Wealth Management
For Bloomberg, Ye Xie covers the aftermath of a disastrous Treasury auction for buyers. A little less than 3 and a half years ago, the world and fixed income markets were in a much different place due to the pandemic and the Fed’s aggressive efforts to flood the market with liquidity. At the time, the 30-year Treasury was auctioned off at a yield of 1.2%, while it now fetches nearly 4.5%.
Thus, buyers of the 30Y have taken a huge loss. In recent weeks, it’s traded around fifty cents on the dollar. Typically, this would mean that holders are concerned about default risk, but this is not the case. Instead, the price is so low because buyers have to be sufficiently compensated given that they can get higher levels of income in so many places.
Simply put, it’s an indication that these buyers essentially top-ticked the Treasury market. Longer-term Treasuries declined by nearly 30% in 2022 and have added to these losses this year as the Fed has remained hawkish for longer than expected. The holders of this specific note include the Fed, ETFs, pensions, and insurance companies.
Finsum: The yield on the 30 year Treasury fell as low as 0.7% during the depths of the pandemic. Now, they are close to 4.5%.
Demand for active fixed income has materially increased in 2023 due to a combination of secular and cyclical factors. Adoption is up due to institutions and advisors becoming more familiar with the new category, while recent data supports the notion that it can outperform passive at least in specific circumstances. From a cyclical perspective, higher rates and increased volatility are also leading to more demand for active fixed income products as managers have more latitude in terms of duration and credit risk.
AllianceBernstein recommends a systematic approach to fixed income in order to outperform benchmarks. It sorts through criteria to identify predictive factors which goes deeper than the traditional approach of duration, beta, and sector.
This criteria includes value, momentum, fundamentals, company financials, and historical market data. Many factors are only applied during specific market regimes when they have greater predictive power.
This strategy allows for increased diversification as returns are uncorrelated from benchmarks and other factors. They also typically have lower costs while allowing for greater customization to fit client needs. This sort of quantitative, factor-based investing is more prevalent in equities, but the company is looking to bring it to fixed income.
Finsum: AllianceBernstein recommends a systematic, quantitative approach when it comes to active fixed income. The key ingredient is dynamic weighing of quantitative factors.
Over the last decades, there has been a constant trend in equities trading towards lower transaction costs, increased transparency, fractionalization which have made the markets cheaper and more accessible for everyone. This is only beginning to happen in bond markets where the majority of trading still takes place over the counter.
One startup, Moment, is taking on the challenge as it’s raising $17 million in a Series A round led by Andreessen Horowitz. It’s expected to be a major opportunity especially as interest in trading bonds has increased amid the spike in rates since last year.
Currently, the major electronic venues for trading bonds are MarketAxess and Tradeweb. Moment’s API seeks to pull data from all these fragmented markets and liquidity pools and provides execution services in addition to analytics and portfolio management tools. The company plans to cover all types of fixed income investments including municipal bonds, Treasuries, and corporate debt.
The company believes it will be able to be the premier platform for retail investors when it comes to fixed income trading. It sees upside opportunity in that only 3% of US households own individual bonds, while 23% of households own individual equities.
Finsum: Interest and activity in fixed income has soared along with rates. Moment, a startup backed by Andreesen Horowitz, is looking to build a platform for retail trading of bonds.
More...
In a strategy note, Scott Welch, the CIO of Model Portfolios at WisdomTree Investments, discusses how markets are unusually calm right now but from a seasonal perspective, investors should get ready for a surge in volatility.
Currently, markets are at their ‘calmest’ since prior to the pandemic, this is evident through the Vix or credit spreads although bond market volatility is elevated. Historically, volatility does tend to increase between September and November especially as trading volumes increase, and people become more mindful of risks.
According to WisdomTree, markets are currently not accounting for a slowing economy, hawkish Fed, and geopolitical tensions. The firm recommends that investors prioritize quality in their portfolios by prioritizing cash flow, strong balance sheets, and operational efficiency as these companies are best suited to handle a downturn in economic conditions.
The second consideration is sufficient diversification at the asset class and risk levels. This is a necessary antidote as many investors are tempted to veer away from their plan during these periods of volatility. With proper diversification and rebalancing, these periods can be used advantageously.
Finally, it recommends investing in less followed parts of the market like managed futures, floating rate Treasuries, or commodities. These alternative asset classes can also provide additional diversification while outperforming in volatile markets.
Finsum: WisdomTree shares some thoughts on the current state of the market, and why investors should prepare for a surge in volatility.
