Tech and Innovation Fixed Income Blog

Bond Managers Power Up for the Digital Future

16 October 2018
4 min read
Bond Managers Power Up for the Digital Future
Jeff Skoglund, CFA| Chief Operating Officer—Investments
Gershon M. Distenfeld, CFA | Director—Income Strategies
James Switzer| Head—Municipal Bonds
Scott DiMaggio, CFA| Head—Fixed Income

The digital revolution took its time getting to fixed income, but today it’s transforming the investing landscape. Already, major advances in technology are helping early adopters gain unique insights and act faster in markets where speed and alpha are increasingly and inextricably linked.

Predictive analytics, automation, artificial intelligence (AI) and machine learning make huge, complex data sets meaningful and useful. With hundreds of thousands of issuers, trillions of dollars in bonds and a largely over-the-counter trading system, the fixed-income world has long needed such upgrades.

Bond managers that have prepared for the digital revolution in investing combine technology with human savvy to solve the market’s most vexing problems. Here’s how.

Turning Puddles of Liquidity into Pools

The ability to find counterparts willing to trade a given bond at a given price has always been the biggest factor affecting a bond manager’s ability to create alpha. Unfortunately, liquidity has grown scarcer and more fleeting since the global financial crisis. Dealer balance sheets have shrunk even as the size of the market has grown dramatically.

When fewer people are willing to take the other side of a trade, prices can move sharply and transaction costs can rise. The problem is especially pronounced when news hits markets, as even small events can give bond investors the jitters and cause liquidity to evaporate in a flash.

For managers, the difficulty of monitoring liquidity conditions compounds the problem. Liquidity pools—markets that provide liquidity for securities—are highly fragmented across third-party sources. It’s inefficient for asset managers to monitor each one and then compare the data. Firms that can’t effectively assess a bond’s liquidity can’t act on their investment ideas, and trades that never happen can’t make money.

Thankfully, new technology is helping plugged-in traders identify counterparts faster and more easily by pulling all external fixed-income trading platforms together on one digital platform. It’s an essential innovation in a marketplace that will digest and react to every new bit of information faster and faster.

Firms that adopt these kinds of platforms can become price makers instead of price takers, resulting in better executions, lower transaction costs and faster investment of cash inflows.

One-Touch Access to Credit Research

To generate better returns for investors, firms need to know not only which bonds are available in a market, but also which bonds help achieve a portfolio’s strategic goals.

The trouble is that research analysts and portfolio managers (PMs) must consider dozens of factors in the analysis, from the capital structure of a bond to the financial health and governance practices of the issuer. Traditionally, fundamental analysts have provided qualitative analyses, forcing PMs to spend precious hours or days going back and forth with various research teams to determine whether a bond is a good investment for the portfolio.

Firms that quantify, digitize and centralize their fundamental ratings make the evaluation process more efficient. Their credit research and rating processes reside in a consistent, accessible framework. This framework allows traders and PMs to immediately grasp an analyst’s assessment of a bond’s risks and potential and to quickly compare two or more similar bonds.

At a time of fleeting liquidity, this centralized format helps managers make the quick calls necessary to seize opportunities that slower-moving firms might miss.

Bringing in the Machines

To fully harness technological advances to build better portfolios and maximize alpha, firms must open new research and trading platforms to machine readers.

Just as consumers have done with the likes of Siri and Alexa, digital-minded bond managers are turning to virtual assistants to search and synthesize enormous amounts of data.

Virtual assistants build orders more quickly and with fewer errors than a human, who is prone to fat-thumb mistakes even when he or she is extremely careful. Automated order building is more revolutionary than it sounds, considering that 80% of corporate bond trades are still carried out over the phone.

But sophisticated virtual assistants can be taught to do a lot more. Some investment managers feed a virtual assistant a list of criteria based on market conditions, research ratings and individual issuer characteristics and receive a list of potential investment opportunities within seconds.

The natural next step would be to teach machines to continuously scan the market on their own for investment opportunities that meet predetermined research criteria. Once machines can do that, it’s a small step for virtual assistants to proactively suggest potential investments to PMs.

Virtual assistants will also likely learn to monitor portfolio activity and look for unusual behavior that could indicate human error. They may even begin to answer simple questions for clients about their exposure to certain credits or risks. And as AI and machine learning advance, they could add value we cannot yet imagine.

