Durham University Finance Society Market Report – Week 6
Maths & Stats – Led by Guy Baverstock and Harry Talks
How the childish trade war between the powers of China & USA has jeopardised their relations with the global economy
By Matthew Bargh
The actions of the power-hungry parties of Donald Trump and Xi Jinping have put serious pressure and increased fragility on the global financial market. Due to the rise of artificial intelligence and driven electronic trading, the increased speed of financial transactions across multiple markets has exerted further pressure on the financial market than ever before. Analysts say that any macroeconomic data shock that forces abrupt forecast downgrades for economic growth and corporate earnings could lead to rapid, violent market moves. China’s quarterly economic growth has therefore stooped to a 26-year low amid the trade war as it struggles against the Trump’s impositions.
The trade war began when Donald Trump signed tariffs on imported solar panels, steel and aluminium for all nations, including China, between January and March 2018. China retaliated by putting additional 15-25 percent tariffs on $3 billion worth of U.S. goods on the 2nd April in the same year. Chinese exports worth $125bn then faced new 15% levies from 1st September 2018, while the Chinese placed a 5% levy on crude oil as an agreement between both parties became more distant. In response to the aforementioned $125bn of Chinese exports facing tariffs, China have unveiled retaliatory tariffs against $75bn worth of US goods – furthering the long-lasting tit-for-tat dispute between the world’s top two economies.
Amongst the noise, the renminbi sunk below to 7.15 a dollar – it’s lowest rate since February 2008. Trade tariffs have contributed to a slowing of the Chinese economy, as well as dampening growth in surrounding regions such as Hong Kong. The renminbi’s losses came as China’s CSI 300 stock index fell by 1.4%. Furthermore, the Hang Seng in Hong Kong closed down by nearly 2%, the Nikkei in Tokyo by 2% and Seoul’s Kospi by 1.5%.
Fears that the trade war will hurt global growth prompted the Swiss bank UBS to cut its rating on equities to underweight for the first time since the 2008 financial crisis. The International Monetary Fund also cited the tariff war in the decision to cut its 2019 global economic growth forecast from 3.2% to 3%.
China’s National Bureau of Statistics reported that retail sales growth fell to 8.2% YoY in January-September, down from 8.4% in the first half. Car sales in the automotive industry’s biggest market fell by 11.7%. Eva Yi and Liang Hong of China International Capital Corp estimate the slowing economy wiped out some 5 million jobs in the first seven months of 2019, mainly due to weak consumer demand. They attributed 1.3m to 1.9m of lost jobs to US tariff rises, with exports to the US – China’s biggest foreign market – down nearly 22% in September from a year earlier. Imports of American goods also fell 15.7%. Other warning signs included declines in corporate share buy-backs and dividend pay-outs that may trigger market turbulence.
On 15th Jan this year, the US and China signed an agreement aimed at easing the trade war that has rattled markets and weighed on the global economy. Donald Trump and Chinese leaders have called this agreement ‘transformative’ and ‘win-win’ respectively. China have pledged to boost US imports by $200bn above 2017 levels and strengthen intellectual property rules. In exchange, the US have agreed to halve some of the new tariffs it has imposed on Chinese products. However, most of the border taxes remain in place, which has prompted business groups to call for further talks. Since the trade war began, extra import taxes have been levied on more than $450bn (£350bn) worth of traded goods and although peace seems to now be on the horizon, both parties have a long way to go to boost both their own and global economies once again.
Elon Musk: Media Mastermind or Immature CEO?
By Tom Fisher
With nearly 30 million personal twitter followers, and an average of 88 tweets a month since 2015, Elon Musk is known to be an avid user of social media. Some question how he has the time to be this active online as he runs 3 companies: The Boring Company, Tesla and SpaceX. Musk is not only known for his high levels of activity online but also his rash accusations and social media wars. Some of these tweets and accusations have caused dramatic effects on the stock price of Tesla. This has led some people to question whether he is indeed a media mastermind or an immature, uncalculated CEO. Musk joined Tesla in 2004 after he invested $30 million and became the chairman of its Board of Directors. In 2010 the company went public at $17 a share, causing Tesla to raise $226 million in its IPO. The modern face of the company arguably began in 2011 when the critically successful prototype of the model S was unveiled. The firms first quarterly profit was made in 2013. More recently, Tesla changed its name from “Tesla Motors” to “Tesla, Inc.” to indicate the new scope of products it makes. These not only include cars, trucks and the recently unveiled SUV, but also solar charging roof panels and an aspiration to become an energy solution across many sectors.
