Fixed-income markets are jittery over plans by the Federal Reserve to raise interest rates later this year.
Despite doomsday media headlines warning investors about a looming liquidity shortage in corporate bonds, Amy Koch, managing director and head of taxable fixed-income trading at Standish Mellon Asset Management, sees no reason to panic.
As someone who creates order out of chaos, Koch thrives in a hectic environment. “To me, this is normal. I don’t know what I would do if there weren’t always multiple things going on at once. I think that is why trading and running a desk is such a good fit. No two days are the same, and every day is a unique challenge,” says Koch, who oversees 12 traders in Boston on the taxable desk and six on the municipal desk, two in Pittsburgh and two in London. There are also two municipal traders in Boston.
Like her counterparts in competing buyside firms, Koch is meeting with a lot of vendors offering the new electronic bond-trading platforms to learn about their solutions. While the head trader seems calm, she acknowledges that since the financial crisis, there is less liquidity from dealers.
Experts monitoring the credit markets say the fears are real.
“Without a doubt, there could be a serious liquidity crisis to hit the corporate bond marketplace and the credit markets in general. The facts are completely blatant, and they can be stipulated,” said Anthony Perrotta Jr., head of fixed-income research at TABB Group.
Clearly, the stakes are high for traditional asset managers that have been buying up new issues. As a fixed-income specialist firm, Standish Mellon has $170 billion in assets under management. It’s sitting atop large bond portfolios of investment-grade and high-yield corporates, along with municipals and emerging-market issues.
Even so, Koch said Standish Mellon is able to obtain the liquidity it needs from the dealers. What’s more, the buyside firm has made adjustments in the way it trades. Like many other large asset managers, Standish has focused on large, liquid new issuesrather than off-the-run securities.
“We are not buying terribly illiquid positions,” she told Traders. Unlike the past, when the firm would hold off-the-run bonds and run the risk of being stuck holding a less liquid issue, “We wouldn’t do that anymore,” she said, adding, “the liquidity inputs are too important.”
Perrotta confirmed that Koch and her peers at other large asset managers have this view because the dealers have always been there to service them. Firms such as BlackRock, Eaton Vance and Standish Mellon are the prized customers of dealers, and they always get the liquidity and services they need, he said.
“Large asset managers are a bit jaded; they recognize it, [a liquidity shortage] but they haven’t felt the effects of it yet,” he told Traders.
Bigger Market, Less Liquidity
While Perrotta agrees that the buyside has changed the way it trades, he’s concerned that it is increasingly being herded into a smaller segment of the corporate bond marketplace. Two years ago, buyside traders snapped up global issues like Verizon and Apple and, more recently, a $17 billion Medtronics deal.
As a result of new issues, the $7.8 trillion corporate bond market is 65 percent larger than it was in 2008, while the amount of liquidity that dealers can provision to secondary-market marketing of U.S. investment-grade and high-ield bonds combined is roughly 21 percent lower. Prior to the credit crisis, the top dealers had roughly $120 billion of balance sheet available to spend on inventory, which would absorb customer selling. Post-crisis, Perrotta estimates that the top 10 dealers are holding about $90 billion, of which $45 billion or so is held in long-term credit. “They do have capacity to absorb investor selling, but that capacity has shrunk significantly,” he said.
Not an Alarmist
Koch admitted that there is less liquidity, according to dealer balance sheets, since the financial crisis. “You can’t argue with that,” she said. Dealers have reduced the number of counterparties that they allow to access their balance sheets, Koch pointed out.
On the other hand, Koch expounded, “Who’s to say what’s the right amount? We look at liquidity differently even though the dealer balance sheets are shrinking.” According to Koch, the new-issue market also brings liquidity into the secondary market: “Swapping out of an off-the-run into a new issue is providing you with a new level of liquidity in a very similar line item.”
As long-term investors, there are steps that the buyside and sellside have taken to mitigate the reduction. Standish has reduced portfolio turnover. “Being a long-only asset manager, we have a longtime horizon in these portfolios. We’re not looking to flip positions the next day or week. We have a target,” Koch explained, referring to credit spreads and relative value. Traders put effort into talking with sellside relationship management teams to “understand where we stand on The Street,” she added.
Though the firm isn’t the largest money manager by asset size, it hopes to outrank its competitors by establishing communication and transparency, and establishing trust. Standish has been in business for 80 years, which helps it to “outrank and get better execution because of having a pristine relationship with The Street,” according to Koch. “We want to be the first rather than the 10th call. That is why we dig deep with The Street.”
One of the major concerns, according to Perrotta, is that buyside firms are holding similar corporate bonds and are heading in the same direction. “What worries me is that the trade has been one way,” he said. “Real money accounts – another terms for traditional asset managers – receive capital inflows, and they’ve been buyers of bonds whose values have increased. The question is, will an increase in rates trigger massive selling through a narrow door?”
Trading Remotely
Even if mayhem were to break out, Standish Mellon is prepared with remote access. “We remote into our desktops so everything is the same,” Koch said. From its trading headquarters in Boston, it executes 24 hours a day, while London supplements the trading in global sovereigns and credits, and Pittsburgh serves as a backup. The firm also has an integrated trading operation with its Singapore office, so after New York closes, it’s active in Asia. Trading remotely has been a huge priority not only for Standish but for BNY Mellon in the last couple of years, according to Koch. Incidents such as the Boston Marathon bombing, Hurricane Sandy flooding lower Manhattan, and snowstorms shutting down Boston transit this year made remote trading necessary.
Centrally organized, all fixed-income traders report into Koch, while she reports to Des Mac Intyre, who is Standish’s president and CEO and heads Standish’s Active Fixed Income business. Under this structure, Standish traders are in tune with their sectors. “They know what portfolio managers are looking at. They have an integral role in portfolio liquidity,” Koch explained .
