It’s About Moving, Not Storage

Traders Magazine Online News, October 25, 2018

Paul Daley

There is a common narrative thread in the fixed income markets today that essentially says, “the fixed income market today is like the equity market of 20 years ago (or 10, or 30).” The implied conclusion is that in 20 years (or 10, or 30) the fixed income market will look just like the equity market of today.

While in most ways this a stretched analogy, in one meaningful way the narrative holds true. In 1998 when I joined the global equity portfolio trading desk at Merrill Lynch it was pounded into my head that, “It’s about moving, not storage.” Wall Street loves a catchy phrase, and for good reason. I am still quoting it 20 years later. We were changing the mindset of the traders and sales people. Earning trades through capital commitment (“buying the trade” aka storage) was no longer acceptable. It was our jobs to earn agency business for the firm (moving). Collecting commissions rather than taking risk was the future. (I only wish that mantra had existed in the mortgage securitization department a decade later.)

The feedback I have heard from a few head fixed income traders lately is that they no longer get paid to execute with the street (i.e. manage inventory). Instead their priority is to fill customer orders. Moving, not storage. The idea that a trader might identify a “cheap” bond, take it into inventory, then try to find a home for it with a customer, but failing that, be able to sell it back to the street at “fair value” on some future date is becoming an antiquated notion. Moving, not storage. Perhaps this shift in business model was started by the post 2008 financial crisis regulatory changes that make capital very dear for brokers. It is ironic that this is the case in an age where capital is so cheap for everyone else. One theory goes that we have a record number of unicorns in the United States because it is so easy to raise money in private markets without a founder losing control that it no longer makes sense to do an IPO. And even some IPO structures are reflecting that reality with management selling stock with limited or no voting rights attached.

If the moving, not storage business model is truly here to stay in fixed income markets (it certainly appears to have become more ingrained in equity markets since 1998) then, following the equity market example, the next logical steps are:

1. A division of labor between those who commit capital and those who face customers.
2. The capital committers will “Wal-Mart” the market by accepting tighter margins to gain bigger market share.
3. The customer facing firms will focus on a “just-in-time inventory” approach.

 

Division of Labor

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