Since Musk joined Tesla in 2004, their share price has increased by 1836% as of close on Nov 27th, 2019. During this time however, it has suffered volatility that has been caused by the actions of Mr. Musk online. On the 14th of July 2018, Musk began to attack cave diver Vernon Urnsworth after he rescued a 12-person football team trapped in Tham Luang cave complex, Thailand. Without evidence, Musk proclaimed online that the diver was a “pedo guy” and later a “child rapist”. The outburst was thought to have been sparked by Musk and Tesla being unable to assist in the rescue mission. Many believe that had Musk helped, he would have received substantial positive support from the media at a time when Tesla and Musk were battling intense negative publicity, after Tesla’s credit rating outlook was downgraded to negative following a “significant shortfall” in the Model 3 production rate. Mr. Musk later apologised for the tweets which seemed to have caused his stock price to fall by about 5%. Many think this showed immaturity and uncalculated rashness and that these are not characteristics acceptable for a CEO.
However, on the other side of the spectrum, many believe Musk to be a media mastermind. On the 7th of September 2018, Musk was seen using marijuana on a live online podcast in California where it’s use is legal. Tesla’s shares plummeted 9% that day which put it at more than 30% off its all-time intraday high of $389.61. To top things off, two of Tesla’s top executives resigned which caused the share price to fall to its lowest point for the year. This all seemed to be triggered by Musk’s actions on a social media platform. The US air force, which has multiple contracts with Musk’s SpaceX reportedly began looking into the marijuana use as the drug is prohibited to be used by someone with a government security clearance. Whilst many think these actions are unacceptable, lots of people saw Musk’s actions as deliberate. Knowing two executives were going to resign, his behaviour would allow Tesla’s stock to fall to its greatest low for that year. Many believe Musk could then buy back shares at this lower price to then sell publicly again when the stock rose higher, which it did quite rapidly over the next two quarters. By the end of 2018, Musk’s stock had increased to nearly $280 a share, an increase of 34% since the Marijuana incident.
A month prior to the marijuana incident, Musk tweeted that he was going to take Tesla private at $420 (roughly a 20% upside from the current stock value) and had secured the funding necessary to back Tesla’s shares. This set off a round of active trading as investors frantically tried to purchase shares before the privatisation buyback which caused the company’s stock to rise by 10% before trading ended. Tesla ended up not going private and Musk was charged with fraud by the SEC, alleging that he had released false and misleading information that drove the company’s stock up. In the aftermath, Tesla and Musk settled on a $20 million fine and Musk stepped down from his position of chairman of the company’s board. Musk would also later have to have his twitter verified by the company’s attorneys before tweeting anything. This has led to people debating whether this again was Musk being a media mastermind or an immature CEO.
Finally, at the unveiling of Tesla’s Cybertruck on the 21st of November 2019, a steel ball was thrown at the supposedly “bulletproof” windows causing them to shatter. Many believe that this was again a media stunt to get people talking about the new product and Tesla as a whole. These allegations come following the belief the company needs a boost after squeezing out a $143 million profit in the past quarter by including $164 million worth of regulatory credits and prepayments banked from customers who have paid for the yet-to-be released “full self-driving” version of autopilot.
Overall, there is plenty of evidence to support both the claim that Musk could be a media mastermind and an immature CEO. It is without a doubt that he is a revolutionary businessman following the massive leaps he has made across all the industries he operates in. He has redefined the electric car industry and could has hopes to help colonize Mars within the next decade. Time and a plethora of new tweets will tell whether he is indeed a media mastermind or an uncalculated, immature CEO.
Civil disobedience, a hindrance to the private sector? A case study pertaining to the effect of the Hong Kong protests upon the performance of the stock markets.
