The accepted wisdom on both the buy-side and sell-side is that inherently flawed humans will inevitably be replaced by technology. Algorithms are getting so sophisticated that humans cannot keep up - at least according to those leading quant-driven hedge funds - and over-paid traders will become slowly extinct.
If this is the case, why are buy-side firms paying their fixed income traders more than ever? Hedge funds and asset managers are allocating a growing proportion of their budgets to paying their traders rather than on technology, according to a report from Greenwich Associates. But the types of skills traders need are changing - pay is heading up because firms want skilled technicians who have a strong understanding of both the financial markets and advanced trade-execution technology.
“Mutual fund firms’ and hedge funds’ fixed income desks reported an increase in their budgets, which mainly goes toward paying traders,” says Kevin Kozlowski, senior analyst of market structure and technology at Greenwich Associates. “A little bit is being spent on technology, but the bulk goes toward personnel.”
70% of expenses in fixed income desks go on trader pay and 30% on technology, it says. In 2014, 62% was spent on technology.
Trader talent is still important, and firms are focusing on deep client relationships and consistently high performance, but tech is an enabler, says Kozlowski.
“It opens up people to do things they couldn’t do prior to the technological advances on their desk, such as trading new products, pre-trade analysis and deeper review of post-trade analysis,” he says. “Liquidity is harder to find, so traders can use technology to source liquidity that used to be more readily available.”
Investment banks are continuing to drive down compensation for their traders, and technology is viewed as a threat, even in more complex products. This is a mistake, says Chris White, the CEO of ViableMkts and the creator of Goldman Sachs' GSessions corporate bond-trading platform
“There’s been a shift in talent from the market-making [trading] desk to the buy side, either hedge funds or asset managers. Asset managers’ have better long-term prospects, whereas sell-side traders perceive their seats to be under threat from regulation and technology,” he says.
Senior traders in fixed income-focused earned an average of $750k in 2015, according to Greenwich Associates and Johnson Associates figures, where as long-only asset managers paid $510k.
While visions of bond-trading robots handing human traders pink slips make for a compelling storyline, that is not the reality in the industry today. A report by Mckinsey last year suggested that most trading jobs in investment banking were at risk of automation in the future, and only bespoke, highly illiquid and complex products required any human input. White believes that is a misguided view.
“There are only a few select products that can be traded in a completely automated fashion, and those are the most frequently traded in the market,” he says. “Anything that has a greater degree of complexity or is more infrequently traded requires human intervention, the human touch.”
For the sell-side desks that are firing their most experienced traders in an effort to lower operating costs, that could be a huge mistake.
“The end goal of technology is not to do away with human traders, but rather to augment their capabilities. The only time we’ve seen that work is the most frequently traded products,” he said. “In fixed income, outside of on-the-run government bonds, the most popular maturity benchmark bonds and CDX, electronic trading has limited utility for institutional trading, because they aren’t actively traded on a daily basis.”
The ability to trade complex products in institutional sizes requires someone who knows what they’re doing. When it comes to big institutional trades and intricate investment products, a machine is simply not going to be able to get the job done.
The murky, false story around what electronic trading does is largely a creation of the buy-side, which tries to create a world where they don’t have to pay for liquidity, and the electronic trading technology service providers themselves in an effort to support the notion that everyone has to trade through their platform.
“Unless you’re trading the most frequently traded plain-vanilla products, buy-side traders at asset managers are still getting paid,” White says. “That’s because their job has gotten more and more complicated over time."
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