Corporate bonds

Accessing corporate bond liquidity

With Joel Kim, Head of International Fixed Income and CEO Asia ex-Japan, Dimensional Fund Advisors

Briefly describe Dimensional Fund Advisors, including its fixed income trading team, operations and capabilities?

Dimensional is a global systematic investment manager, founded by David Booth in 1981, and with $653 billion in assets under management as of September 30, 2021, including approximately $120 billion in fixed income securities. Dimensional has a long history of applying academic research to practical investing. We are associated with some of the most respected names in financial academia, including Nobel laureates Eugene Fama and Robert Merton, as well as longtime Fama research partner Ken French.

We have 13 offices around the world, including Asia-Pacific malls in Singapore and Sydney. Since launching our first fixed income strategy in 1983, we have expanded our offering to help our clients customize fixed income solutions based on academic knowledge.

In terms of staff, we trade fixed income securities using a team approach overseen by our investment and best execution committees. The Fixed Income Desk has global trading capabilities, allowing us to interact directly with every market in which we trade.

What is your professional background and career path?

I started my fixed income career in 1998 in Europe, where I managed globally developed fixed income strategies at what was then ING Investment Management. I moved to Hong Kong in 2002, where I held various positions in FI portfolio management, finally as head of Asian debt. In 2011, I joined BlackRock in Singapore, where I was responsible for fixed income portfolio management in Asia, notably in Japan and Australia. I first joined Dimensional in its Singapore office in 2016 before moving to London, where I ran the EMEA fixed income office. I am currently based in Singapore where I combine my role as CEO for the Asia ex-Japan region with overseeing Dimensional’s non-US fixed income business.

What are the main challenges in accessing corporate bond liquidity?

The need to maintain profits while continuously meeting regulatory requirements through balance sheet reduction has led dealers to act more as agents than principals. “Dealer velocity,” a metric that shows the rate of dealer balance sheet turnover, has increased dramatically over the past 15 years. Divergences in regulations and data availability have led to differences in transparency and liquidity in global credit markets. In this context, greater diversity in the number of sites and protocols provides additional ways to find liquidity, but also adds complexity and the need to invest in data and technology. The ability to aggregate and manage data has become critically important.

How does Dimensional partner with sell-side banks for liquidity provision, and how has that evolved?

Although we are working with a growing number of platforms and alternative liquidity providers, sell-side banks remain an important source of liquidity. Banks help bridge the gap between when a seller wants to sell and how long it takes to find a buyer, because fragmented credit markets always mean we may not be able to align perfectly. Banks add value, especially for more frequent transactions, block size and primary issuance.

How does Dimensional partner with electronic trading platforms for liquidity provisioning, and how has this evolved?

Technology, regulation and changes in market structure have resulted in the electronicization of fixed income markets and a more diverse use of protocols and locations for accessing liquidity. Exchanges via electronic platforms represent around 90% of our total trading volume, compared to around 10% fifteen years ago. While most of our exchanges are still RFQs, electronicization has allowed our processes to become more data-informed and rules-based. It also allowed us to become liquidity providers rather than just liquidity seekers. With increased bond trading segmentation, we are moving to low-contact, fully automated trading for the most liquid segments of the markets.

What recent developments in trading protocols have contributed to the liquidity supply?

With few voices at this point, we use several alternative protocols, including anonymous and electronically disclosed tenders, dark pools, and central limit order books. Peer-to-peer networks that allow direct trading with other buyside participants have been the biggest source of liquidity since we adopted them in 2015.

As we are a systematic manager, our portfolios tend to be very diversified. Our investment process aims to reap factor premiums and emphasizes having the right overall portfolio characteristics. This leads to more flexibility in the trading process, as traders can work with substitutable securities. This is in contrast to traditional active bond selection where trading becomes very issuer and issue specific. Our ability to publish a large pool of substitutable securities on various buy-side networks, coupled with the advantage of being patient in our execution, allows us to act more often as providers of liquidity rather than as buyers. of cash. To give you an example, we publish approximately 4,000 titles on several sites every day, of which approximately two-thirds are candidates for purchase and one-third are candidates for sale.

How important is data and how would you describe the current state of data usage on buy-side trading desks? What are the “pain points”?

As a systematic asset manager, Dimensional extensively leverages data from all investments. We have a dedicated in-house data team within research that focuses on data management and cleaning. This team assesses what data can be used and how, in addition to data that is managed within the portfolio management and trading teams. For fixed income securities in particular, we are heavy users of market data throughout the investment process – from alpha generation to risk management to trading. In the latter case, we use the data for price discovery, liquidity provisioning and for TCA. What sets us apart from most other fund managers is that sourcing liquidity is not solely the responsibility of the trading desk. It starts with portfolio managers, who apply systematic liquidity screening of the entire investment universe every day to help determine where to focus. We run algos, using both ticker data when available, as well as other post-trade data sources to systematically identify liquidity. Combining trade-based data with quote-based information in this way helps us determine positioning and available liquidity. We believe our approach to data accumulation is unique to our trading process.

In terms of weaknesses, there are significant differences in data availability and quality between regions, due to variations in regulation and market structure. In this area, the United States is ahead of Europe and APAC. However, we believe that over time there will be more convergence, with Asia eventually catching up.

What is the future of liquidity sourcing in corporate bonds, ie what could be the key themes in one to three years?

Technology, data and regulation-driven transparency will accelerate liquidity supply improvements and further drive the transition to low-contact, rules-based trading processes. More segmentation also means structuring trading desks appropriately, hiring the right people and ensuring adequate skill diversity within teams. For example, a prerequisite for candidates wishing to join our negotiation team is an ability to code. The winners will be managers who can take advantage of these developments effectively. Naturally, we believe that systematic managers like us are well positioned in this environment.

Accessing Liquidity in Corporate Bonds first appeared in the fourth quarter 2021 issue of World trade, a publication of Markets Media Group.