Macro

Wall Street’s Portfolio-Trade Fad Hooks Slow-Moving Muni Market with 1,500 Bond Deals

Portfolio trading in municipal bonds gains traction, with MarketAxess enabling trades of up to 1,500 bonds in one transaction.

By Max Weldon

7/11, 10:49 EDT
S&P 500
iShares 20+ Year Treasury Bond ETF
iShares 7-10 Year Treasury Bond ETF
BlackRock, Inc.
Intercontinental Exchange Inc.
MarketAxess Holdings, Inc.
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Key Takeaway

  • Portfolio trading is gaining traction in the municipal bond market, promising increased liquidity and reduced transaction costs.
  • MarketAxess launched a tool for muni portfolio trades, allowing up to 1,500 bonds in a single transaction.
  • Despite challenges like infrequent trading of smaller borrowers' bonds, the method could significantly benefit muni investors by enhancing pricing insights and liquidity.

Portfolio Trading in Municipal Bonds

The municipal bond market is witnessing a significant shift as portfolio trading begins to gain traction. This method, which allows investors to buy or sell bundles of bonds simultaneously, has been a staple in the US corporate bond market for the past six years. Now, municipal bond managers are starting to adopt this tactic, which promises to inject more liquidity into a traditionally buy-and-hold market. This market often deals with debt from small towns and school districts that may not trade for extended periods, making it difficult for investors to determine the value of specific bonds and contributing to higher trading fees.

Peter Borstelmann, president of ICE Bonds, part of the fixed-income business at Intercontinental Exchange Inc., noted that portfolio trading in munis is "still in its early stages" but sees "room to grow." Intercontinental Exchange began offering muni portfolio trading last year and has already seen several transactions. Vanguard Group Inc. is among the investment managers utilizing this method, according to a source familiar with the matter.

MarketAxess recently launched a portfolio-trading tool for munis, allowing investors to trade up to 1,500 bonds in a single transaction. Jim Switzer, who leads AllianceBernstein’s muni team, highlighted the method's utility for year-end tax-loss harvesting, where investors sell large quantities of bonds to reduce clients' tax bills. Switzer expressed a desire for more money managers to "crack the code" to make the method more widely utilized.

Challenges and Opportunities

Despite its potential, portfolio trading in the muni market faces several challenges. The market is dominated by smaller borrowers whose bonds trade infrequently, making it difficult for investors to determine prices. There are nearly 1 million active muni CUSIPs compared to 40,000 corporate bond identifiers, according to Bank of America Corp. strategists. Matthew Schrager, co-head of TDS Automated Trading at TD Securities, pointed out that the difficulty of shorting municipals makes portfolio trades tricky. "People can only sell you what they own," he said.

Another hurdle is the growth of separately-managed accounts (SMAs), which require managers to achieve the best execution on each individual bond they sell, complicating portfolio trades. Despite these challenges, the benefits are evident. Portfolio trading has reduced transaction costs in the corporate bond market by over 40%, according to a 2022 study by Barclays. The technique accounted for about 10% of US corporate bond trading volume in June, up from a monthly average of just under 2% six years ago.

Izzy Conlin, head of US institutional credit for Tradeweb Markets, noted that portfolio trading has made the corporate bond market more liquid and could offer similar benefits for state and local government debt. Eric Kazatsky, head of municipal strategy for Bloomberg Intelligence, added, "If portfolio trading in munis happens en masse, it makes it a more liquid asset class."

BlackRock's Muni Market Strategy

BlackRock Inc. is making strategic moves to bolster its municipal bond business under the leadership of Pat Haskell. Haskell, known for his dynamic leadership style, took over as head of municipal bonds earlier this year. He faces the challenge of reversing severe outflows from actively managed mutual funds, which have seen net outflows of approximately $13.7 billion since 2020. Despite improved performance in recent months, outflows have persisted.

Eric Kazatsky, senior US Municipals Strategist at Bloomberg Intelligence, commented, "Haskell has his work cut out for him to reinvigorate investor confidence on the open-end fund side, which continues to lose assets to alternatives." BlackRock's municipal-bond assets under management grew to $185 billion in the first quarter, up from $163 billion at the end of 2019, largely driven by funds that track indexes, such as ETFs.

Haskell's appointment aligns with BlackRock's broader push to encourage reliance on actively managed funds, which account for 26% of its $10.5 trillion in assets under management. These funds, managed by professionals who identify opportunities and manage risks, charge higher fees, making performance crucial. Haskell's track record at Morgan Stanley, where he integrated retail and institutional desks and launched a trading algorithm for munis, suggests he is well-equipped to tackle these challenges.

Street Views

  • Peter Borstelmann, ICE Bonds (Cautiously Optimistic on portfolio trading in municipal bonds):

    "It’s still in its early stages... there’s room to grow."

  • Daniel Kelly, MarketAxess (Bullish on portfolio trading for munis):

    "In response to interest from clients, MarketAxess last month launched a portfolio-trading tool for munis... which allows investors to trade as many as 1,500 bonds in a single transaction."

  • Jim Switzer, AllianceBernstein (Bullish on the use of portfolio trading for tax-loss harvesting):

    "We embrace it, we use it in as many places as we possibly can, including in munis. There are limits in the muni market though to portfolio trading – and probably the biggest limiting factor is just the nature of the muni market."

  • Matthew Schrager, TD Securities (Neutral on challenges of portfolio trades in munis):

    "Portfolio trades in munis are generally tricky... People can only sell you what they own."

  • Izzy Conlin, Tradeweb Markets (Cautiously Optimistic on liquidity benefits of portfolio trading):

    "Portfolio trading has helped to make the corporate bond market more liquid. Investors get better insights on pricing... If portfolio trading in munis happens en masse, it makes it a more liquid asset class."