Bond Managers Power Up for the Digital Future

16 October 2018

4 min read

Jeff Skoglund, CFA| Chief Operating Officer—Investments

Gershon M. Distenfeld, CFA | Director—Income Strategies

James Switzer| Head—Municipal Bonds

The digital revolution took its time getting to fixed income, but today it’s transforming the investing landscape. Already, major advances in technology are helping early adopters gain unique insights and act faster in markets where speed and alpha are increasingly and inextricably linked.

Predictive analytics, automation, artificial intelligence (AI) and machine learning make huge, complex data sets meaningful and useful. With hundreds of thousands of issuers, trillions of dollars in bonds and a largely over-the-counter trading system, the fixed-income world has long needed such upgrades.

Bond managers that have prepared for the digital revolution in investing combine technology with human savvy to solve the market’s most vexing problems. Here’s how.

Turning Puddles of Liquidity into Pools

The ability to find counterparts willing to trade a given bond at a given price has always been the biggest factor affecting a bond manager’s ability to create alpha. Unfortunately, liquidity has grown scarcer and more fleeting since the global financial crisis. Dealer balance sheets have shrunk even as the size of the market has grown dramatically.

When fewer people are willing to take the other side of a trade, prices can move sharply and transaction costs can rise. The problem is especially pronounced when news hits markets, as even small events can give bond investors the jitters and cause liquidity to evaporate in a flash.

For managers, the difficulty of monitoring liquidity conditions compounds the problem. Liquidity pools—markets that provide liquidity for securities—are highly fragmented across third-party sources. It’s inefficient for asset managers to monitor each one and then compare the data. Firms that can’t effectively assess a bond’s liquidity can’t act on their investment ideas, and trades that never happen can’t make money.

Thankfully, new technology is helping plugged-in traders identify counterparts faster and more easily by pulling all external fixed-income trading platforms together on one digital platform. It’s an essential innovation in a marketplace that will digest and react to every new bit of information faster and faster.

Firms that adopt these kinds of platforms can become price makers instead of price takers, resulting in better executions, lower transaction costs and faster investment of cash inflows.

One-Touch Access to Credit Research

To generate better returns for investors, firms need to know not only which bonds are available in a market, but also which bonds help achieve a portfolio’s strategic goals.

The trouble is that research analysts and portfolio managers (PMs) must consider dozens of factors in the analysis, from the capital structure of a bond to the financial health and governance practices of the issuer. Traditionally, fundamental analysts have provided qualitative analyses, forcing PMs to spend precious hours or days going back and forth with various research teams to determine whether a bond is a good investment for the portfolio.

Firms that quantify, digitize and centralize their fundamental ratings make the evaluation process more efficient. Their credit research and rating processes reside in a consistent, accessible framework. This framework allows traders and PMs to immediately grasp an analyst’s assessment of a bond’s risks and potential and to quickly compare two or more similar bonds.

At a time of fleeting liquidity, this centralized format helps managers make the quick calls necessary to seize opportunities that slower-moving firms might miss.

Bringing in the Machines

To fully harness technological advances to build better portfolios and maximize alpha, firms must open new research and trading platforms to machine readers.

Just as consumers have done with the likes of Siri and Alexa, digital-minded bond managers are turning to virtual assistants to search and synthesize enormous amounts of data.

Virtual assistants build orders more quickly and with fewer errors than a human, who is prone to fat-thumb mistakes even when he or she is extremely careful. Automated order building is more revolutionary than it sounds, considering that 80% of corporate bond trades are still carried out over the phone.

But sophisticated virtual assistants can be taught to do a lot more. Some investment managers feed a virtual assistant a list of criteria based on market conditions, research ratings and individual issuer characteristics and receive a list of potential investment opportunities within seconds.

The natural next step would be to teach machines to continuously scan the market on their own for investment opportunities that meet predetermined research criteria. Once machines can do that, it’s a small step for virtual assistants to proactively suggest potential investments to PMs.

Virtual assistants will also likely learn to monitor portfolio activity and look for unusual behavior that could indicate human error. They may even begin to answer simple questions for clients about their exposure to certain credits or risks. And as AI and machine learning advance, they could add value we cannot yet imagine.