By Rhys Belcher
Hong Kong recently has been experiencing the largest civil protests in living memory in response to the attempts by the Chinese government to introduce a bill that would allow the extradition of Hong Kong nationals to mainland China. Whilst these protests are not economic in motive, the disruption to the everyday business of the region is clear. Hundreds of thousands flooding the streets, as well as the brutal response of the police, combined with the consequential scrutiny, would assumedly have a severely hindering effect upon the performance of private entities attempting to operate in midst of the protests. This article will attempt to assess whether the protests have hindered the performance of the stock markets and private entities.
The Hang Seng Index monitors the performance of the largest companies trading in Hong Kong and is largely accredited with indicating the overall stock performance within Hong Kong. The analysis of the performance of the Hang Seng Index over the past 6 months has an interdependent relationship with the events associated with the Hong Kong protests or so-called ‘Umbrella Protests’. For example steep decline from 28,146.50 points on the 30th of July to 25,281.30 on the 13th of August coincides directly with the escalation of violence in the protests following the protestors’ defacing of the Chinese Liaison Office in Hong Kong and the subsequent retaliation by both police and what were suspected to be gang members who brutally assaulted protestors at the Yuen Long train station. In this period, civil servants also went on strike which served to further cripple the infrastructure of Hong Kong. The impact of this on stock market performance is reflected by the plummet of the Index to its lowest point within the period in question.
The -10.18% drop in stock price cannot be assumed to be independent of the massive civil disobedience that wholesale defined Hong Kong in this period. The violence and disruption that have continued since have inhibited the full recovery of the Hang Seng Index also with the market fluctuating significantly and closing most recently at 26,893.73, which was 5.78% lower than its closing value four months prior in the period of comparative stability.
Concerning more recent events within the past week, the turbulence caused by the protests have been cause for international and domestic concern as investors feel the heat on the performance of the Hang Seng Index. The pro-democracy candidates swept the board in local council elections on the 25/11/2019 which saw a 0.82% spike in the performance of the Index. This may be a reflection of popular support of pro-democracy candidates inspiring confidence within the private sector.
Therefore, there is a clear correlation between the performance of the Hang Seng Index as an indicator of the performance of the economy within Hong Kong. The disruption caused by the protests to the everyday workings of the region can be traced in temporal relevance to the rapid decline of the stock performance particularly in the July/August period. Thus, it can be concluded that civil protests, particularly within Hong Kong, can have a significantly negative effect on the performance of private business.
Industrials – Led by Alexander Plant
UK Car market is on the verge of being wiped out
Concerns are erupting within the UK car manufacturing industry as there is uncertainty around Brexit. Sales in the UK dropped by 6.8% in 2018 and fell a further 9.1% in 2019, implying greater uncertainty.
In Britain, the car sector is one of the most productive industries and in terms of good exported, it accounts for 14% of the total, the largest of any sector.. However, the growing concerns of uncertainty has diminished investments, undermined production expectations and raised alarms on the stability of jobs. Executives are pushing for a single market which means frictionless trade. This will ensure a large part of the supply chain involved in the manufacturing of cars would go unaffected. On top of the Brexit uncertainty, the UK is also facing the threats of tariffs from the US which is adding increasing pressure on the car market as a retaliation for imposing British tech tax. There are concerns from companies that a trade deal with the US could be catastrophic for the future of UK Plants.
Two-thirds of UK car exports go to Europe or countries with EU trade agreements according to the Society of Motor and Traders (SMMT), which means a Brexit with no deal can put UK car manufacturing under threat. Currently the UK and other EU members can sell cars among each other under a certificate. Homologation is a process within the EU that requires car manufacturing companies to meet certain emission standards. So, a no-deal Brexit will mean setting new standards and certificate, which will be a very costly and timely process for car manufacturers in the UK.
