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How understanding fixed income challenges can help win against the passive trend

This blog post is an extract from Terry’s executive summary in the newly released report, Fixed Income 2018: Goals and Challenges for the Front Office, which includes insights from 100 Heads of Fixed Income.

The fight for fund flows between active and passive management has been going on for more than a decade. While passive management has pulled ahead since the financial crisis, the return of volatility, including the recent spike in the VIX, and increased inflation, as the Fed looks to raise interest rates, are conditions that favor active management. MorningStar reported that active funds experienced improved performance during the period between June 2016 and June 2017, with funds’ success increasing substantially in 10 out of the 12 categories it tracks.

Against this backdrop, the ability of active managers to produce alpha from complex and illiquid instruments such as fixed income, is even more essential. For this group, the ability to quickly engage in new strategies and deploy new asset classes, is crucial to producing the returns that will attract new investors. Yet to make these strategies even more competitive, special attention must be paid to improving operational efficiency

These considerations were top of mind when we commissioned WBR Insights to speak to 100 of your colleagues, active in fixed income, to learn about their chief concerns and their plans for 2018. The survey focused on the front office and included chief investment officers, desk heads, portfolio managers, and traders. What we found, is that as a group these professionals are dedicated to resolving roadblocks and inefficiencies that create opportunity costs and hamper performance. 66 % said that reducing operational cost and improving profitability of the fixed income desk was their number one priority for 2018. (See question 1.)

What we found is that fixed income professionals are intensely interested in creating value from new asset classes and geographies. Yet they confront operational challenges that have been decades in the making, primarily stemming from the proliferation of best-of-breed solutions and multiple systems. To capture immediate opportunities, front offices have been continually adding new platforms to their mix of services. Gaps in these systems have created corresponding data gaps, meaning that often the crucial information required is simply not available, or even non-existent. For example, 81% of you are challenged to understand firm-wide limits, counterparty exposure, and other important risk indicators, and 70 % are challenged to secure timely and accurate start of day/intra-day positions and cash projections. (See question 2.)

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These results show lack of connection to the operations function and gap in understanding how operations can contribute to the fixed income team’s goals. It is hard to see how managers will be able to make progress on their 2018 priorities including identifying new regional or asset class opportunities (62%), improving firm wide compliance (51%), improving risk management (58%), and implementing new fixed income technology (63%) without better integration with the operations team. (See question 1.)

Today, we believe that best-of-breed has run its course. Additional pressures including new regulations, decreased liquidity, and increased fragmentation, new regulations and electronification of fixed income trading are combining to make the fixed income markets tremendously complex and of course, a great source of alpha for quality active managers.

So, the question for you, the fixed income advocate, is this: has your firm kept up and are you confident in your team’s ability to profitably handle the instruments you focus on? This pivotal time in the markets, where conditions are expected to “go back to normal,” in terms of volatility, inflation and others, presents an opportunity for you to question the status quo, and ask if multiple systems still make sense, or if consolidation, and a closer relationship with operations could be a better option.