Humans should always retain control over key decisions and complex client interactions. But brainy virtual assistants—helped along by further advances in data science and machine learning—will bring bond managers and their clients a host of benefits, including better trade execution, capturing more opportunities to buy and sell bonds, and the time and ability to discover unique research insights.

For fixed-income investors, it’s never been more important to find out whether a manager is at the forefront of the bond market’s digital revolution or losing ground to the analog status quo.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

About the Authors

Jeff Skoglund is Chief Operating Officer (COO) for Investments. He is responsible for driving strategic planning, organizational effectiveness and operational excellence. Skoglund was previously COO of Fixed Income and was responsible for business strategy, innovation and technology, and talent management. Earlier in his career at AB, he was director of Credit Research and a portfolio manager for high-yield bond strategies. Prior to joining AB, Skoglund was a managing director at UBS Investment Bank, where he held numerous management positions, including global head of credit research and head of US credit desk analysts. He was an acclaimed high-yield analyst at UBS, Merrill Lynch and Credit Suisse, ranked #1 by Institutional Investor in automotive/auto parts six years in a row. Earlier in his career, Skoglund was an equity analyst and investment banker at Lehman Brothers and worked at Morgan Stanley in equity derivatives. He holds a BS in finance from Miami University, Ohio, and an MBA from the University of Michigan. Skoglund is a CFA charterholder. Location: Nashville

Gershon M. Distenfeld thrives on facing challenge, solving problems and putting people with different personalities and different viewpoints together to "make the engine run." When he joined AB in 1998 from a role as an operations analyst at Lehman Brothers, Distenfeld had long been fascinated by the high-yield market, and he led that practice at AB from 2006 to 2016 before assuming responsibility for all of credit. He has been co-head of fixed income since 2018.

In an industry that tends to focus on the short term, Distenfeld's investment philosophy takes the long view, considers a range of outcomes and focuses on the downside. This approach puts process and constant innovation at the forefront, making full use of AB's proprietary technology to mine the insights of fundamental and quantitative research.

"We're constantly reinventing ourselves," Distenfeld says. "We don't just sit still. We adapt to new information so we can find new factors that work."

Distenfeld's eye toward the long view extends to his charitable work with organizations like New Jersey NCSY. This youth organization for disaster relief partners with Habitat for Humanity and NECHAMA to repair homes and lives affected by natural disasters.

James Switzer is a Senior Vice President and Head of Municipal Bonds. He is responsible for driving our municipal bond strategy, including the firm’s innovation efforts within our municipal research, trading and portfolio construction processes, underpinned by best-in-class technology. Switzer has been instrumental in the strategic repositioning of our trading organization and the development of our industry-leading trading tools, ALFA and Abbie. Before joining AB in 2011, he was a managing director at Société Générale, where he managed the Financial Institutions Credit Trading Desk, and at BNP Paribas, where he managed the Investment Grade Trading Desk from 2000 to 2002. Switzer also formerly served as a sector portfolio manager and trader at UBS Principal Finance (from 2002 to 2005) and at Sigma Capital (from 2005 to 2008). Earlier in his career, he worked at Paine Webber and Co.; Kidder, Peabody & Co.; and Alex. Brown & Sons. Switzer holds a BA in biology from Colgate University. Location: New York

As Co-Head of Fixed Income and Director of Global Fixed Income, Scott DiMaggio oversees all of AB's Global Fixed Income, Canada Fixed Income and US Multi-Sector Fixed Income strategies, as well as their associated investment strategy, activities and portfolio-management teams. Prior to joining AB's Fixed Income portfolio-management team, he performed quantitative investment analysis, including asset-liability, asset-allocation, return attribution and risk analysis for the firm.

DiMaggio came to AB as a quantitative analyst, drawn by the firm's culture of strong mentoring and smart, collaborative people who wanted to win for their clients.

"The world of fixed income—the world I grew up in—is enormously complex," DiMaggio says. Its complexity needs an active management approach. His investment philosophy combines the lenses of fundamental and quantitative research to generate the information that can lead to risk-adjusted returns for clients. Fully leveraging AB's proprietary technology, it's a process that DiMaggio and his team refine and repeat.

"What we do is process driven and structured," DiMaggio says. "We like to be consistent."