A possible scenario that can arise after Brexit is trading on the rules of the World Trade Organisation, meaning 10% tariffs on vehicles and border checks which raises several issues according to the SMMT. For example, Nissan could be affected as 70% of sales are exported from their UK plant in Sunderland and by applying tariffs of 10% on business sales within Europe could seriously be threatened. 6,000 people are employed by Nissan in Sunderland and these additional costs will most likely affect employees. Nissan who are the largest the UK car plant producer could be forced to move elsewhere as competitors Honda announced plans to shut down a major factory in Swindon where 3,500 jobs will be lost due to the uncertainty surrounding Brexit. For now, at the end of the tunnel there isn’t a sign of light for the UK car industry. Possibly, post-Brexit trade deals will be made that will save the market from being wiped out. Diesel policies in the UK, regulatory changes, consumer changes, slumps in China and Europe are other issues for the UK car industry.
Tesla – The Electric Bull
By Ben Harrington
The last 3 months have seen Tesla lead an electric revolution, with its market value passing $100bn for the first time in mid-January. But how much is Tesla really worth, given its quite volatile valuation in the last few years? Such a dramatic bull has cemented Tesla as a leader in the industry, as well as Elon Musk’s, Tesla’s founder and CEO, reputation as one of the greatest entrepreneurs and businessman; it is not often Trump labels you as a ‘great genius’.
Since November Tesla’s valuation has more than doubled, resulting in questions whether the electric revolution is really worth that much, or whether another bubble is arising within the technology-automotive sector. However, Musk proves to be an erratic leader making some questionable decisions with regards to running Tesla.
It might just be worth looking at Tesla’s giant $100bn valuation in a more realistic sense. Tesla’s value is worth more than the combined value of Ford and General Motors, its biggest US rivals. In addition, it has surpassed the might of Volkswagen, which is Europe’s largest carmaker. It does seem dubious, with Ford and General producing 13 million cars per year, compared to Tesla being expected to deliver a measly 360,000 vehicles this year. Evidently this is rather impressive, given that Tesla only became profiting in 2019.
Analysts at UBS are now becoming bearish on Tesla’s soaring valuation. At $100bn, Tesla is deemed to be ‘too expensive’ and the price is indicative of 1.4 million cars being sold at a 11% profit margin per annum – this truly is quite far-fetched. Furthermore, the latest rally is indicative of a valuation of 98 times profits, which provides further doubt of how sustainable the bull rally really is.
The current numbers, however, may not fully represent the might behind Tesla, but represents what Tesla embodies and stands for – breaking barriers. Tesla’s mission is to break barriers and accelerate the world’s transition to sustainable energy. Through developing high-performance pure electric vehicles, setting new standards in range, design and cost within the efficiency, such cars are some of the highest-rated in the industry. Tesla remains well ahead of its competitors.
Such growth has been rapid, through Musk investing his own fortune in the company, Tesla’s growth has been fuelled to its access to cheap capital and credit. In a world characterised by angel investors desperate to grab a foot in the technology industry, the business has been kept going despite turbulent times. What Tesla benefits from is a market monopoly in a sector the large traditional manufacturers have not yet created anything competitive with. Perhaps Tesla is leading the charge in transforming the automobile sector from a ‘manufacturing’ industry to a ‘technology’ sector in order to survive in the bull pit.
Real Estate and Construction – Led by Ethan Bradshaw
Mass Withdrawals from UK Property Funds
By William Lee
M&G Property Portfolio has shut its gates against investor withdrawals and many property funds have followed suit in face of global market uncertainties. Following the Brexit vote in 2016, withdrawals from UK property funds have increased and, though reviving in 2017, the level of withdrawals has increased by a landslide. The performance of property funds reflects general public confidence in the performance of the property market and such issues are relevant to the current market paradigm of slowing global real estate price value growth.
M&G has a specific investment strategy problem that is shared amongst many property funds. M&G invests in assets that require a long time to produce returns whilst simultaneously making an effort to enable investors to withdraw upon demand. Investors have been demanding back their investments from even before M&G has had an opportunity to implement its investment plan and so, for the stable return and efficient protection of the investor capital, the fund has rescinded the investor’s ability to withdraw their investments. The conflicting goals of long-term wealth-maximization and a desire for access to short term returns are inherently contradictory and cannot function well within such strong presence of pressures and counter-pressures.
