- Quants focused on the corporate bond market are in high demand after a year where the strategy multiplied.
- The biggest names on the buy side — titans like Cliff Asness’ AQR, Steve Cohen’s Point72, Jim Simons’ Renaissance Technologies, and Izzy Englander’s Millennium — were some of the first to dive into quant’s fixed-income possibilities.
- Now, it’s become more widespread. One electronic marketplace says it’s seen the number of systematic strategies on its trading venue double every year since 2017.
- Blackstone, the world’s largest alternatives manager, has jumped into the trend as well. The firm bought a $7.5 billion manager that uses quant strategies in the corporate bond market at the end of November.
- Visit Business Insider’s homepage for more stories.
Billionaire Blackstone founder Steve Schwarzman’s New York-based asset manager is made up several different units: A massive real-estate portfolio that has contributed half of the firm’s earnings this year; the world’s largest hedge-fund investor; its flagship private-equity funds; and the newly renamed Blackstone Credit arm.
The credit unit, which used to be called GSO, added a new team in late November — $7.5 billion DCI, a San Francisco-based quant shop that focuses on the corporate bond market.
DCI represents a drop in the bucket for Blackstone, which manages around $584 billion, but Schwarzman has a big vision for the new team.
“I said ‘you’re at $7.5 billion now, what do you think you can get to?'” he said on Dec. 9th during Goldman Sachs’ US Financial Services conference.
DCI’s leadership believes all firm needs to explode is the credibility that comes with the world’s largest alternatives manager, Schwarzman said.
“If we have the Blackstone name and the Blackstone relationships, we could really grow — we have the numbers … Why couldn’t we get to $100 billion?”
Schwarzman is not alone in his grandiose vision of deploying quantitative strategies in credit trading. A growing number of big banks, hedge funds, and asset managers have put resources behind similar plans in recent years.
As more of the corporate bond market trades via electronic channels, as opposed to over the phone, industry players are empowered to deploy these algorithmic-based strategies.
MarketAxess, the largest electronic market for US corporate bond trading, saw $116.5 billion traded via systematic funds during the first three quarters of 2020, a 150% increase from the same period a year ago, according to a spokesperson.
Meanwhile, the London Stock Exchange Group’s MTS BondsPro has seen the number of quant strategies deployed on the trading venue double each year since 2017, David Parker, head of MTS Markets International, told Business Insider.
Jason Quinn, chief product officer at Trumid, said the trading venue has “seen increased interest from quantitative firms in recent months.”
Whether it’s banks, or other non-traditional dealers, using algorithms to make markets, or investors applying quant strategies to fill orders, there is no denying the rise of systematic trading in corporate bonds, Izzy Conlin, US institutional credit product manager at Tradeweb, told Business Insider.
“It’s absolutely here,” Conlin said.
“Both kinds of participants are absolutely using these systematic strategies, they just may be using them in slightly different ways,” she added.
Investors are betting big on quant strategies in bond trading
Blackstone is just one of many investors embracing the quant strategies in bond markets, which has been relatively slow to adapt to the new algorithm-driven reality compared to equity markets. Big managers like Renaissance Technologies, Point72, and Millennium began building up teams over the last couple of years, as Business Insider has previously reported.
Headhunting firm Selby Jennings predicts that the bonus pool for this type of talent is going to rise by 5% compared to last year — and will be in-demand in 2021.
“These are the people everyone is looking for right now,” Vickram Tandon, the head of US business development for Tardis Group, said of systematic credit and credit arbitrage talent.
A person familiar with Point72’s Cubist unit’s plans said they are expecting to grow their team, which includes Zhendi Su, a portfolio manager who joined the firm in San Francisco last year after working at BlackRock as the head of US credit research.
AQR, which manages $138 billion, has a long history of applying quantitative strategies to various markets. Bond trading is no different. Tony Gould, a managing director on AQR’s fixed-income team, said the firm first began trading credit systematically around 2013.
The firm’s focus on applying quantitative strategies in fixed income has seen significant growth in recent years, more than tripling since January 2018. Currently, AQR manages roughly $5 billion in standalone long-only and long-short systematic fixed-income strategies.
Over the years, more firms have deployed systematic strategies into the bond market, he said, including fundamental funds. Many are mixing quantitative inputs into their investment process for a so-called quantamental approach, he added.
The trend saw an even greater boost in early 2020, as discretionary managers in credit began to underperform their benchmarks, Gould said.
