The Digital Revolution Is Coming To Fixed Income
Artificial intelligence, automation and predictive analytics are transforming virtually every industry, but bond investing hasn't really changed. The typical investment process is inefficient, from research and portfolio construction to trading. But this story will change as human and machine join forces. In the next few years, we expect the rise of fixed-income technology to open a wide gulf in performance between those managers who have integrated cutting-edge tools into every stage.
In the past, the quest for excess return (alpha) was dominated by either the superhuman bond investor who attempted to singlehandedly navigate global markets or the quantitative shop that could exploit inefficiencies in the short term but couldn't see the bigger picture.
In an information-heavy world, just sticking with the status quo won't be good enough. It's imperative to integrate technology into the investment process to provide managers with tailored information that enables faster decision-making, makes every step of the process more efficient, and provides a more complete picture of risk and opportunity.
Several firms have used a "best of breed" strategy, creating or sourcing individual tools to help in one specific area of investing, such as research, trading or portfolio management. That's a good start, but to stay ahead, firms will need to focus on how these tools work together to create an ecosystem that magnifies the human impact.
Building Liquidity: Turning Puddles Into Pools
Liquidity is the number-one issue influencing a fixed-income manager's ability to create alpha. Firms that can't effectively assess a bond's liquidity won't be able to implement their investment ideas. And if a trade can't be implemented, there's no way it can make money.
"Liquidity pools," or markets that provide liquidity for credit securities, have long been highly fragmented across multiple external third-party sources. The information provided by these sources is valuable, but it's inefficient to continually monitor each one and then compare and contrast the data.
To keep up in a marketplace that will digest and react to every new bit of information faster and faster, successful fixed-income managers will need to use technology that pulls all external fixed-income trading platforms together in one place. Firms that adopt this technology can become price makers instead of price takers, resulting in better executions, lower transaction costs and faster investment of new cash inflows.
These kinds of trading platforms aren't theoretical anymore.
In 2016, we developed ALFA (Automated Liquidity and Filtering Analytics) with this need in mind. By aggregating separate pockets of existing market data into a single user interface and enabling our traders to filter by specific identifiers or security characteristics, ALFA helps AB traders make better, more informed decisions on the price levels at which less liquid and illiquid securities should trade. The objective is to be able to buy bonds for clients' portfolios at the lowest price and sell them at the highest price.
ALFA can also alert our traders when certain market events occur. In February 2017, for example, ALFA flagged to one of our emerging-market debt traders that an unusually high number of dealers were offering bonds issued by the Brazilian Development Bank (BNDES), one of the largest development banks in the world. Our trader took a closer look at the offers and discovered that BNDES was trading at a lower valuation than the bonds of another large Brazilian bank, Caixa Econômica Federal (CAIXBR), which we deemed to be a fundamentally weaker credit.
Find out more about Abbie and review our checklist to see if your asset manager is ready for the digital future in the full white paper.