The current trend is a worrying indictment of property market performance. 2019 has been harsh for retailers with Debenhams, Patisserie Valerie, Thomas Cook, and Mothercare falling into administration. Coupled with general uncertainty fueled by Brexit, other geopolitical uncertainties, as well as investor attitude – many are not confident in ability of the property market to rise back. According to the FT, certain influential figures within the real estate market – namely Sam Zell, ‘Chicago-based real estate billionaire’ who has ‘disposed of almost all the properties within Equity Commonwealth, a $3.9bn real estate investment trust’ – are selling their office property portfolios and invested interests in the current market. This potential implication of such an investor attitude feeds back to further investor uncertainty. This uncertainty is manifested within the market; quoted price falls of more than 20 per cent in the prime London Real Estate market, millions of Chinese properties becoming unused, and listed real estate securities are now traded at a significantly lower price than book value. These figures act also as indicators to the reason why investors are pulling their money from the UK property funds and facilitate a general understanding of the current property market, specifically so of the UK.
In response to this uncertainty the FCA have reported that they will bring in new 2020 regulations enforcing the need to inform investors of the risks of illiquid funds – according to the FT. Because property funds in the UK, i.e. M&G Property Portfolio, have no choice but to invest the majority of capital in illiquid funds, investors are likely to stray away from illiquid investments until such global instability subsides. From this it is crucial to take away the fact that the current performance of UK Property Funds reflects explicitly public confidence in the UK real estate and construction industry.
Renovation of the Old Real Estate Model
By Alexander Jimenez
Being in the era of innovation, it is hard to not notice that the Real Estate industry is severely lacking in technological improvements. It has relied upon the same agonising and tedious model: human brokers are hired to represent buyers and sellers of homes to find a successful outcome for their clients. The tech industry has definitely realised the opportunity to digitalise the industry. Companies have already offered digital open houses and closings. Now, they are going even further and updating that arduous model of home buying with something called “instant buying” or “iBuying.”
The idea behind iBuying is merely house flipping with the click of a button, while using an advanced algorithm to target and identify opportunities that would lead to better efficiency than the traditional home flipper. The main contenders in the field are Zillow, Opendoor, and Offerpad. Keller Williams, Century 21, and Coldwell Banker are some of the popular brokerages that have announced plans to follow suit with the iBuying trend.
There are many skeptics of this trend. These companies snatching up homes and not having a plan of what they can sell them for creates risk and volatility in the entire market.
There has been some success in Phoenix and Las Vegas. In Phoenix, iBuying accounts for 6% of transactions. The iBuying model has the advantage for the right person in the right situation. Individuals sometimes need to make a sudden move, but that often comes with a hefty price. iBuying says it can make it less costly, thus helping those affected by this circumstance. It also helps those looking to sell their house who don’t want to make the repairs to drive up value. In one case, a 68-year-old Phoenix resident sold her home to Zillow for cash $10,000 above what broker quoted her. She might have made more if she did the renovations herself before selling, but in this trade off she was much happier leaving it for someone else to do.
The model in Phoenix and Las Vegas has been able to perform well, but it is mainly because these markets are stable and relatively cheap. The true test is to see if it can work in other markets that are more expensive and require higher maintenance costs. The algorithm may prove to be less effective because it hasn’t had to deal with more unstable variables which don’t exist in Phoenix or Las Vegas.
Overall, this is an exciting trend for the industry and has the potential to be something substantial, but as of right now it is too early to tell.
Consumer Discretionary – Led by Robert Swift
Deliveroo and Amazon what’s the hold up?
By Joshua Beuvink
The popular food courier service Deliveroo has come under immense financial pressure in recent years, as increased competition in the food deliver market has reduced profit margins meaning that the firm made an operating loss of £185 million last year. Between 2013 and 2015 Deliveroo took the European food courier service by storm with its new model of food delivery allowing couriers and restaurants the ability to offer higher end takeaway food. An investment of £442 million by the online retailer Amazon in June 2019 appeared to have relieved some of Deliveroo’s financial pressure, but the UK Competition and Markets Authority subsequent investigation has led to increased concern for the UK’s 3rd largest food delivery service.
