Institutional investors warned of changes in dealer commitment

Asian fixed income trading volume among investors in the region increased 5% year-on-year in 2011, outpacing growth in the US and Europe, finds a recent report by Greenwich Associates.

Further, fixed income assets under management by Asian institutions rose by more than 50% last year to more than $2 trillion, notes the research firm in its 2011 Asian Fixed-Income Investors Study.

What was noticeable was that as Asia’s fixed income markets expanded last year, bonds denominated in local currencies accounted for about 40% of overall regional trading volumes.

Greenwich points out that this in fact understates the role of local currency products in Asia as interest rate derivatives make up about a third of overall Asian fixed income trading volume, and many of these products are denominated in domestic Asian currencies, too.

“Although the composition of Asian fixed income trading volume has fluctuated to some extent over the past several years in terms of local currency products versus products denominated in G7 and G3 currencies, there is no doubt that these markets have undergone a sea change over the past decade,” says Greenwich Associates consultant Tim Sangston.

The firm notes that growth in domestic currency products is providing institutional investors with an incentive to do business with dealers that have the broadest regional fixed income platform – namely HSBC, Deutsche Bank and Citigroup which have a combined market share of 30%.

And this trio could be set to enhance their position even further, with Greenwich noting signs of a shift in strategy among many sell-side competitors, as banks in some cases abandon costly efforts to build pan-Asian platforms in favour of more targeted strategies.

“For the past 10-15 years, global banks have taken on clients in a range of Asian products and countries as they worked to build their presence here,” says Greenwich Associates consultant Abhi Shroff.

“But now that they’ve established these businesses, many dealers are wrestling with the questions: ‘What do I really want to be in Asia? What products do I want to cover, and for who?’”

Greenwich warns that as individual dealers re-think their strategies, institutional investors in Asia should be watchful for changes in dealer commitment to specific products, regions or even to the dealers’ relationship with the institution itself.

It notes that when assessing dealer relationships in the present market environment, Asian institutions are paying less attention to things such as research provision and are focusing more on getting the best price on their trades.

It points out that from 2010 to 2011, institutions downgraded their ratings of the value of written research, investment strategies, analyst visits and trade ideas provided by desk analysts, while increasing their ratings on secondary trading.

“Given the heterogenous nature of Asian fixed income markets and the level of volatility in global financial markets, we find it unlikely that institutions are really finding less value in sell-side research," notes Sangston.

“Rather, we think these results indicate that institutions feel quite secure in their ability to obtain the research and other services they need and, as a result, are focusing less on rewarding providers and more on getting the best price on their trades.”

In particular, the firm points to a risk of smaller institutions finding themselves squeezed as global dealers refine their approaches to the Asian markets and become more selective in their allocation of capital and resources.

It argues that institutions should take proactive steps to identify dealers that provide liquidity, research and other services deemed essential to their investment processes; and partner those dealers to ensure that relationships are perceived as beneficial to both sides.

“In some cases this might require institutions to consolidate additional trading volumes with these important dealers in credit, high-yield, derivatives and other products that offer attractive margins to the sell-side,” adds Shroff.

“At the very least, it will require all institutions to be more conscious about how they allocate trading business to different dealers across the full suite of fixed income products.”