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Key Themes for 2023: Trading



Zach Tucker, Head of Trading

If 2021 was the celebration party for portfolio trading (PT), then 2022 was the year of the exchange-traded fund (ETF). We closed 2021 engaged with numerous counterparties regarding PT capabilities listening to accomplishments and platitudes around the latest financial product touted to be profitable for both parties. Realistically, PT was created to address the issue of liquidity for custom baskets of securities. A nuance we must acknowledge is that these portfolios may be a combination of buys and sells. A fund experiencing large inflows/outflows or desiring a quick change in strategy could more efficiently price a large number of bonds for a swift transaction with a single counterparty. In short, the PT service made things more efficient from a time, pricing, and resources standpoint. No matter the iterations or details, let us be clear that this was a tool for liquidity.

In 2022, there were numerous periods where liquidity in credit markets was sub-optimal. During those periods, brokers remarked consistently that ETF funds were skewing their markets by blindly hitting bids or lifting offers to fit within their basket of bond parameters. In a market of bespoke securities such as fixed income, the ETF investor looks for broader exposure rather than single-bond risk. Many fixed income managers bemoaned a wide bid-ask spread and the ‘stupid’ levels where bonds were executed with many of these trades attributable to ETF funds, while some managers instead saw an opportunity. One thing that became clear was that ETFs had become the new tool solving for the same issue as PTs—the need for liquidity.

While we reflect on the past year and consider themes for the next, how the liquidity picture will look and develop should be top of mind. Financial engineering is always progressing in the background, and there are certain to be more products, tools, and outlets as fluid market dynamics demand. Much ink was spilled on the PT (r)evolution despite garnering just ~3.5% of credit trading volumes. It was a product used predominantly by active fixed income managers. As we can see from ETF fund flows in 2022, investors sought the “buy or sell at any level” liquidity it provided, perhaps with less of an eye for returns and more for the ability to express a macro view. To throw another product into the liquidity mix, we should give a nod to the U.S. government soliciting solutions to improve Treasury liquidity as the Fed removes itself from being an active buyer.

We see this trend of seeking liquidity continuing in 2023, and one that will hold the attention of Wall Street quants and stodgy investors alike.



Chart, line chart, histogram Description automatically generatedMorgan Stanley Corporate Credit Strategy October 14, 2022



Chart Description automatically generatedCS Credit Strategy Daily, December 7, 2022



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