As institutions gravitate toward fixed income, they are bumping up against liquidity constraints forced upon them by prevailing request-for-quote based systems.

“The dominant electronic trading mechanism for corporate bond trading among institutions is the point-to-point network RFQ,” said Anthony Perrotta, CEO of Cornerstone Resources, at Markets Media’s Fixed Income Trading & Investing Summit 2013. “The reality is that institutional investors are having trouble accessing liquidity pools, and are not getting the level of service they deserve.”

Cornerstone Resources is an independent firm offering advisory and management consulting services in the areas of fixed income market structure, Dodd-Frank (Title VII) implementation, and electronic trading.

The answer, paradoxically, may be found in retail platforms.

“The demands of institutional investors aren’t being met by traditional means or liquidity providers,” Perrotta said. “The retail market has a liquidity pool that is not readily available to larger asset managers, insurers, and hedge funds. The initial solution required in the cash corporate bond market is not a complete overhaul of market structure; it’s a simple solution, like building a bridge.”

The leading retail fixed income ATS, BondDesk, offers tens of thousands of unique offerings of different sizes; the firm has more than 5,000 individual corporate bond Cusips, with more than $1 million notional available at any particular point in time.

“We provide financial advisors with FactSheets on any Cusip they are interested in, which include things like duration, price sensitivity, coupon maturity, etc.,” said John Bagley, president of BondDesk Trading, at the Markets Media Fixed Income event. “This makes it possible for financial advisors to understand all the attributes of a bond, which can be a little daunting at first.”

BondDesk and Vestmark have launched a service that will enable financial advisors to provide clients with personalized bond portfolios that deliver all the advantages of investing in individual securities with the conveniences of investing in bond funds or other packaged products.

The new service unites BondDesk’s retail fixed income platform, BondWorks, with Vestmark’s award-winning wealth management platform, VestmarkONE.

Institutions are trading bonds more frequently and in smaller sizes, which lends itself to a less granular trading mechanisms such as those afforded by retail bond trading platforms.

Since 2006, block trades ($25+ million), as a percentage of par value, have declined by 20%. Conversely, round-lots ($1 million to $25 million) have grown by 37%. Odd and micro-lots have grown by 150% and 197%, respectively.

At the moment, many institutional investors direct their electronic execution to platforms offering access to a pool of potential liquidity providers, as opposed to an existing pool of liquidity.

While the RFQ mechanism satisfies the workflow needs of institutional traders, its value proposition depends heavily on the maintenance of the status quo and current market structure. Since fill rates for RFQ platforms can range from 60%-85%, executable pools would serve as a strong complement to the “on-demand” liquidity these platforms facilitate.

“While BondDesk’s platform is not a CLOB, its ability to provide certain execution is evident in fill rates that exceed 97%,” Perrotta said. “TMC, Knight BondPoint, and Tradeweb offer similar services in the electronic retail business. Banks have streaming liquidity available on a click-to-trade basis. Providing access to that would provide institutors with a deep pool of liquidity.”

Institutional investors are increasing their use of ETFs for fixed income in order to gain exposure to the asset class.
As decreased fixed income bond liquidity has driven institutional investors to explore new ways to access fixed income markets, fixed income ETFs are increasingly being used by investors to access liquidity and implement investment strategies.

Some 55% of institutions invest in domestic fixed income ETFs, according to a survey by Greenwich Associates. Usage of domestic fixed income is most common among insurance companies at 78%, although 74% of registered investment advisors also employ ETFs in domestic fixed income.