There are several themes that have been moving stocks during the recent pandemic-induced market volatility. For example, people are staying home, which had led to increased usage of streaming services like Netflix and online shopping destinations such as Etsy. One less-discussed theme is that all this volatility has also led to a spike in trading activity, which has benefited financial exchanges.
Tradeweb Markets (NASDAQ:TW), which went public in 2019, operates electronic trading marketplaces for various types of financial assets including government bonds, high-yield bonds, ETFs, and mortgage-backed securities. Many of the assets moved on Tradeweb's services are traded over the counter and do not have a great deal of trading volume. Therefore, the company's exchanges assist market participants in finding liquidity at a lower cost than bank traders would charge to do it over the phone.
A work from home play
The whole financial exchange industry has observed robust growth in trading volumes since the pandemic hit investors' radar. Tradeweb reported its trading volumes grew by 39% year over year in the first quarter.
|Asset class||YoY Change in Tradeweb's Average Daily Trading Volume|
A key reason Tradeweb has benefited is that traditional Wall Street bank traders have been working reduced shifts or working from home. This has created a dynamic where more trading volume has been routed through electronic exchanges because traders have become harder to reach or slower to respond.
Will Tradeweb lose some of that business when traditional traders return to their normal desks? Almost certainly, but the company has likely permanently taken some market share now that it has proven it can work well as an alternative.
Tradeweb also benefits from network effects. There are several competing electronic networks, but investors choose Tradeweb due to the large pools of liquidity found only on its network. To put the size of the company's network into perspective, in 2019, it facilitated $720 billion in trades.
In addition, it's the leading electronic marketplace for several financial products including U.S. Treasuries and interest rate swaps. The company started electronic trading in these products over 20 years ago, providing it with a first-mover advantage.
Traders naturally gravitate to Tradeweb in areas they know they can have access to the most liquidity. As more traders join the network, the network is strengthened by gathering even more liquidity. This is a powerful flywheel that prevents new competitors from entering the market.
An attractive long-term growth story
Tradeweb has been a good stock to own in 2020. Its value is up sharply year to date due to all of the cash flow generated by the bump in trading volume. However, there are even better reasons to own Tradeweb for the long run. The company is at the forefront of market electronification for fixed-income and over-the-counter financial products.
Trillions of dollars of fixed-income and interest rate assets trade every day, but the vast majority of those trades are still facilitated through phone calls to live traders. Over time, more trading will take place on electronic exchanges and Tradeweb is in prime position to benefit.