Wall Street’s Portfolio-Trade Fad Hooks Illiquid Muni Market


(Bloomberg) -- The boom in portfolio trading is starting to creep into the market for state and local government debt.

The tactic, which allows investors to buy or sell bundles of bonds at once, has become popular in the US corporate bond market over the past six years. Now municipal bond managers are starting to catch on, too. 

Portfolio trading holds the promise of injecting more liquidity into the buy-and-hold market, where debt sold by small towns and school districts may not trade for months or even years. That makes it difficult for investors to determine the value of a particular bond and has contributed to higher trading fees — a problem that may be eased if more rarely traded bonds are included in lots sold by portfolio trades.

“It’s still in its early stages,” said Peter Borstelmann, president of ICE Bonds, part of the fixed-income business at Intercontinental Exchange Inc., adding that there’s “room to grow.” 

Intercontinental Exchange started offering muni portfolio trading last year and has seen several transactions since then. 

Vanguard Group Inc. is among the investment managers that utilize the method, according to a person familiar with the matter.

In response to interest from clients, MarketAxess last month launched a portfolio-trading tool for munis, said Daniel Kelly, the firm’s head of municipal securities, which allows investors to trade as many as 1,500 bonds in a single transaction.

AllianceBernstein’s muni team, led by Jim Switzer, has been portfolio trading with dealers using tech that the money manager built internally. The method is ideal for year-end tax-loss harvesting, he said, when investors look to sell large quantities of bonds at the same time to drive down clients’ tax bills before the year is over.

Switzer said he would like to see more money managers “crack the code” so that the method is more widely utilized.

“We embrace it, we use it in as many places as we possibly can, including in munis,” he said. “There are limits in the muni market though to portfolio trading – and probably the biggest limiting factor is just the nature of the muni market.”

Tricky Trade

One reason is because the market is dominated by smaller borrowers whose bonds trade so infrequently that some investors may be hesitant to buy them or unsure of how to determine the price. While there are 40,000 corporate bond identifiers, known as CUSIPs, in the US, there are nearly 1 million active muni CUSIPs, according to Bank of America Corp. strategists. 

“Portfolio trades in munis are generally tricky,” said Matthew Schrager, co-head of TDS Automated Trading, the quantitative trading arm of TD Securities. 

He said the difficulty of shorting municipals means it may be harder to conduct portfolio trades when investors are looking to buy a particular basket of bonds. The ability to short-sell corporate bonds enables dealers to offer securities that they don’t own as part of a portfolio trade. 

“People can only sell you what they own,” Schrager added.

Another roadblock has been the growth of separately-managed accounts. Regulations require SMA managers to achieve the best execution on each individual bond that they sell. That is harder to do in a portfolio trade, he noted.

Liquidity Boon

Despite the hurdles, the benefits of adopting the tactic are apparent. Portfolio trading has reduced investors’ transaction costs in the corporate bond market by more than 40%, according to a 2022 study by Barclays.

The technique accounted for about 10% of US corporate bond trading volume in June, up from a monthly average of just under 2% six years ago, according to data from bond-trading platform Trumid, which began offering corporate bond portfolio trading in early 2023. 

Izzy Conlin, head of US institutional credit for electronic-trading platform Tradeweb Markets, said portfolio trading has helped to make the corporate bond market more liquid. Investors get better insights on pricing, she said, adding that the market for state and local government debt could see similar benefits.

While Conlin said there haven’t been many portfolio trades that include baskets of muni bonds, she has seen taxable munis as part of larger transactions.

“If portfolio trading in munis happens en masse, it makes it a more liquid asset class,” said Eric Kazatsky, head of municipal strategy for Bloomberg Intelligence.

--With assistance from Erin Hudson and Maggie Eastland.

(Updates to add additional detail on Trumid in 17th paragraph.)

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