A popular new trading strategy that involves bundling and pricing corporate bonds in baskets is helping investors reduce their execution costs by a meaningful amount, according to a novel study by Barclays Research that explains the exponential growth in Portfolio Trading.
Portfolio Trades incurred transaction costs that were more than 40% below the transaction costs of trades executed via the standard request-for-quote (RFQ) protocol, the research found. This is the first study to use a comprehensive set of Portfolio Trades to compute cost savings and analyze why this trading protocol works so well.
“Our findings suggest that Portfolio Trading is remarkably effective,” said Jeff Meli, Global Head of Research at Barclays. “Portfolio Trading benefits from spill-overs from the ETF ecosystem, which drive down transaction costs. In investment grade, ETFs allow investors to crowd-source liquidity in illiquid bonds included in portfolio trades; whereas in high yield, where the ease of hedging is an important driver of execution costs, ETFs offer an efficient outlet to manage and hedge risk.”
Portfolio Trading involves trading a basket of bonds as a single piece of risk and transacting the entire basket with one dealer. The strategy has grown rapidly, accounting for 8% of market-wide TRACE volume, up from virtually zero in 2018. This rise tracks growth in the adjacent ETF market, which Barclays sees as a primary catalyst for Portfolio Trading’s emergence. Inquiries on Barclays’ trading desk have mirrored the industrywide growth, reaching approximately $175 billion in 2021, up from zero in 2018.
Trading desk data was a key part of the underlying analysis, and was used to develop a machine-learning algorithm capable of identifying Portfolio Trades in TRACE.
“With the consolidation we are seeing on the buy-side, as well as the further push to electronify the credit markets, we expect Portfolio Trading to continue to be an important strategy for investors,” said Yoni Gorelov, Co-Head of U.S. Credit Trading at Barclays.
Part I of the study, published in May, measured the size of the market, and drew conclusions about how and why investors are constructing portfolios. Part II analyzes execution costs and assesses the drivers of cost efficiencies in different parts of the corporate bond market. A third part, which will discuss optimal portfolio construction strategies, will be released in the near future.