By Vuk Magdelinic, CEO, Overbond
It’s a difficult time for fastened earnings buyers. A 40-year bull market in bonds noticed US 10-year Treasury yields fall from virtually 16% to lower than 1%. They are nonetheless lingering close to document lows and in main European markets 10-year charges are unfavourable or barely constructive. At the identical time, spreads on funding grade and high-yield bonds are traditionally tight. These low charges and tight credit score spreads are anticipated to persist for years.
Investors are trying to find yield
Investors trying to find larger yields on this low-rate atmosphere have been extending period in credit score and shifting into lower-rated funding grade, rising market and excessive yield bonds. But this introduces elevated credit score and liquidity threat and reduces diversification advantages as these lower-rated securities are extra extremely correlated with equities. These buyers are reaching larger yields by enormously elevated threat and, with spreads as tight as they’re, they’re not being correctly compensated.
But not all fund managers are following these methods. Some have used the diligent number of particular person company bonds to outperform with out taking up extra threat. This requires some type of relative worth or rich-cheap evaluation.
Market construction has modified
Concurrent with this difficult yield atmosphere, there have been dramatic adjustments in fastened earnings market construction. New merchandise akin to ETFs, the emergence of digital all-to-all platforms and non-dealer liquidity suppliers utilizing algorithmic and excessive frequency buying and selling are among the many developments re-shaping the business and creating new sources of company bond liquidity. Major digital bond buying and selling platforms reported document buying and selling volumes in 2020, together with document buying and selling of U.S. and European company bonds — for which e-trading has grown dramatically within the final decade.
Quant buying and selling is rising on the buy-side
The elevated electronification of the markets has created extra useable and accessible commerce knowledge. This enhance in each real-time and historic transaction knowledge has made it doable to combination giant quantities of knowledge for every shopper in actual time to be used by AI instruments. New sources of company bond liquidity, the provision of richer knowledge units, the electronification of bond buying and selling and the event of extra highly effective AI with cloud computing have now made purely quantitative bond buying and selling execution doable. Even quantitative hedge funds have been shifting into the fastened earnings house.
Beyond hedge funds, digital buying and selling and the usage of AI for commerce automation have turn out to be the brand new customary for buy-side desks and are a prerequisite for remaining aggressive. Buy-side desks are spending closely on know-how and growing their use of AI for analytics and automatic buying and selling. And they’re more and more turning to quant buying and selling in fastened earnings so as to add alpha and enhanced beta utilizing methods that isolate elements akin to carry, momentum, high quality and volatility and by making use of quant modelling to directional, yield curve and rich-cheap evaluation.
