders, especially for junk bonds. To Brian Rubin, co-head of US fixed income trading at the firm, voice-based trading offers a variety of benefits, including making it easier to trade quietly, and to trade more securities in times of market turmoil.
“You don’t want the world to know what you’re doing,” he said in an interview.
Rubin also prefers voice orders when it comes to trading from CCC-rated companies many of which tend to be more obscure, less liquid securities.
But CCC debt is a relatively small portion of the junk bond market, said Winifred Cisar, global head of strategy at research firm Creditsights Inc. That tier of debt represents a little more than 10% of outstanding high-yield securities.
For the rest of the market, electronic trading can expose investors to a far wider array of potential buyers and sellers, compared with calling a dealer on the phone.
“If you trade electronically, then you have increased exponentially the number of eyes on whatever you’re trying to do. And that just presumably increases your chance of success,” Cisar said.
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