“There’s increasingly a recognition of the need for different sources of return in portfolios beyond just leaning on credit risk, which has then led to an exploration of more systematic ways of trying to add returns,” he said.
It’s a trend Gould expects to continue. AQR research shows active fixed-income managers, over the long term, tend to be persistently long on different forms of credit risk. As a result, they usually suffer when equity markets drop because credit risk is more highly correlated with equites.
Meanwhile, a systematic approach is more diversified and one that AQR believes will attract allocators, he said.
“Systematic strategies can generate returns in a different way, through security selection. Those returns are not dependent on how equity markets are doing or how the economy is doing,” he added. “Ultimately, what’s going to drive interest in these strategies is that they offer much better diversification than traditional discretionary strategies do.”
Gould’s not alone in his belief that systematic strategies are the future of the market.
Schwarzman, too, sees the approach as having the potential to be a big part of Blackstone’s future.
“I think we can build another significant leg to the firm,” he said during the Goldman conference. “This is the start really of quant in junk and in other parts of fixed income.”
Systematic trading requires sought-after talent
Selby Jennings’ report found that the rise in these types of strategies has subsequently increased the need for traders that are familiar with these markets.
“We expect demand to continue to increase in 2021 and continue to seek individuals coming from high frequency, market making, and any relevant buy-side/sell-side execution backgrounds who have experience with these products,” the report reads.
The profile of a bond trader has changed significantly over the years. What once was a highly relationship-based role is shifting. Learning programming languages, such as Python, has become the norm at many shops.
Gould said it’s important AQR traders having some type of background in coding.
Tradeweb’s Conlin, who previously spent almost eight years at BlackRock, including over five years as a bond trader, said the skillsets required of those on the trading floor have become increasingly technical.
“There are traders coming in that have computer science backgrounds, and they’re building models or they’re building algos,” she added. “Those are the ones that are going to trade.”
New venues and new data have helped quants
While other markets — such as equities and Treasurys — have been faster to welcome quant strategies, corporate bonds have been a slower build.
Part of the lag is because only over the past few years has a significant portion of bond trading occurred electronically. The growth of electronic marketplaces such as MarketAxess, Tradeweb, and Trumid has also led to new, innovative ways to trade, from portfolio trading — where a large bundle of bonds can be traded in one fell swoop — to all-to-all protocols — which allows investors to trade directly with each other, in addition to dealers.
The total volume of electronic trading in November for investment grade (35%) and high yield (25%) bonds were both new records, according to a recent report from consultancy Greenwich Associates. Average daily volume for the month was $35 billion, up 9% year-over-year.
But it’s not just a matter of having a place to trade. Improvements in data have also gone a long way. While self-regulatory agency Financial Industry Regulatory Authority (Finra) has distributed TRACE, transaction data on the corporate bond market, for decades, trading venues and other vendors have taken the data a step futher in recent years.
“TRACE only tells you what has been traded. There’s been a huge development in products that give you an idea of where the next print is going to be and other information that isn’t available within regulatory tapes,” Max Callaghan, a hedge fund, ETF and CEEMEA sales manager for MarketAxess, told Business Insider.
MarketAxess’ Composite+ is one such example, he added.
“It’s that sort of data product that really allows these sort of systematic-factor trading strategies to be far better honed, as far as their signal analysis and also that capture,” Callaghan said.
Rolling out quant strategies still has its challenges
Plenty of work still remains as firms look to roll out these new strategies.
The process does have the benefit of others markets having already blazed a path, Gould said. The fact systematic strategies are already well established in portfolio management for a variety of asset classes means the trend is more palatable.
Still, the bond market provides its own set of unique challenges due to the complexities around the liquidity and transaction costs, which aren’t as much a consideration in equities or rates, Gould added.
“It’s not something that you can do with a couple people and a coder. You really need to commit to this if you’re going to do it properly in the credit space,” Gould said.
Investors typically take a deliberate approach, MTS’ Parker said. Often times they start small, testing and tweaking their techniques as they go, he added.
As a result, significant impacts to bond trading due to an increase in quant trading is still a ways away.
“It’s a bit like they are moving into the neighborhood, and the culture of the neighborhood hasn’t changed yet,” Parker said. “But they are in the houses.”
Leave a Reply
Leave a Reply
This site uses Akismet to reduce spam. Learn how your comment data is processed.
