Corporate Bonds Lead E-Trading

Terry Flanagan

Investment-grade debt is leading the charge when it comes to electronic trading, more so than high-yield and emerging markets, which are still in the nascent stages of ‘electronification.’

“It’s a bigger market,” Mike Nappi, senior investment grade trader on Eaton Vance’s investment grade desk, told Markets Media. “There are bigger issues. You have more players involved. It lends itself to electronic trading probably more so than any other asset class under the fixed income umbrella. It’s where most e-trading platforms were started.”

Nappi has been trading investment grade bonds — those rated BBB or higher by credit agencies — at Boston-based Eaton Vance since 2006. By his estimation, he has spoken about market structure and electronic trading at four or five industry conferences over the past two years.

“It’s a continued collaboration on how to improve market structure,” Nappi said. “The notion that it’s ‘broken’ right now sometimes gets exaggerated, but there’s also the realization that things could deteriorate. Do we have the right things in place to keep the market two-way and flowing?”

Demand has risen overall for fixed income as yields remain at rock-bottom historical levels. Fixed income exchange-traded funds attracted over $7.9 billion of inflows in January, according to State Street Global Advisors. In the corporate sector, investment grade has attracted more inflows than high-yield over the last six months.

“The race between investment grade and high yield started neck and neck with inflows into junk bond ETFs narrowly outpacing flows into their high quality counterparts,” said Dave Mazza, head of research, SPDR ETFs and SSgA Funds. “However, over longer periods, investment grade is still in the lead.”

Nappi has been a trader long enough to have developed a perspective on how markets worked prior to the crisis, then seeing them freeze up during the crisis, and in their current post-crisis, highly regulated state.

He often tells his desk, ‘Right now we’re in an environment where the easy trades — on the run, large issue trades– are easier than ever to do.’

The flip side is that it’s more difficult to find the other side when trading less liquid names, which comprise the bulk of the market’s issues. “The ability to call in and try to get a bid on the phone on a block of off-the-run bonds has changed,” said Nappi. “There’s a lot more effort involved. I’ve seen that transform from when I started trading in ’06 to now.”

“For the bonds we want to sell, it’s a challenge,” Nappi said. “It’s not impossible. We certainly get it done. Our tickets continue to increase, but it’s just the degree of difficulty goes up. The amount of time it might take to buy or sell a security may take a little longer.”

The exact amount of trading in investment grade debt is estimated at between $16 billion and $18 billion a day, but Nappi believes the actual number is more than $25 billion. “Anything over $5 million is reported, but the true size of that trade is on a delay,” he said. “Remember you have a market that’s just increasing in size. You’re actually seeing volumes decrease if you look at them as a percentage of the overall market.”

This is typical of any over-the-counter market, including investment grade. This is beginning to change, however, amid a general market push for greater transparency in transaction reporting. 144A bonds, for example, began showing up on Trade Reporting and Compliance Engine (Trace) last year.

“For years, those bonds weren’t on Trace. You had no way of knowing where a bond traded if you sold it to a broker over the phone,” Nappi said. “Now you can see that. I think that’s a big step.”

As for algorithmic trading, Nappi said, “I don’t think you’re seeing that at least in the investment grade space. I’d be surprised if that was the case because the way bonds trade don’t really lend themselves to algorithmic trading, unless you’re really focused on on-the-run issues where you have 50-60 million bonds trade on a per-day basis.”

Featured image via Dollar Photo Club

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