Longevity and trading do not go hand in hand. Investment banks are drafting in younger traders to replace the old guard – ‘juniorisation’ is the new buzzword – and those with deep market experience are on the periphery.
At nearly $9 trillion, U.S. corporate bond market is one of the largest in the world and one of the most important as institutional fund managers rack up a higher concentration of bonds in their portfolios. But for market ‘veterans’ – and this can mean anyone with over a decade of experience – the growth of electronic trading, combined with balance sheet restrictions, means that they are often finding their skills out of date.
We spoke to one survivor – who has over 13 years experience – on how the job has changed. He wished to remain anonymous.
What’s changed in corporate bond trading?
In the old days the market was a lot more rational, driven much more by fundamentals. Obviously, there were some technical distortions at times, but you could more easily understand and define why Limited Brands traded here and why JC Penny traded there. In this day, you absolutely have NO idea why Limited is here vs. JC Penny being there.
The valuation of some of the names have nothing to do with how we look at credit fundamentals. We have much less of a handle on pricing and value today than ever before.
Why do you think this has occurred?
All the regulations have brought illiquidity to the market. That weird vacuum we have right now is directly related to the new rules.
But haven’t the regulators helped improve pricing information through initiatives like the Trade reporting and compliance engine (TRACE)?
Generically, in the good old days, you wouldn’t care as much about TRACE. You would look at it, but you would have a map in your head more or less that gave you your sense of where things were supposed to be at different credit levels. These days, as a sell-side trader, you rely a lot more on TRACE than the fundamentals of the company because there are so many trades that occur at whacky levels. The reason for this is because there is so little balance sheet on the sell side, we are seeing massive technical distortions due to normal trading activity. This becomes even more exaggerated when we see a massive sell off like we have seen in January and February.
How is this environment impacting your ability to provide liquidity?
Yes. It has changed as internal regulations became more strict. This has had the biggest impact. Before, you didn’t really care if you held the position 30, 60, 100 days. At some point, someone might have come to you to cut the position, but that was the consequence. At one bank where I worked, they were one of the first to change the cost of capital rules to become exponentially more expensive than what most traders were used too. Now most banks have reduced their risk by tiering the cost of capital over time. In the first 30 days of holding a position, you get charged the standard LIBOR +60, but after 30 to 60 days, it could be LIBOR +100, over 60 is LIBOR +200 and so on.
When you were starting as a corporate bond trader pre-crisis, what was your expectation on compensation and job security? What is it like today?
I would probably say that if you were making, all in, 5% or more of P&L in the good old days, you were doing pretty well. 7%-10%, you were doing great and it would have been hard to get a better deal.
After the crisis, the first couple of years, the market was still pretty good in terms of pay for 2009 and 2010. Somewhere around 2011, things started falling apart. P&L on fixed income desks dropped dramatically, so upper management at the banks began having trouble figuring out how to pay traders. The main issue was that the historical value of the trading seat was maybe $10m to $15m a year in P&L, but the trader for 2011/2012 only made $5m-$10m. Was this drop due to poor performance by the trader or is the market different?
After several years of declining market making revenue, most banks have responded by raising trader salaries, but significantly cutting the annual bonuses.
In the past, if the desk could have made $300m to $400m for the year, that would be considered good. Now, $100m to $200m is the new normal.
What is the mentality of a veteran trader today? What is your career strategy?
Blackrock is now how hiring young traders is the way to improve their desk, but I think that credit is a different market. Having younger people won’t help the market. Putting younger people in credit seats will make things a lot worse.
Because they have very little experience dealing with illiquid markets and volatility. Absolutely no experience being a sales person, which is a key skill to being a good trader.
The consequence to this is already happening. When a young trader gets hit and sees the market trading down, he/she will immediately go and try to hit the street. This starts a snowball effect where the price of the bond takes a beating because people are so scared and don’t know how to handle it. A more senior trader will be more thoughtful when they get hit and will have different methods of hedging themselves.
How have the expectations of the buy-side changed over the years?
To me, the buy-side have been just as damaging to the health of the market and liquidity as the regulators. They have caused a problem by not trading at acceptable levels, so bonds don’t move. When a major account calls and you give them a market for $2m, they want you to provide the same market for $10m. If you don’t, they will say that they are seeing “better away” and will threaten to do the business away from you. For a trader that is holding a position in that bond, it creates a real problem because they will move the market against you by trading with others, so it is an unfortunate situation.
In general, the buy-side is demanding the sort of execution that a dealer cannot possibly provide. The way the market is right now, they have to be MUCH more flexible on price so that dealers can take risk. If everyone were to chip in, both buy-side and sell-side, and become more flexible, things would be a lot smoother.
What do see as being the next step for your career?
Personally, I would love to transition to the buy-side because it has become a much better seat. You can put trades on based on fundamentals, you have time to hold a position and electronic trading makes it easier to access the market.
How important is it to understand how electronic trading works?
It is very important. As much as people want to say that the corporate bond market will not work like the equity market, liquid, on the run names are definitely going to electronic systems. The off the run bonds will be traded by voice, but electronic will have a major place, so you can’t avoid it and have a future in the market.
William R. Valentine (a pseudonym) has worked in financial markets for over 20 years with roles at several leading financial institutions. His career includes sales, trading and platform building in both equity and fixed income markets.