Humans’ top bots in bond trading test
Flesh-and-blood traders saved day when algorithms failed in March but pace of tech innovation likely to continue to gain speed
IT TURNS out the corporate bond market still needs traders.
The algorithms that dealers use to buy and sell bonds with their customers failed in March at the height of extreme volatility from the coronavirus pandemic, according to investors and price data. The nimble analysis of flesh-and-blood traders was suddenly needed to price bonds, edging out machines that normally can trade large portions of the market without any human input.
The bond market has been one of the last corners of finance to move into the digital age, slowly modernising from the rise of electronic trading to new venues that will remove much of the interpersonal communication from the process of selling company debt.
Yet even as digital platforms set record volumes in the first quarter, market watchers said the bots failed a test when Treasuries and credit spreads were so disorderly.
“Good old-fashioned blocking and tackling is still very much a part of the business,” said Chris Coccoluto, head of investment-grade bond trading at Manulife Investment Management.
Blown Out
The virus-related disruptions were profound. At the height of the volatility, Treasuries rallied to record low yields and corporate bond spreads gapped out to levels last seen in 2009. The securities are linked as the vast majority of investmentgrade bonds trade at a premium to Treasuries, adding an extra layer of complexity when neither market was fully functional. While humans were able to spot the new patterns quickly, the bots could not adapt because algorithms are built on historical data, said Chris White, founder of advisory firm Viablemkts LLC.
Cutting Risk
For decades, banks have stepped back when prices are unpredictable and buying too much from a customer could trigger multimilliondollar losses in just days. At the end of March, dealers cut risk-taking mainly by shutting off algorithms that were spitting out incorrect prices left and right.
With Wall Street pulling back, asset managers stepped up to fill the void, according to Marketaxess Holdings Inc data. Voice trades – in which counterparties agree to a price over the phone, but process and hedge digitally – rose to a record, according to Tradeweb Markets.
Roughly 70 percent of the investment-grade corporate bond market still trades with some element of human interaction, especially larger transactions over $2 million. The record credit trading volumes handled on Marketaxess, Tradeweb and Trumid Financial LLC show how traders took advantage of platforms to execute smaller, simpler transactions electronically, which in turn allowed them to focus their attention on more difficult deals that require complex analysis, said Chris Bruner, head of US credit at Tradeweb.
Market turmoil also led to record volumes in portfolio trading, a relatively new practice that can price and sell a bundle of hundreds of bonds in minutes. Barely a concept three years ago, it is now a fastgrowing part of the market. New data-analysis tools that allow prices to be fully automated are part of the reason that traders have seen their ranks greatly thinned in recent years.
The events of this year may end up making bots better. Jpmorgan found that algorithms can in fact learn from humans in tempestuous markets. An algorithm it trained to recommend trades based on human market commentary significantly outperformed those based on only market observable features in March, strategists led by Joshua Younger said in a report last month.
The pace of tech innovation and disruption will continue to gain speed, said James Switzer, global head of fixed-income trading at Alliancebernstein. In March and April, his firm boosted by 500 percent its usage of Marketaxess’s all-to-all protocol, which allows for anonymous trading and can match investors with each other, as well as banks, on the other side of a transaction.
“That’s what’s going to come out of this, a desire by the buy side to embrace all-to-all trading because we can’t always depend on dealer balance sheets,” Switzer said. “If we have to find the other side of the trade in an anonymous all-to-all fashion, we’ll do it.”
Electronic powerhouses like Alliancebernstein and Blackrock have forged ahead to embrace technology. While both value having traders with market experience, they have also expanded recruiting criteria to include coding skills.
Others like Mike Nappi, head of investment-grade credit trading at Eaton Vance, still like the old school way of getting the job done.
“We don’t have a fully automated trading desk – I want our traders to have a sense of what’s going on in the market,” Nappi said. “... there are going to be humans needed, just maybe not as many.”