Interview with Sarah Biller of Capital Market Exchange

Capital Market Exchange (CMX) was founded in 2010, in the wake of the financial crisis. CMX provides fixed income credit analysts, portfolio managers, and bond traders with predictive analytics and sentiment analysis – that is, a unique perspective on factors driving bond prices, and a look at which bonds or sectors may be under- or over-priced.

Sarah Biller is the company’s co-founder and President.

Q.    Sarah, tell me about CMX.

A.     CMX transforms professional investors’ views on emerging risks into actionable trading signals. We take unstructured data and put it into a form that bond investors can act on.

For example, asset managers who hold telecom debt in core investment grade corporate bond portfolios may be concerned about the risks posed by telecom firms with increasing leverage levels. Some may be as concerned by this as they are by the ability of telcos to continue to build innovative products and services or to maintain profitable customer acquisition trends. We quantify their dynamic opinions and use that data to create our proprietary Sentiment Adjusted Spread. Investment teams use our spreads to better understand the relationship between these factors at an individual issue level as well as how a specific issuer stacks up against its peers. They also use our spreads to identify mispriced bonds.

Q.    Though the global bond market is bigger than the global stock market, and bonds are more complicated securities than stocks, it seems like there are fewer analytical tools for fixed income portfolio managers and traders and certainly fewer startups addressing their needs. Am I correct in these assumptions, and if so, why do you think that is?

A.     You are correct to suggest that there are fewer start-ups focused on bond investors’ needs. But, it’s also true of FinTech generally that there are fewer start-ups serving the institutional asset management space than serving the retail payments space.

Start-ups in the credit space have to deal with tremendous price opacity in the bond market (which means data is both sparse and expensive), making it very difficult for any early stage firm to marshal the resources and data it needs to test it ideas. Secondly, with most institutional asset managers, the time to market acceptance for a new input to investment decisions is between 24 – 36 months. Professional investors managing billions of dollars understandably look for a track record of persistent performance before acceptance. For entrepreneurs and VCs alike, the demands of the professional investors seem like a lifetime and few have the patience.

Q.    How do you identify trading and investment opportunities and do you differentiate between the two?

A.     We identify mispriced bonds by looking for differences between our Sentiment Adjusted Spread and the current market spread. The lack of liquidity in the bond market – meaning not every bond trades every day – delays the flow of information into the issue’s spread. This hampers price discovery and distorts the value of the bond. We can arbitrage this slow movement of information by quantifying the opinions of investors who are buying and selling bonds.

Q.    How do you quantify expectations of risk?

A.     We numerically quantify expectations. For example, investors buying bonds issued by pharmaceutical companies have been concerned about the value of their holdings once the recent healthcare law is fully implemented. We might proxy concerns over “regulatory risk” by analyzing the growth rate of each pharmaceutical firm’s reported allowance for doubtful accounts in tandem with other factors. In other words, our analytics help us adjust credit spreads by how much each firm in our universe estimates its trade receivables will not be paid.

Q.    How are you capturing sentiment? How many market participants do you need to work with to produce actionable data?

A.     We look directly to professional investors for their views. It is highly curated.

Q.    How are your analytics delivered?

A.     Our analytics are web-based and available via secure login.

Q.    Have you back-tested the output of your analytics and what are the results?

A.     We have back-tested the results of our analytics using six different tests and had positive results. For example, if investment teams had done nothing more than used our Sentiment Adjusted Spreads to identify and invest in a sector neutral basket the most mispriced rich/cheap intermediate duration index eligible issues in 2013, they would have outperformed the Barclay’s ITR Index by greater than 400 bps. There is tremendous opportunity in the credit markets to use unstructured inputs to generate alpha.

Q.    Tell me about the analytical work you did around the surprising impact of Basel III capital requirements and credit risk.

A.     For the better part of three years, Europe broadly has been of significant concern to professional bond investors. We have, over time, analyzed the European debt crisis to reflect the most current “sentiment” whether it be concerns over a bank’s exposure to its sovereign government’s debt or, in other periods, what debt banks where writing off. The most recent work on Basel III was a surprising conclusion in that our analytics showed spreads widening for certain institutions adhering to the very rigorous Basel III requirements rather than tightening (e.g., revealing less risk) as one might have believed if relying on conventional wisdom. We released our conclusions that Basel III might be adding more stress to the global banking system rather than the intended outcome of strengthening it. We were obviously pleased to see that the ECB reviewed and amended its Basel III requirements post our and others voiced concerns.

Q.    You recently added high yield and CDS to your repertoire. Are there plans for sovereign debt or emerging market bonds?

A.     Yes, we are currently working on an emerging markets offering.

Q.    How do you reach potential clients?

A.     We have direct sales model and area also in conversations with large data providers to jointly distribute our outputs.

Q.    What is the revenue model?

A.     We are currently a SAAS business.

Q.    Are you operating solely in the U.S.?

A.     We are focused first on selling to U.S.-based asset management firms. We have sales teams in Boston and in San Francisco.

Q.    Who is your competition?

A.     We are the only firm providing quantified investor sentiment to bond investors. We do compete with traditional data providers who have a lock on operating budgets as well as some emerging products in the sentiment and unstructured data space.

Q.    Do you consider CMX a big data company? Can you also be an asset manager?

A.     By virtue of the size of the global credit markets and the amount data it takes to quantify the most salient of investor opinions, we can’t help but be in the realm of big data. It is not uncommon to see one of our fourteen different models crunch 10 – 12 million data points.

The asset manager question is a very good one. This is one of three questions we are asked in every meeting: why aren’t we running money? Some firms and individuals we have met with have even offered us investment capital to start our own fund.

Q.    Is there a use case for retail investors?

A.     Yes, there is a use case for retail investors. They are at a huge information disadvantage, especially in the bond market. We are currently working with a large and well-regarded private wealth management firm to provide some of our tools to their Advisors. Some might argue that the liquidity constraints we currently see in the corporate bond market could be addressed if the retail investors sitting on the sidelines as given pricing clarity they need to actively trade.

Q.    How did you arrive at the name “Capital Market Exchange”?

A.     Our early vision for the firm stretched as far as our Sentiment Adjusted Spreads being adopted by the industry as the fair market value for a bond, enabling us to anchor a long overdue electronic exchange market for corporate bonds. Some firm somewhere will fill the need for a market-based price mechanism for the capital markets.

Q.    CMX raised a Series A and additional capital from Kormeli LLC. Are there any plans to raise a Series B?

A.     We are raising a round now.