The Future of Fixed Income Sales and Trading
This is a question I get asked quite a bit from people looking to break into wall street, especially Sales and Trading (S&T). Given the heavy automation in equity trading will fixed income become almost fully automated soon or is it there already?
First and foremost one needs to realize how big the fixed income market is :
This chart only shows fixed income bonds and not any derivatives which is an astronomically big number given Interest rate swaps is one of the most liquid products in the world.
Having spent my entire wall street career in fixed income it might seem like I have a bias but I will try to give my true and honest opinion on this. I will break it down in a few different topics.
Automation is probably the singular biggest push by all the broker dealers in the market to try and provide the fastest liquidity to the market. Sell-side has to constantly make prices to a range of clients on the buy-side. This includes everyone from central banks, hedge funds, asset managers, pension funds, etc. There can be times when you as a singular trader of the 10year curve see 20+ inquiries of different sizes and cusips in a matter of 10 seconds. How as a human can you be expected to price them all instantly within a 2-3 second window of each inquiry? This is where one of the biggest push for automation has been. Being able to auto-quote prices for clients and take the manual pricing away from the traders has helped many banks gain market share and relieve stress from the traders.
Automating and creating automatic execution is great for traders, banks and buyside. There has been a significant amount of hiring of financial engineers that has taken place over the last few years in this area. Majority of the banks have entire algorithmic execution desks to help the front-line traders be able to do a better job and help the desk grow market share.
Now you might be thinking that if you have quants building programs to trade with clients then why do you need a trader?
Fixed income markets are still relatively inefficient. Although the key on the run bonds and futures are extremely liquid and some of the most liquid instruments in the world, the off the run bonds and non-treasury bonds are still quite illiquid. For example: There are maybe 1-2 shops in the world that automate more than 20mm of a TIPS inquiry. There are only a handful that will autoquote credit bonds and even what is autoquoted is in the 1-5mm. There is no way at the moment for algorithms to be able to handle large off the run and on the run flows in the market. At the same time algorithms obviously cannot take market views or set up a consistently alpha generating relative value book. This is where the traders have succeeded tremendously and where their value comes in. Traders are required to make markets and prop trade their books. The automation helps you gain the market share from clients on small odd lot pieces which result in larger trades that are one by “voice”. These prices are outside of what you see on the screens and therefore need human intervention and judgement to make fair levels. There is a big demand for this as majority of the flow driven PnL made on the street is from large orders not from the small automated executions.
There are many shops that are quite large that still don’t have robust automation to price trades in on the run treasuries (the most liquid). So not only can people go the route of helping build those systems, students can also aim to become traders to be able to handle large flows and make large scale decisions for their portfolios for their banks where automation is not suitable or cannot take the risk.
How does a dealer desk make its money? Dealer desks essentially make their money by trying to capture bid offer on a client flow or by prop trading. Majority of the profit made by a bank on a fixed income trading desk is essentially by taking positions and views on the market. This can be through a variety of strategies. Some are as follows:
1) Futures/Cash basis carry trades
2) Relative value of the off-the-run to on-the-run bonds
3) Macro duration and curve views
These are all strategies that are almost impossible to automate. They have strong quantitive aspects but have a qualitative sense as well. There will always be smart fast thinking and creative individuals needed on the desk who have a strong grasp on the markets and macro-economics to be able to take positions that result in positive expected value.
Liquidity and the range of products
I mentioned above about liquidity in fixed income. I want to emphasize this again. The less liquidity in a market the more the human trader is of greater value. Being able to do price discovery is quite tough in many bonds out there. Trading an off the run Thai local currency linker is very different than pricing 5mm 10yr interest rate swap.
There is a waste amount of products in fixed income. Almost every product has its own trader or even in many cases its own desk. For example in January I traded with 26 different Traders worldwide at 1 bank alone across a variety of products in my portfolio.
Here are some possible list of traders at a bank:
o US Markets:
· Short term
· 10 year (there are desks where there are 2y,5y 7-10y, 30y and sepeare futures traders)
· 30 year
· Swaps (probably on average 3-4 traders on a swap desk at minimum)
· TIPS/Inflation cash
· TIPS/inflation swaps/options
· Mortgages (can be 4-5 mortage traders)
· Asset backed securities (3-4 minimum)
o European markets :
o Every country in Europe essentially has their own trader in nominal bonds and separate desk in inflation program and other in swaps like US
o Emerging Markets :
o Every country has their own set of traders and again some of the more volatile countries like Mexico, Asian EM, South American EM, African EM have several traders for each area.
The above does not even include options traders and exotics trader across various countries and asset classes in fixed income. In addition, all the traders have a range of VPs, Associates and analysts. This also coupled with strategists, research etc.
Sales has been an area that has been severely cut back in the last several years. Salespeople are exactly who you would think they are. They are the connection between the bank and the client. It is their job to be the point person for all issues and be responsible for generating more business for the firm. The main tangible here that makes a good Salesperson is just pure tangibles. At the end of the day wall street is still a relationships business and sales will be needed. I do personally think there will be significant consolidation in sales. You will have sales people cover more and more clients and more sales being let go. Sales are paid quite a bit and do not take any of the downside on risk to the trading desk. There are many shops where sales pay is now tied to trading desk pay (this is good and bad).
Regardless given sales relationship nature there will be further consolidation and more shops will become more focused on trading desks than sales desk. I think if you are going to enter sales then you have to be very knowledgable about the products you will be selling and have to have an absolutely personable and likeable personality. I personally believe the future is a bit limited or tougher in sales.
In short, the future for fixed income on wall street is still strong especially in trading. DB recently shut their entire global equities program but have their fixed income desk firing on all cylinders. JPM and GS fixed income desks are their crown jewels. There will always be demand for fixed income products as long as the word “debt’ exists. The more debt USA and the world goes into will create more fixed income bonds to trade. Although there will be automation there will still be a lot of demand for macro-view based traders.
The ideal way to prepare for the future in fixed income is to have strong math, programming and macroeconomic base to be able to compete with the new generation of graduates applying to the desks. This will help you keep up and help with the automation and be able to create new strategies and try to automate some of the qualitative aspects of your job.
There will always be a need for yield and we as fixed income traders will be here to provide liquidity.