Portfolio trading volumes rise “like Moore’s law”

Published on 17 November 2020

The success of portfolio trading as a method for executing bond deals is leading to a doubling of volume every year at some investment houses, including Invesco. The ability to price a trade for many different bonds with crossover in the types of instruments – such as emerging markets and investment grade blue chip – and the direction of trades – with buying and selling possible in a single transaction, creates a new dynamic in liquidity provision.

Ray Uy, global head of fixed income and currency trading at Invesco, says the growth of the protocol is akin to Moore’s Law, the observation made in the 1970s that computer processing power was doubling every two years. Portfolio trading is valuable in a range of market conditions, he says, outlining the reasons for its increasing use within the investment management community.

Dan Barnes Welcome to Trader TV, I’m Dan Barnes. Portfolio trading boomed in March, during the sell off, but Ray Uy, global head of fixed income and currency trading at Invesco, says that portfolio trading has value all year round if used in the correct way. Today, we’re going to be discussing how Invesco is using it, and why it is expecting its volumes of portfolio trading to double next year. Ray, welcome to Trader TV.

Ray Uy Hey Dan, glad to be here. Thanks for having me.

Dan Barnes So tell us, how have you seen your execution priorities changing over 2020?

Ray Uy Very subtly. I think we’ve always had an emphasis on looking at technology, looking at developments in the markets to refine our strategies, and for us the emphasis this year has been on leveraging that technology towards the deployment of a systematic toolkit for execution. Portfolio trading falls within that toolkit.

Dan Barnes And so what effect has that had on the trading protocols that you use as you mentioned portfolio trading there?

Ray Uy The traditional RFQ as well as voice still exists. Obviously, within primary credit trading it’s still a very huge part of the overall activities. I think portfolio trading has almost had a hyperbolic growth over the last three years, in terms of a much more efficient and useful tool that can be deployed in secondary trading, and depending on the type of execution, it is a very useful alternative to the traditional protocols.

Dan Barnes What sort of trades to you see it working best for?

Ray Uy Given the market structure, really the sweet spot for portfolio trading in fixed income is in credit. The two factors that generally drive the best outcomes are a function of liquidity and diversity. So if you have a diverse portfolio, that has reasonable liquid characteristics that you’re seeking to trade, that’s a very good starting point. And then you can overlay that with, ‘is the risk profile compatible with other passive vehicles in the market?’ Probably the greatest factor ushering the growth of portfolio trading is not only the utility on the buy-side, but the utility on the sell-side in terms of how they’re thinking about their risk management. And it’s sort of broadened that opportunity set for them to manage their risks from their market making activities by integrating other channels.

Dan Barnes That’s great. Thanks very much. Now we’ve seen the portfolio trading protocol being popular on electronic platforms. We’ve seen sort of electronic liquidity providers who are very focused on the ETF space, providing it, and traditional dealers as well. Do you see all of those as being useful avenues to supporting this as a protocol?

Ray Uy Yes, I think really it’s been a tailwind for your newer fixed income players, that have historically been more tied to the ETFs. The technology lift on the sell-side to get this working well wasn’t insignificant, and I think some of the ETF market makers were organized in a way where their books were consolidated, and so they could engage in this model much more seamlessly at the start. Now, the traditional firms that generally have more fragmented structures with different sector desks etc., they’ve come up the curve very quickly.

Dan Barnes The thing I think that’s most interesting about portfolio trading is perhaps that it doesn’t rely upon some sort of instantaneous liquidity, which typically you don’t get in credit. So it does seem to have a more natural fit in the corporate bond space.

Ray Uy Yeah, I think it created a nice framework for both the buy-side and the sell-side to look at line items and the risks associated with that on an aggregate basis. The traditional OTC structure, fixed income is by phone, it’s individual line items, and if you’re a trader, you’re working each line item and really negotiating and engaging. I think there’s still value to that, but portfolio trading is a good lower touch tool that is really efficient at solving for very basic things, like cash flow management. And 10 years ago, if you won a huge mandate, it might take you a month to invest. But with portfolio trading, you’ve shrunk the window down to hours, and by shrinking that execution window, you’re really reducing any tail exposures or any potential for a shock to really impact your outcomes.

Dan Barnes We’ve also seen a lot of positive commentary around the certainty that it provides, and when we had the sell off in March, obviously people aren’t looking for price improvement in itself, it’s a question of getting it done. So that seems to fit well across different scenarios, then?

Ray Uy We have a good test scenario to see where the limits are, and I think it’s performed better than everyone expected initially in volatile markets, because everyone thought this just works when things are calm. We’re able to refute that with real empirical evidence, but fixed income markets are still driven by capital, and to a lesser extent, supply and demand, obviously. So those are still very real constraints. And for the majority of outcomes within calm, not too volatile, it works well. But in the extremes where, if nobody is making markets, it doesn’t really matter. And portfolio trades are getting done, so I try to be balanced about it. You know, it’s a great tool, it’s not a panacea for everything, of course, but it’s great.

Dan Barnes So what sort of volume do you think you might be putting through portfolio trading next year?

Ray Uy We’ve been doubling each year, so we started three years ago from nothing. A couple of billion to five billion to 10 billion. It’s almost like Moore’s Law. I would expect us to double our activity next year, so 20 billion, that would be a very easy threshold.

Dan Barnes You mentioned about how this is benefiting clients. How do you see Invesco’s investors overall benefiting from the more diverse execution capabilities you have, including portfolio trading?

Ray Uy Because we’re able to transact this efficiently, the range of solutions we can provide to clients expands. And from the simplest passive strategy to the most complex, active, and implementation tools such as portfolio trading, really bridges that continuum. Our portfolio managers, our product people can be as creative as they want, and if the market structure is compatible, then portfolio trading is a very useful tool in helping deliver those outcomes. And in fact, this year we were very successful with a very prominent, institutional client and the differentiator was our capabilities in this space.

Dan Barnes That’s fantastic. Ray, thanks very much.

Ray Uy Thank you.

Dan Barnes I would like to thank Ray for his insights, and of course you for watching. To catch up on our other shows or to subscribe to our newsletter, go to TraderTV.NET or ETFTV.NET.