What Is a Blind Bid?
The term blind bid refers to an offer made by investors to purchase a basket of securities without knowing which securities are included or their cost. Blind bids are commonly executed by institutional investors and portfolio managers. These types of bids are commonly used by financial professionals if and when they don't want to affect the overall market price of the securities in a basket. Executing these transactions without any knowledge of the variables involved can be quite risky for traders.
- A blind bid is an offer to buy a basket of securities without knowing the composition or cost of each.
- These types of bids are commonly made by institutional investors and portfolio managers.
- A blind bid is risky since investors aren't aware of the composition of the basket and may end up owning worthless securities.
- Institutional investors use blind bids to avoid influencing the overall market or incurring the cost of finding and executing targeted buy and sell trades.
- Blind bidding is also commonly used in real estate, auctions, and awarding government contracts to independent contractors.
Understanding Blind Bids
Bids are offers that are made by various market makers—individuals or companies—to buy and sell different assets. This often applies to various investments like stocks and bonds. In most cases, when an individual or institutional investor decides to make a bid to purchase a security, they note how much of the security they wish to purchase and the price they're willing to pay to execute the transaction. For instance, a trader may put in an offer to purchase 100 shares of Company ABC at a price of $25 per share.
There are some cases where the investor doesn't have any knowledge of the assets on which they're bidding. These instances are called blind bids. A blind bid is an offer to purchase a bundle of securities where the investor has no knowledge of the exact securities being purchased. Traders don't necessarily know the names of the stocks or assets, and may not even have any knowledge of the prices of each. They don't actually have this information until the trade is executed.
As noted above, these bids are commonly used by institutional investors and portfolio managers who make trades for multiple clients. They use these bids to avoid influencing the overall market or incurring the cost of finding and executing targeted buy and sell trades. This enables them to trade a book of securities without knowing the number of stocks in the portfolio and their notional value. The larger the blind bid transaction, the greater the risk premium associated with the underlying securities.
Although there may not be a direct impact on the price of the securities involved, blind bids ultimately carry increased basis risk. That's because the investor making the bid is unaware of the composition of the investments being bid on. The risk is that investors will end up owning worthless securities.
Institutional investors make basket trades (orders to buy and sell securities at the same time) to avoid changing the asset allocation in their managed portfolios caused by price movements.
Institutional investors look at the purchase of securities differently than individual investors. Individual investors look at factors like liquidity, volatility, and company news to determine a price to pay, whereas institutional investors make trades in the hundreds of millions of dollars and involve entire books of securities. The practice is similar to buying an abandoned storage unit without knowing what’s inside, but having a good idea of what to expect in general.
Other Types of Blind Bids
In addition to securities trading, blind bidding takes place in other parts of the financial markets.
- Real Estate Bids: Buyers can make blind bids or blind offers for properties in the real estate market. When a property is listed, multiple parties can make offers to purchase at the same time without knowing how much the other interested parties are willing to pay. There is no transparency in this process, which can see the sale (and ultimate winning) price shoot up as potential buyers have to guess what will put them on top.
- Auctions: Auctions are sales where buyers try to outbid each other for a good or service. The individual with the highest bid wins. Auctions that involve blind bidding hide the value of all bids submitted by potential buyers. Just like blind offers in real estate, this involves some guesswork, where the bidder must decide how much to pay in order to win the auction.
- Infrastructure Projects: Governments commonly use a blind bidding process in order to award contracts for various projects, such as infrastructure improvements or information technology projects. Invitations are sent to independent contractors who, in turn, send in proposals with how much they're willing to accept as payment for the job. Bids are sealed and kept secret until the due date when a winner is declared—usually the one with the lowest dollar figure. This allows all participants to take part in a fair process.
Example of a Blind Bid
A blind bid might be submitted that reveals only general characteristics of a book of securities, such as its beta, volatility, and other attributes without specifically listing them. So let's suppose that the portfolio has very low volatility and consists of bonds.
An institutional investor may seek fixed-income investments with low volatility and come across the blind bid. Since they’re simply looking to reduce risk in their portfolio, they may choose to purchase the book of securities without knowing the individual components. The characteristics of the portfolio may suggest that they consist of highly-rated corporate bonds and/or government securities, and so the blind bid may offer a compelling value.
The Bottom Line
A blind bid is an offer to purchase a bundle of securities without knowing the exact securities being purchased. While individual investors would never make such a deal, these transactions are commonplace among institutional investors that are more concerned with the characteristics of a portfolio than the individual components.
Blind bids carry substantial basis risk, which is the risk that the investor ends up holding underlying assets that are not comparable to the investment portfolio the investor sought exposure to initially. The potential that these instruments will not be negatively correlated heightens the risk of excess gains or losses in a hedging strategy, which would ultimately increase the risk threshold beyond the investor's risk tolerance. Basis risk can be found in certain custom derivative contract transactions that involve different currencies, volatility profiles, or betas.