Wall Street’s E-Trading Boom Adds New Fuel to Private-Debt Mania

The rise of electronic trading and growing popularity of portfolio trading has had an unintended consequence for the US corporate bond market: making private credit even more attractive.

Portfolio trading, where investors can buy or sell a group of bonds in one or just a few transactions, often via exchange-traded funds, has grown to account for nearly a tenth of the trading volume in the market. That’s helped boost liquidity, which has, in turn, flattened the extra yield that investors get for holding bonds that trade infrequently.

The measure, known as the liquidity risk premium, was worth just 5% of the compensation that investors demand for investment-grade bonds as a whole at the end of last year, compared with as much as 30% a decade ago, according to Barclays Plc data. The British bank’s strategists say this vanishing reward has been a tailwind pushing buy-and-hold type investors like insurers and pensions into the private debt markets.

“That’s a big driver — maybe the biggest driver — right now, from the continued demand from that community for private credit,” Barclays’ global head of credit research, Jeff Meli, said in an interview. “They don’t need the liquidity in public markets and the yield reflects the increased liquidity.”

The topic of shrinking compensation for buying and holding bonds came up at the Milken Global Institute Conference last week. For instance, Jean Hsu, managing investment director of private debt at CalPERS, said the pension firm is growing its exposure to non-public assets to 30-40% of its portfolio from 20% previously.

“The illiquidity premium is driving us to allocate to the alternative areas, like all the privates,” Hsu said.