Fixed income portfolio trading 101: Minimize risk and unlock future opportunities

This article was written by Paul Kaplan, Global Head of Credit, Equities, TRS, and Price Transparency at Bloomberg.

A growing number of fixed income traders are turning to portfolio trades when they want to buy or sell a large number of bonds quickly. This involves bundling multiple securities into an all-or-none inquiry that can be analyzed, priced, and executed at the security and basket level. Portfolio trades tend to be negotiated with a small number of counterparties, but executed with a single firm – a characteristic that differentiates this from list trading.

Why opt for portfolio trading?

There are several reasons why a trader may choose portfolio trading:

• It’s efficient. Traders can avoid the time-consuming task of executing each security on a line-by-line basis.
• Minimize information leakage. Unlike trading a large number of individual securities with a large number of participants, all-or-none Portfolio Trades do not alert the market to a buy or sell program, so there is not time for the market to adjust richer or cheaper.
• Improved liquidity for illiquid bonds. Traders can recognize increased liquidity by including illiquid bonds in a basket of more liquid assets, as dealers are axed to trade a larger number of securities. This also helps to widen the universe of investible bonds.
• Rebalance portfolios: Traders and portfolio managers can rebalance their portfolios with greater ease and be confident of the result. For instance, they might want to change their portfolio’s sector weighting or their holdings’ average duration. Instead of gradually buying or selling the necessary assets to reach that goal, the trader or portfolio manager can achieve their target in a single all-or-none trade.
• Sell-side benefits. Sell-side traders have become axed in fixed income portfolio trading too. They often use the strategy to accumulate a large number of securities for more complex trades, or as part of their create-and-redeem process — now a large part of trading activity in the corporate bond space. Sell-side traders are also able to offer a better price because they benefit from having more time to review, analyze, and determine the most appropriate hedges for the large amount of risk.

Going electric

Fixed income portfolio trading is not new, but the electronification of the process has accelerated in recent years. That’s been helped by a surge in corporate bonds issuance and the growth of fixed-income ETFs.

Electronic platforms have replaced a voice-driven practice that was long and laborious, which involved creating a portfolio on a spreadsheet and emailing and calling dealers to negotiate prices on each item and at the portfolio level. Sometimes the dealer would be unable to honor the request and the process would start again with a different firm.

The next step

Electronic platforms have revolutionized portfolio trading; now, Bloomberg has created its own solution that makes several evolutionary leaps. While spreadsheets are still part of the portfolio creation process, tools such as Bloomberg’s Portfolio Trading Basket Builder (‘Basket Builder’, PTBB <GO>) integrates the data, analytics, communication tools, and pricing power of the Bloomberg Terminal into a single package that’s specifically built for fixed income traders and portfolio managers. The Basket Builder allows buy-side and sell-side to create the optimal basket of bonds before execution. From spreadsheets, order management systems or Bloomberg monitors or functions, traders can create portfolios, have them reviewed pre-trade by prospective dealers to ensure the securities are available and at satisfactory prices, analyze those quotes, and compare them against market references and benchmarks. Once the optimal basket is created, traders can easily move to execute the trade, on an all-or-none basis, via Bloomberg BOLT, where up to six dealers can be put in competition. Once the trade is complete, straight-through processing allows risk and p/l to be immediately updated without the potential for erroneous manual calculation and booking. This also simplifies and helps to manage reporting processes.

Bloomberg’s offering adds further value by also enabling dealer quotes to be spread to references such as Bloomberg’s Evaluated Pricing service (BVAL). This is in addition to other market standard quote types and references. This can help buy-side traders and portfolio managers better manage performance tracking error to their benchmarks and end of day closes.