“Yes, liquidity is less, but I’m not as alarmed as some of the pieces I’ve read,” Koch said. “I’m comfortable with our liquidity. Of course, it’s something we monitor daily, and I think we have good tools in place.”
From Softball to Trading Desk
Koch grew up in Warwick, R. I., where her family owned eye care and laser treatment stores. Koch, however, was drawn to economics and business headlines. As the fourth generation in her family to attend Holy Cross, she double-majored in economics and Spanish while playing Division I softball. She basically stumbled into her job in 1998 in the back office at Liberty Financial, which was later bought by Columbia Management. “Once I saw the trading desk, I knew where I wanted to be,” she recalled. “I saw the process. I wanted to be the one executing those trades, being in those meetings.”
Koch became a junior trader at Columbia Management, where she started out on the high-yield desk: “There was very little liquidity. I learned how I wanted to trade.”
Liquidity and transparency were eye-openers. “I was able to develop my own style, which has helped me get to where I am today,” Koch said.
She joined Standish Mellon in 2004. David Horsfall, who was then head of fixed-income trading, hired Koch to become an investment-grade trader. “He was the jack of all trades. He was a great mentor,” Koch said. Her training involved understanding the strategy and the portfolios, “so you are able to filter out the information and piece it together for the team,” she explained.
“We like to say here that all the traders have a portfolio management mindset. And not one of the trades that appear on the blotter should be a surprise,” she added. “That way, when traders get their morning color, they know whether the firm is a buyer or seller of a particular credit and they can piece together information in those morning meeting calls.”
Internally, traders work very closely with portfolio managers. “They need to know what the PMs’ views are on the long end of the yield curve, what sectors are underweight and overweight in different credits, and what the target credit should be,” she explained. “You’re that practical application of their best ideas into the portfolio.”
In 2009, five years after joining Standish, Koch was promoted and took over the trading desk from Horsfall, who became a deputy CIO and a portfolio manager for the absolute return strategy. She took on administrative duties like tracking spreadsheets, implied commission reporting to The Street, and building transparency in the firm’s numbers and rankings.
To develop more meaningful conversations with the sellside, Koch helped Standish develop its own internal score ranking process, tracking total liquidity, new-issue allocations and new research visits. The goal was to look at all of its relationships holistically, improve and open up communication across all sectors, and eliminate personality conflicts. “We want to understand where we rank with brokers and where they rank with us,” she emphasized.
E-Trading Venues and Consolidation
Now that liquidity is more scarce, attention is shifting to electronic trading platforms. Many startupsare vying to solve the liquidity shortage with their own solutions.
Last year, BlackRock published a paper that advocated market structure changes, urging more electronic-trading solutions with different protocols as well as more standardization of bond issues.
Currently, Standish utilizes MarketAxess as its go-to platform to trade more efficiently. This is mainly for odd-lot issues, which can be a high percentage of a money manager with cash flow’s trades, and a lower percent of its volume. The request-for-quote model is mainly used for small transactions around $2 million and under, relying upon dealers to provide liquidity.
A new wave of electronic-bond venues, ranging from Electronifie and Bondcube to equity-oriented players such as Liquidnet and Investment Technology Group, have launched dark pools aimed at matching buyers and sellers. According to Reuters, 30 e-trading platforms are competing to address the crisis in corporate bond liquidity. Some allow buyside firms to trade with each other.
“There is a lot of competition out there,” observed Koch, whose firm is in talks with a bunch of electronic-trading venues. That said, she was skeptical that a proliferation of venues can solve the problem. “We’re seeing people who can take liquidity from one platform and put it on another. We haven’t seen anything that changes the landscape to any significant degree,” she said, adding that she would like to see some consolidation to make the liquidity pools more efficient.
With multiple venues, she cited the issue of the buyside facing integration bills, client reviews and IT costs. “It’s a significant burden to do this level of due diligence, which is why we can’t have three, five or 10 platforms. We need to have a smaller number of platforms and new liquidity. You can’t just transfer liquidity from one to another,” Koch insisted.
If Standish is going to take 15 percent of MarketAxess’s volume and transfer it to another venue, that’s not going to help her firm, she said. “I want to see a new pool of liquidity from other entrants that I don’t have access to,” said Koch, who predicts that only a few venues will survive.
While bond liquidity is top of mind, Koch is juggling other projects as well. One of Standish’s top IT projects relates to counterparty risk and collateral management, which are playing an important role in the post-financial reform and central clearing world. “Given central clearing, you exchange your counterparty risk from the dealer to the clearinghouse,” she said. This could involve figuring out eligible collateral for a corporate bond portfolio in emerging market debt. The tools can determine ” the best options for an emerging-markets portfolio: cash, U.S. Treasuries, or taking a haircut on a higher-rated corporate bond,” she explained.
As the job of head of trading has evolved, Koch is dealing with lots of meetings, demos and research panels, so while she was trading initially, she doesn’t have an asset class now: “I can’t dedicate the kind of time and commitment that our sector traders do.” She is, however, allowed to step in to trade if needed.
In her personal life, Koch was thrown into chaos when she lost both of her parents from different illnesses over the past two years. But through this tragedy, she met her husband, got married, became a stepmother to 10-year-old Brooke and moved to the suburbs. Now she’s awaiting the birth of her first child while finishing up a four-month home renovation. While Koch will take some time off in June, she plans to return to the trading desk, where interaction is key.
“I feel that I am good at prioritizing, summarizing and being able to move on,” she said. Like her work in the trading space, these skills are valuable and may explain why she is not spooked by the dire headlines.
“You have no control over what is going on in the markets,” Koch concluded. “All you can do is be prepared and react accordingly, and you will have more good days than bad.”