Humans should always retain control over key decisions and complex client interactions. But brainy virtual assistants—helped along by further advances in data science and machine learning—will bring bond managers and their clients a host of benefits, including better trade execution, capturing more opportunities to buy and sell bonds, and the time and ability to discover unique research insights.

For fixed-income investors, it’s never been more important to find out whether a manager is at the forefront of the bond market’s digital revolution or losing ground to the analog status quo.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

About the Authors

Jeff Skoglund, CFA

Jeff Skoglund is Chief Operating Officer (COO) for Investments. He is responsible for driving strategic planning, organizational effectiveness and operational excellence. Skoglund was previously COO of Fixed Income and was responsible for business strategy, innovation and technology, and talent management. Earlier in his career at AB, he was director of Credit Research and a portfolio manager for high-yield bond strategies. Prior to joining AB, Skoglund was a managing director at UBS Investment Bank, where he held numerous management positions, including global head of credit research and head of US credit desk analysts. He was an acclaimed high-yield analyst at UBS, Merrill Lynch and Credit Suisse, ranked #1 by Institutional Investor in automotive/auto parts six years in a row. Earlier in his career, Skoglund was an equity analyst and investment banker at Lehman Brothers and worked at Morgan Stanley in equity derivatives. He holds a BS in finance from Miami University, Ohio, and an MBA from the University of Michigan. Skoglund is a CFA charterholder. Location: Nashville

Gershon M. Distenfeld, CFA

Gershon Distenfeld is a Senior Vice President, Director of Income Strategies and a member of the firm’s Operating Committee. He is responsible for the portfolio management and strategic growth of AB’s income platform with almost $60B in assets under management. This includes the multiple-award-winning Global High Yield and American Income portfolios, flagship fixed-income funds on the firm’s Luxembourg-domiciled fund platform for non-US investors. Distenfeld also oversees AB’s public leveraged finance business. He joined AB in 1998 as a fixed-income business analyst and served in the following roles: high-yield trader (1999–2002), high-yield portfolio manager (2002–2006), director of High Yield (2006–2015), director of Credit (2015–2018) and co-head of Fixed Income (2018–2023). Distenfeld began his career as an operations analyst supporting Emerging Markets Debt at Lehman Brothers. He holds a BS in finance from the Sy Syms School of Business at Yeshiva University and is a CFA charterholder. Location: Nashville

James Switzer

James Switzer is a Senior Vice President and Head of Municipal Bonds. He is responsible for driving our municipal bond strategy, including the firm’s innovation efforts within our municipal research, trading and portfolio construction processes, underpinned by best-in-class technology. Switzer has been instrumental in the strategic repositioning of our trading organization and the development of our industry-leading trading tools, ALFA and Abbie. Before joining AB in 2011, he was a managing director at Société Générale, where he managed the Financial Institutions Credit Trading Desk, and at BNP Paribas, where he managed the Investment Grade Trading Desk from 2000 to 2002. Switzer also formerly served as a sector portfolio manager and trader at UBS Principal Finance (from 2002 to 2005) and at Sigma Capital (from 2005 to 2008). Earlier in his career, he worked at Paine Webber and Co.; Kidder, Peabody & Co.; and Alex. Brown & Sons. Switzer holds a BA in biology from Colgate University. Location: New York

Scott DiMaggio, CFA

Scott DiMaggio is a Senior Vice President, Head of Fixed Income and a member of the Operating Committee. As Head of Fixed Income, he is responsible for the management and strategic growth of AB’s fixed-income business and investment decisions across the department. DiMaggio has previously served as director of Global Fixed Income and continues to be a portfolio manager across numerous multi-sector and multi-currency strategies. Prior to joining AB’s Fixed Income portfolio-management team, he performed quantitative investment analysis, including asset-liability, asset-allocation, return attribution and risk analysis for the firm. Before joining the firm in 1999, DiMaggio was a risk management market analyst at Santander Investment Securities. He also held positions as a senior consultant at Ernst & Young and Andersen Consulting. DiMaggio holds a BS in business administration from the State University of New York, Albany, and an MS in finance from Baruch College. He is a member of the Global Association of Risk Professionals and a CFA charterholder. Location: New York

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Bond Managers Power Up for the Digital Future

Turning Puddles of Liquidity into Pools

One-Touch Access to Credit Research

Bringing in the Machines

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