Fixed-Income Managers Look to Crack the Code of Model-Delivered Accounts
April 5, 2021 — Boston
Fixed-income managers have been unable to enjoy distribution through model-delivered separate accounts, although exceptions exist among a few distribution partners that have deep relationships with counterparties
While fixed income is an important asset class in the separate account space, it represents less than 5% of model-delivered accounts, according to the latest Cerulli Edge—U.S. Managed Accounts Edition.
The way bonds are traded makes it difficult for an asset manager to deliver a bond portfolio to a broker/dealer (B/D) in a model format. “Low-grade corporate, emerging market, and municipal issues trade infrequently, whereas the average daily trading volume of many stocks numbers in the tens of millions of dollars,” says Tom O’Shea, director. When an asset manager sends a set of equity tickers to an overlay portfolio manager (OPM) at a large B/D, there is usually sufficient liquidity for the B/D to send the trade straight to the market. In contrast, if the asset manager were to send CUSIPs for a municipal bond to the B/D, the OPM would have to enter the bond market and post bid or ask prices for the bond and wait for a buyer or seller to emerge.
Additionally, fixed-income trading still depends upon human networks. Stocks are usually traded through electronic networks that execute trades within seconds. Bonds, on the other hand, are traded through buyers and sellers with long-established relationships that facilitate negotiation. “Fixed-income asset managers typically have deep sell-side relationships, developed over years, that allow them to buy and sell bonds at institutional-level pricing that is unavailable to an investor buying through a retail overlay portfolio manager,” remarks O’Shea.
Despite these challenges, a limited number of firms are delivering model portfolios of fixed-income securities. The few asset managers that offer model-delivered bond portfolios do so through only the largest B/Ds. These B/Ds typically have trading desks with the same deep relationships with counterparties enjoyed by large fixed-income asset managers. These model portfolios are also limited to high-grade, highly liquid fixed-income securities.
Ultimately, Cerulli believes that fixed-income models will remain difficult to deliver in a model format. “The bond market is structured around the trading habits of large institutions,” notes O’Shea. “Due to the challenges related to trading and liquidity, it remains likely that fixed-income separately managed accounts will continue to be manager-traded aside from rare exceptions.” he concludes.
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