Portfolio trading challenged on best execution

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For decades, tourists have flocked to Spain’s Costa Brava in anticipation of the three Ss, broadly understood to refer to sun, sea and sangria. At last week’s FILS conference, traders flocked to Barcelona to broaden their understanding of how portfolio trading can help them handle another three Ss.

“We’re looking to solve for size, speed and sensitivity,” said James Deighton, global head of investment grade credit trading at HSBC.

Portfolio trading activity has increased significantly over the past 12-18 months, panellists noted, with most volume seen in investment grade corporate credit, as well as selected other liquid segments of the European and US bond markets.

Lee Sanders, head of execution for global FX and UK & Asia fixed income trading at AXA Investment Managers, said portfolio trading was an important “weapon in the buy-side arsenal”, which also gave sell-side firms an opportunity to add value to key relationships, at a time when smaller transactions are increasingly executed electronically on trading platforms.

Sanders said portfolio trades – in which buy-side clients ask banks to execute a basket of 50 or more trades, collectively worth upwards of 50 million, for a single aggregated price – could be extremely valuable to buy-side fixed income desks “if we’re up against the clock and need instant liquidity”. But he later suggested that speed was not necessarily the most significant factor in opting for a portfolio trade, noting the relevance of market direction and information leakage to the decision-making process, and acknowledging the time required to assess risk on a diverse basket.

According to James Chapman, head of credit trading for Europe at RBC Capital, portfolio trading interest from clients covers a “broad church of requests”, including rebalancing, tactical adjustments and other forms of risk transfer. In the euro and sterling markets, portfolio trades are typically managed by a single sell-side counterparty, panellists said, with AXA IM’s Sanders underlining the importance of discretion on both sides, to enable cost-effective recycling of risk.

But in the larger US dollar market, it is common for buy-side firms to approach three to four banks for prices for portfolio trades. This can be conducted manually, but it is increasingly supported by the major bond trading platforms. According to Iseult Conlin, US credit product manager at Tradeweb, the platform had facilitated portfolio trades in excess of US$1 billion.

“Portfolio trading is still in its infancy in fixed income. As such we’re trying to be flexible with the protocol,” she said.

Size is not the only reason that the US market is able to support ‘in-comp’ protocols, said HSBC’s Deighton, citing the wider range of hedging options afforded by its deep and sophisticated credit ETF market. “The risk management ecosystem is very different,” he observed.

But, at least one delegate wanted to know, can portfolio trades be justified in terms of best execution? Rather than achieving best execution on a line-by-line basis, traders should evaluate portfolio trading in terms of the best outcome overall for the client, said Sanders.

“It may be possible that the bank is unwilling to provide liquidity in a particular bond on an individual basis, but will do so as part of a portfolio trade.”

Taking up the risk management theme raised by panellists, a presentation by Brett Olson, head of fixed income for EMEA at iShares, highlighted the growing appeal of bond ETFs to institutional investors. Predicting a doubling in the volume of bond ETFs to US$2 trillion by 2023, Olson cited strategic and tactical asset allocation, and cash and liquidity management, as well as hedging, as factors driving institutional usage. “Asset managers and owners are actively using ETFs in portfolios to make themselves more efficient,” he said.

©The DESK 2019

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