The ‘why now’ and what’s to come for middle-office outsourcing
During the post-2008 financial crisis volatility, the popularity of outsourcing key middle- and back-office functions rose as asset managers saw the value of an outsourced operating model. We have recently seen how market volatility has created operational challenges for fund managers due to the COVID-19 pandemic and the subsequent instability in the banking system. As a result, there is a renewed need for real-time transparency into counterparty exposure, securities exposure and available liquidity. Demand is growing for ready-to-deploy technology and talent to mitigate the impact of market uncertainty on managers’ portfolios.
Market uncertainty also compels managers to look for ways to control costs and make them more predictable while creating scale. Internal middle-office teams are often regarded as a business expense, susceptible to high employee turnover and replacement costs. Technology savings are also a key factor driving middle office outsourcing, as managers recognize owning and maintaining best-in-class technology makes limited financial sense in the long run.
The demand for a more efficient exchange of information, coupled with cost control measures, has motivated asset managers to look at outsourcing.
Why Now?
In its May 2023 Insights Report, Hedgeweek found the outsourcing trend is accelerating, with around 60% of hedge funds outsourcing back-office functions and 40% outsourcing the middle office. Some 34% of firms surveyed said they were planning to outsource more. There are three primary motivations:
- Outsourcing allows firms to focus on their core competencies and securing the best possible deals. Moreover, working with a service provider brings specialized expertise in various asset classes and geographies, shortening the time to market for new product launches. Leveraging a service provider’s resources and expertise on key business strategies makes scaling in a dynamic market easier.
- Access to advanced technology without a costly in-house build-out. Not only is there no high upfront cost nor ongoing maintenance, but an effective middle-office service provider can also rationalize and connect data across multiple processes. A centralized data approach can bring efficiency gains and data integrity.
- Outsourcing makes it easier to achieve scale while controlling costs. For firms in growth mode, increased acquisition activity, multi-jurisdictional operations, maintaining operational governance, data complexity and increased investor scrutiny are just a few challenges outsourcing helps address.
What’s to come for middle-office outsourcing?
Outsourced operating models must have the flexibility to adapt to the changing business needs of managers. Today, firms are seeking support in such areas as:
- Lifecycle support across all asset classes, including publicly traded securities, complex fixed income such as bank debt and distressed debt, illiquid OTC derivatives, real assets and other static assets.
- Consolidated investment reporting and analysis to tell the “story” so managers can extract meaningful data quickly and easily.
- Investment-level forecasting, both in terms of liquidity requirements and scenario planning, to account for varying degrees of market uncertainty.
- CSDR and T+1 settlement requirements put pressure on managers to meet strict deadlines. Outsourcing to a provider with an automation infrastructure and effective post-trade processes will enable managers to accelerate their readiness.
The full lift-out vs. select activities
As disruptions to day-to-day operations weigh on fund managers, many consider the benefits of a full lift-out of their middle and back-office operations systems and staff. In the full lift-out scenario, the most significant benefits to a firm are cost savings, scalability, immediate access to industry-leading expertise, and staff continuity. Any growing firm looking to get into new markets or reduce the cost of its operational infrastructure stands to benefit from a lift-out. Smaller managers, however, may find it easier to outsource selected operational activities.
The ways hedge funds manage their operations is evolving. Many asset and fund managers have outsourced their back-office operations for years, but more are realizing many other functions can also be performed more efficiently by an external service provider – putting the middle office in the spotlight. Funds of all sizes want to focus on investing, not operations; outsourcing allows them to find this balance.
To learn more about Middle Office outsourcing and SS&C download the whitepaper ‘Three Key Drivers of Middle Office Outsourcing’
VettaFi announced that it would be acquiring EQM Indexes, a provider of custom thematic indexing specialists. It marks VettaFi’s second acquisition in the space as the indexing and ETF data provider continues increasing the amount and quality of offerings for asset managers. In April, it acquired ROBO Global Index suites.
EQM uses a quantitative approach to construct customized, niche indices for industries like e-commerce, rare earths, block chain technology, etc. Most of its customers are advisors and wealth managers who are based in North America, Europe, or Asia.
Following the completion of the deal, VettaFi will have more than 300 indexes that comprise $19 billion in assets including ETFs and direct indexing products. The firm was founded in 2022 through a merger of various entities in the ETF data and indexing space.
Clearly, the firm believes that direct indexing has more room for growth. According to Brian Coco, VettaFi’s head of Index Products, “A great investment idea can often remain just that: an idea. But with a well-constructed index, great investment ideas can become great investments. Building custom indexes is something at which EQM has long excelled, and we are very excited to add EQM’s expertise to our index offerings.”
Finsum: VettaFi announced the acquisition of EQM Indexes, a provider of custom indexing solutions. It marks a continuation of the firm’s investment in the direct indexing space.