Why the hold up?
The CMA’s investigation is based upon the premise that in allowing Amazon to invest in Deliveroo, Amazon would be discouraged from possibly pursuing a food courier service of its own. The delivery service industry directly affects consumers’ pockets as profits are made through delivery service fees attached onto the delivery. As a result the CMA is keen to encourage competition in the market so as to maintain low service charges and protect the consumer from possible exploitation. The decision was met with shock from Deliveroo’s investors, many of whom believed that the incoming funds would have been vital in ensuring the continued operation of the UK’s third largest food delivery service. This shock was further exacerbated by the merger of two of Deliveroo’s competitors in the form of JustEat and Takeaway.com in August 2019. However as of the 23rd of January this case has been re-opened for analysis by the CMA.
So why does it matter?
As aforementioned, Deliveroo is the UK’s 3rd largest food delivery service and operates in a market which enjoys incredible levels of consumer loyalty. Within the UK, the firm delivers to 45,000 users a day, employs 15,000 couriers and is licenced to deliver from 15,000 UK restaurants making it very much a part of daily life in towns and cities across the country. For these individuals, the CMA’s investigation has been met with frustration as uncertainty has meant jobs, contracts, and consumers have been left in the dark over the future of the firm.
For investors, the CMA’s investigation has prevented necessary funds from being used in order to continue to compete with other delivery services in a market that operates on incredibly fine margins. Furthermore the recent re-opening of the JustEat and Takeaway.com merger, suggests that the CMA is focused intently on the future development of this market reducing the opportunity for profits similar to those of 2013-2015.
The food delivery service is currently operating in a market that will only be profitable for those firms who can survive the shrinking profit margins the longest. The CMA’s investigations have sapped Deliveroo of vital funds to compete in the cutthroat food delivery market. Subsequently unless the investigation ends with a positive ruling for Deliveroo, it is likely that the firm will continue to suffer losses and ultimately have to exit the market, damaging not only the lives of its employees but also its consumer in the process.
Financials – Led by Tchilasa Kibona
What does China’s new financial regulations mean for global investment banks?
By Sophia Li
Foreign banks have spent past centuries pushing into China’s financial markets – which China has always been very protective of, with ongoing disputes between China’s financial regulators over the amount of access global investment banks should be given.
Previously in April 2018, it was announced by the securities regulator that foreign investors could take majority stakes in securities joint ventures, whereas before there had been a limit of no more than 49%. Now just this week, Chinese officials stated that from April 2020, foreign banks will be allowed to apply to take full ownership of any joint ventures, essentially 100% of stakes. This gives global investment banks broader access to China’s $21 trillion capital market, and an opportunity to capitalise on these new regulations.
Upon this new relaxation of regulations, which possibly comes as a result of the increasing pressure from the US to liberalise the markets and the China-US trade deal, companies such as UBS, Nomura, JPMorgan, Morgan Stanley and Credit Suisse have all wasted no time to take action.
JPMorgan launched a 51 percent-owned securities joint venture in December and is currently applying for a 100 percent stake in a futures joint venture. UBS and Nomura have all taken similar strategies, with UBS taking majority ownership of Beijing-based UBS Securities through increasing stakes to 51 percent, and Nomura also initiating a 51 percent owned securities joint venture. Morgan Stanley and Credit Suisse are both in the process of launching 51 percent owned joint ventures, whilst Goldman Sachs has yet to receive public approval for its application to increase its stake in its joint ventures investment bank.
The increase of stake levels to 51 percent means the investment banks gain majority ownership in their joint ventures and hence allow them to integrate their China revenues into their global earnings. This could mean potentially new higher returns to shareholders, despite some of whom are doubtful of their investments in China. Their concern comes as no surprise, with China’s investment bank revenues shrinking from $7.8 billion in 2016 to $5.9 billion in 2019, and foreign banks acquiring only 4 percent of that in 2019, decreasing from 9 percent in 2016.
Another issue for the global investment banks is the domestic competition it faces. Foreign banks hold a very small percentage of the domestic market in China and will find it hard to compete with local investment banks such as China International Capital Corporation (CICC) and Citic Securities, who have dominated the Chinese investment bank markets.
