04.12.2012
By Terry Flanagan

Investors Flock to Bonds

While the recent spike in market volatility has sent investors looking toward bonds to hedge risk, it is also part of a broad shift to fixed income as a diversification tool.

“It’s clear after the volatile equities markets of the past decade, that there’s much more emphasis, especially on the retail level, to have a diversified portfolio which includes greater exposure to fixed income,” said Peter Campfield, president of BondDesk Trading. “When we speak to firms that have retail client bases, it’s clear that it’s not if we should have fixed income in their portfolio but how much should we have. We think there will be increased demand for fixed income.

In addition, while market volatility usually has a direct correlation to overall trading volume, it also has a unique effect on bond trading.

“During periods of high volatility you typically see a reduced level of trading, particularly if the higher volatility occurs within the context of a negative tone in the marketplace,” said David Killian, senior vice president and senior portfolio manager at Valley Forge Asset Management, a subsidiary of Susquehanna Bancshares. “This again primarily reflects a higher degree of dealer unwillingness to commit capital and increase balance sheet exposure to credit instruments. This dynamic is only exacerbated during negative market environments. This creates an environment whereby buy-side clients may not be able to execute sales at market prices or may not receive any bid at all during very volatile periods.”

The fixed-income space is one that is rapidly growing amid the uncertain market landscape. Market correlation remains high and there does not seem to be any conviction as to which way things are headed.

Asset manager BlackRock is looking to capitalize on the surge in bond trading by launching its own trading platform. It’s BlackRock Solutions arm will look to circumvent Wall Street and the traditional broker-dealer process with its own bond trading dark pool, according to reports. It would offer its client base, which includes sovereign-wealth funds, insurance companies and other money managers an anonymous crossing network for the trading of fixed-income instruments. While liquidity may be lower than other bond trading platforms, at least at its inception, the upside would be fees much lower than those offered by the traditional broker-dealer model.

However, market observers don’t expect the initiative to significantly cannibalize from the existing Wall Street model, as BlackRock and its clients would most likely continue to route most of their orders to brokers, where liquidity is higher.

The move also comes at a time when the big banks are culling or eliminating their proprietary trading operations. Fixed-income is historically a very expensive space, with orders routinely totaling in the six and seven figure range in value. Combined with the fact that bonds can be highly illiquid, brokers often find themselves taking on proprietary risk when one of their clients unload their fixed income instruments, sometimes for an extended period of time, while they look for the other side of the trade.

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