Assessing the New Landscape for Evaluated Pricing in Illiquid Bonds – US Muni and Corporates

Jimmy Suppelsa, COO of Eagle alliance vendor Best Credit Data (BCD), highlights why industry consolidation is opening the door for tech-driven offerings that offer quality and coverage in evaluated bond pricing.

By design, municipal bonds are a tax-efficient alternative for income investors seeking regular and predictable interest payments. This lends to the idiosyncratic nature of the muni market, as it’s the only asset class in which individual investors make up more than 50% of the investor universe. As allocations to municipal bonds often underpin individual retirement accounts, trading volume is minuscule compared to the size of the actual market. In a high-volume trading session, there may be 12,000 trades that affect less than 1% of the roughly 1.25 million active securities. This is why pricing can seem so lumpy to outside observers. At the same time, it is also why two or even three sources of pricing data are needed to arrive at a valuation that best serves a fund’s investors or clients.

In fact, most fund managers self-regulate to incorporate two independent sources of evaluated pricing data. Even in this new era of deregulation, the need for both a primary and secondary source will remain critical, as pricing is often quite volatile relative to other markets due to the lack of volume. Recent consolidation, however, has altered the evaluated pricing landscape and amid the search for alternatives, many are now exploring how new models can complement the offerings of existing players.

To get a sense of what the consolidation means for the market, it helps to understand how fund managers employ evaluated pricing data. In the muni space, for instance, the relative illiquidity and lack of transparency has forced dealers to develop more sophisticated means to value bonds than what is typical in equities or even high yield fixed income securities. They may rely on benchmark yield curves as one input or seek to draw parallels to trades involving “comparable” securities, which share similar ratings, maturity and structural characteristics. Given the illiquid nature of the muni market, it’s imperative that dealers have other sources of pricing data at their disposal.

Opening the Door for Disruption

To be sure, the recent consolidation has raised concerns about impending price increases. From the perspective of institutional investors and traders, price has always been an issue, and recently there has been increasing pushback against duplicative fees for evaluated pricing data as consultants or other advisors pass along these costs. Still, an even more urgent question relates back to where these institutions will turn to replace either their primary or secondary source for evaluated pricing data. And when it comes to finding a suitable alternative, price will almost certainly be trumped by quality, which most dealers active in the market would define as accuracy, timeliness and coverage. This screen, of course, will limit the number of viable candidates but, notably, it also will open the door for disruptive technology.

Traditionally, evaluated prices have been generated manually. Legacy providers, for example, may employ hundreds of analysts, whose ability to accurately assess a valuation is often dependent on the liquidity of the securities being evaluated. These costs and the time required to price these bonds “by hand” are ultimately passed through to clients, who may only recognize a tendency for stale pricing, mispricing or input errors in hindsight.

At BCD, we’ve streamlined the evaluated pricing process by partnering with Google to create a fully automated pricing system. Utilizing Google’s cloud platform and its Analytics infrastructure and BCD’s proprietary methods, BCD can offer evaluated pricing that is created from the largest number of observable inputs in mere minutes, leading to greater transparency in how we arrived at the evaluated price.  The result is coverage — combined with accuracy, speed and transparency — that extends across 1.25 million municipal bonds and 30,000 U.S. corporate bonds.

Through layering transactional pricing data, bid-offer inputs, and available positional data, BCD’s observation-based pricing model yields a far more accurate picture of a bond’s intrinsic value than simple matrix-pricing archetypes. Moreover, the valuations reflect all market movements and each security is calculated independently, which leads to added precision. This is supported by “next day” error tests used to assess evaluated pricing data. For example, in a recent study that tracks the frequency of outliers among vendors (defined as a deviation of more than 5% between the evaluated price and the executed trade price), BCD’s proprietary model produced a 98% accuracy rate.

The consolidation of evaluated pricing vendors is helping BCD to gain a foothold in what has traditionally been an industry slow to adopt new technologies. Ultimately, the promised change that results from the industry consolidation may have less to do with vendors joining forces. We believe that a year from now, many will view it as the catalyst that gave dealers a reason to look beyond the status quo.

In September, 2016, Best Credit Data Inc. formed an alliance with Eagle Investment Systems to provide end-of-day bond pricing and analytics available to Eagle’s global client base. Through the collaboration, Eagle’s clients can receive BCD’s municipal and corporate bond pricing directly through Eagle’s portfolio management suite of data management, investment accounting and performance measurement solutions.

Jimmy Suppelsa is a cofounder and COO and in this capacity, leads the sales, marketing, operational and client service functions of BCD. Jimmy previously spent nearly 21 years at FactSet, creating, building and leading many different teams and businesses, including the Data Feed and Data Warehousing Businesses.

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