However, to address this issue many of the global investment banks have decided to focus on their strengths in China markets. For example, David Chin, head of UBS’s investment bank in Asia-Pacific, has announced that UBS are “not going to compete head-on with domestic players but will focus on cross-border business”, targeting areas of the business where Citic Securities and CICC find it harder to compete.
In brief, the relaxation of China’s financial regulations undeniably introduces new possibilities and opportunities for foreign global investment banks, however, it is also clear they will certainly encounter challenges such as the influence of domestic companies and the process of building a reputable name for the global investment banks in a new country will take several years.
The Structural Changes in Fixed Income
By James Float
Over the last 3 years, portfolio trading in fixed income (FI) markets has expanded from nothing to $88bn worth of yearly trades completed. Stemming from a series of structural changes in the industry, the strategy’s growth is far from complete and looks set to have further long-term impacts.
FI portfolio trading concerns the sale of high-value portfolios featuring a number of different bonds in one transaction, often with the intention of a large-scale risk transfer. Historically, a lack of speed and efficiency in pricing bonds (due to the variety and complexity of bonds available) had made this difficult thus investors wishing to gain high levels of exposure to bonds had traded synthetic derivatives created by investment banks. However, since the first FI portfolio trade in late 2017, this market has expanded rapidly with the growth of FI exchange traded funds (ETFs) and an increased usage of technology hastening the process.
The emergence of portfolio trading has partly been enabled by the growth of ETFs in the FI market. Whilst ETFs have been a mainstay of the equities market since the early 1990s, their popularity in FI is more recent with bond ETF asset values hitting $1tn for the first time in 2019. Bond ETFs are constructed such that a collection of bonds are exchanged with a market-maker for a number of ETF shares that can then be traded similarly to a stock – the ETF shares can also be redeemed for the underlying bonds. ETFs mimic the underlying bonds and can provide effective diversification. The growth of the FI ETF market and the liquidity it provides has led to a wealth of data concerning the underlying bond prices and subsequently aided the development of portfolio trading.
A trend towards algorithmic trading and the usage of electronic trading platforms, such as MarketAxess, in FI has resulted in greater amounts of publically available pricing information. Trading platforms have begun producing indicative bond prices with banks and trading firms often including these indicative prices in their models. The result is that, combined with the greater volume of FI ETF price information, the ease of pricing individual bonds increases and thus engaging in portfolio trading is much more efficient – a Citi analyst claims pricing a large basket of bonds now takes seconds where it once took hours.
The growth of FI portfolio trading has been hailed as a potential solution to liquidity problems stemming from investors wishing to withdraw funds. Asset managers would traditionally be forced to sell their most liquid bonds leaving a less liquid and thus more risky portfolio which can escalate into a spiral of further withdrawals. Through the use of portfolio trading, fractions of the entire portfolio can be sold thus maintaining a comparable risk and liquidity level and hopefully assuaging investor fears.
In response to the growth of FI portfolio trading, both banks such as Morgan Stanley and investment management firms such as Invesco have been investing heavily in their FI portfolio trading capabilities. The implications of this are not yet clear – some industry analysts are expecting to see similarities with the introduction of portfolio trading in equities. This occurred years ago due to the increased ease of pricing equities and resulted in a greater volume of trades but contracting spreads reduced profitability in equity trading. If this were to occur in FI, profit margins would be compressed and trading jobs are likely to be at risk. The pressure on traditional banks is increased by newcomers, such as trading platform MarketAxess, which are revolutionising the FI market and increasingly providing services directly to banks clients.
With a variety of applications including portfolio rebalancing, risk management and provision of access to a wider variety of bonds, FI portfolio trading and its benefits have already become integral to the FI market. The longer term impacts of its development are not yet clear but it would be reasonable to expect spreads being compressed. In combination with the increasing digitisation of bond trading and innovative market newcomers, the biggest impact of FI portfolio trading may be the pressure it places on bank’s traditional FI trading models and the subsequent structural changes required.
Report Edited By Charles Longford