What we’ve got here…is failure to communicate (September 28th 2011)

I went to see a theatre adaptation of the Paul Newman classic “Cool Hand Luke”.  It got me thinking about the speech paraphrased for the title of this post. Right, so what has that got to do with Fixed Income Trading?
What we’ve got here…is failure to communicate
Trading requires a difference of opinion or of time horizon.  If I think a bond is worth 101 and I am happy to hold to maturity and the best bid I can find is 101 then I will hold the bond.  If you think the bond is worth 101 then you will not buy it from me.  In time horizon terms, I may not be able to hold the bond until maturity as I need to fund redemptions from a fund, so I have to accept less than 101. Ok, markets 101 over.
The majority of institutional real money asset managers I have worked with or know about seem to have pretty similar investment models.  And valuation models (or just Bloomberg ALLQ). So you are unlikely to find many trading opportunities among a consensus of valuations – only trades based upon different time horizons.
So – if you were trying to build a bond trading platform in line with http://www.cassiopee-bonds.com/ then how do you actually get trades?
In a previous post I suggested that the key is RETAIL+INSTITUTIONAL=TRADES!
I think that the real trick here is structural; bear with me...
A retail business will have relationship managers who keep the client relationships going.  They are the people in the driving seat in some ways.  There is a dealing desk which is often seen as an extension of the back office and a cost centre rather than a profit centre.  At the back is a custody operation which one assumes will be making a few pennies from lending out stock in the same way that an institutional custodian will lend stock.
So – if you say to the wealth management dealing desk – put your positions onto the order book at limit prices and employ some kind of maker/taker model such that the desk can generate some PnL then you have a series of heads of desk who would be interested.
So what’s the relevance of the title?  Well, the failure to communicate in this case is that buy-side market participants are so segmented that there are multiple discrete segments.
Retail money is not interacting with institutional money
“Small institutional orders” run through the platforms such as BV, TW, MA, BLP.
“Large institutional orders” are on the telephone
So – if we have a market place (or multiple competing marketplaces) where all sizes of orders can interact in an anonymous fashion then we should see more trading – provided there are enough firms who understand the model and are willing to make the changes to their models and trading behaviour.
In my discussions on this subject I keep echoing the point that the equities markets can – in this specific case – teach the fixed income people a thing or two.  Construction of synthetic order books, smart order routers, partial executions, different order types (not just market or limit), market surveillance, compliance, audit,  exchange memberships and so on are all well trodden paths for the equities world.
Oh, and if you fancy seeing the play, follow this link http://www.aldwychtheatrelondon.info/

[Original post here ]