Goldman conjures $20bn bond trade from ETF boom

Bloomberg

Goldman Sachs Group Inc. is using its position in the $800 billion market for exchange-traded bond funds (ETF) to build a business that its Wall Street rivals now want to emulate. The bank has this year almost tripled the volume of ‘‘credit portfolio trades,’’ whereby it buys or sells large scale blocks of securities through ETFs, to around $20 billion globally from $7 billion in all of 2017, according to people familiar with the matter. It’s able to do this because it acts as a so-called authorized participant, whose responsibilities include supplying the securities underpinning the funds, according to the people who asked not to be identified because it isn’t public.
New York-based macro credit trader William Wolcott is overseeing the strategy, which was extended to Europe at the start of this year, having been available to U.S. clients since 2016, according to one of the people. JPMorgan Chase & Co. and Citigroup Inc. are also exploiting their authorized-participant roles in similar ways but Goldman’s operation is the biggest and most advanced, the people said.
“There is a real demand for these portfolio trades from investors,” said Sean George, chief investment officer at hedge-fund manager Strukturinvest AB in Stockholm and a former credit trader at Deutsche Bank AG and Jefferies Group LLC. “Goldman is a very entrepreneurial firm and true to form it was tactical enough and smart enough to see an opportunity and capture it before others did.”
JPMorgan hired Stephen Waugh, former BlueCrest Capital Management money manager, in New York last month to lead its efforts and plans to add additional staff, according to people familiar with the matter. He reports to Eric Pitt, they said.
Since Waugh joined, JPMorgan has traded both investment-grade and high-yield bond portfolios for clients, a person said. Jay Mann, head of global fixed income and currencies beta trading in New York, is overseeing Citigroup’s effort, the people said.
A spokesman at Goldman said the bank carries out portfolio trades to facilitate the creation or redemption of ETF shares and to reduce trading costs for clients trading multiple bonds and sectors.
Andrew Jamieson, global head of ETF product at Citigroup in London, said Citigroup is well-positioned to take advantage of demand for portfolio trading because it has a fixed-income franchise and maintains an inventory of bonds. A spokeswoman for JPMorgan declined to comment on its business.
Supply Control
Authorized participants, provide liquidity to the bond ETF market by obtaining the underlying assets for the funds and controlling the supply of shares. This allows them to buy and sell large blocks of bonds at a fraction of the cost of trading the securities individually, the people familiar with the matter said. They can obtain bonds for clients by purchasing shares in the ETF and then redeeming them for the underlying notes. If a client wants to sell a portfolio, the bank buys the bonds and hands them to the ETF issuer which uses them to back new shares.
Banks have carried out similar trades for their clients for several years but wider adoption by Wall Street follows a ballooning of credit ETFs since the first funds appeared 16 years ago.
“If you were to go back a few years, trades like these would not have been possible,” said Brett Pybus, head of product strategy for Europe, the Middle East and Africa at BlackRock Inc.’s iShares unit in London.
Pybus also said that while BlackRock can see shares being created and redeemed in its ETFs, it doesn’t always know whether this is being used by authorized-participant banks to trade bond portfolios.
Cost Efficient
Trading in this way won’t always save investors money, according to people familiar with the matter. As portfolios rarely line up exactly with the ETFs, the banks may need to source additional bonds in the market, thereby driving up the cost. The banks also only make commissions of up to 0.05 percent of the portfolio’s notional value and will typically handle trades worth more than $10 million spread across about 25 bonds, the people familiar with the matter said.
“The maturity of the ETF market is now hitting a tipping point where fixed-income ETFs are being adopted by credit desks at large investment banks,” said Jason Griffin, director of Capital Markets and Business Development at ETF provider HANetf Ltd. in London. “There is a growing realization among credit traders, who rarely utilized ETFs in the past, that they can be a valuable tool to access the bond market and can serve as an additional liquidity pool.”