01.27.2014

Fixed Income Focuses on Post-Trade

01.27.2014
Terry Flanagan

Corporate pension funds are shifting out of equities into bonds, as pension fund managers invest in fixed income to reduce risk and lock in higher interest rates after a surge in yields.

“This is yet another indication that the much discussed “Great Rotation” in the fixed income markets—the large market shift of investors selling out of low-yield bonds and buying into higher yielding ones—will be a major focus in the fixed income markets in 2014,” said Kevin Arthur, director, fixed income markets at Omgeo.

As a result, those on the buy-side—including pension funds and other asset managers—are executing more fixed income trades, increasing pressure on all phases of trade processing. “Paradoxically, just as asset managers are looking to execute more fixed-income orders, brokers are finding it far more challenging to make a profit due to thinner spreads and increased regulatory and compliance demands,” said Arthur.

Last year saw significant outflows from bond funds, primarily due to rising rates and anticipated further steepening of the yield curve, both adversely impacting bond values.

Outflows from bond funds totaled $49 billion in the third quarter, the first outflow recorded since the fourth quarter of 2008, and down from net inflows of $54 billion in the second quarter, according to the Investment Company Institute.

However, the pendulum swung back towards bond funds during the first week of 2014. In contrast to the first full week of 2013, when record setting flows into emerging market and global equity kicked the ‘Great Rotation’ narrative into high gear, the New Year kicked off with bond funds posting their biggest weekly inflow since early May while equity funds recorded modest net redemptions, according to EPFR Global.

Overall, bond funds took in a net $5.2 billion while equity funds posted a collective outflow of $427 million.

The fixed-income markets are executing even faster with recent advancements in execution technology and the creation of more electronic trading platforms. With investment firms focused on the speed of execution, it remains of paramount importance that the middle and back office keep pace.

“As such, buy- and sell-side firms are making adjustments across their post-trade infrastructure with one common solution identified: automation. Automation is particularly helpful when it comes to eliminating risks that can stem from trade clearing,” Arthur said.

An Omgeo study found that fixed-income trades can have settlement failure rates as high as 7%. Automation reduces the risk of human error and ensures that trades move to clearing and settlement quickly and correctly.

“A firm is only as strong as its weakest link in the trade processing life cycle,” Arthur said. “Greater community coordination and automation will be essential to keeping the markets running efficiently and allowing participants to garner the best possible risk-adjusted returns as the fixed-income landscape continues to evolve.”

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