Over the years, trading equities has become more efficient and more transparent. By transparent, I mean that anyone, whether institutional or retail, with access to PC and the Internet can see the price of any listed or OTC stock. For example, if I want to buy 100,000 shares of Intel or Cisco, the depth of the market and the fact that I can see the exact price where it is trading (to the penny thanks to new SEC regulations) and easily execute my buy order of 100,000 shares, usually without moving the price of the stock. For the very large institution that wants to buy 100,000,000 shares, they have to be more careful and buy stock over time to avoid moving the stock price too much, known as slippage. But my point is that the price is transparent to any and all that want to trade.
Now, did you ever wonder when you went to buy or sell a municipal or corporate bond if the price you were getting was the best price possible? Welcome to the opaque (defined by the American Heritage dictionary as impenetrable by light, neither transparent nor translucent) world of bond trading
. With the notable exception of Treasury notes and bonds which are transparent (at least to those of us with Bloomberg terminals), most bonds are traded "over-the-counter" like a stock in the Pink Sheets of yesteryear.
Let's say you have an account at brokerage firm "A." You have $50,000 of a municipal bond to sell so that you can buy a stock or new car. So, you call the broker for a bid. The broker comes back with "X." How do you know if X is the right price or, is that a bid that is points away from the "round-lot" or institutional market? Having lived on both the sales and trading
(sell-side) and the investment advisory (buy-side), I have a pretty good idea of what goes on in the world of bond trading in both small lots of just $25,000 and trades as large as $250,000,000. I can assure you that the world of round-lots is much more efficient than the world of odd-lots. There are many reasons, much of which is because us institutional guys have fancy Bloomberg screens and other sources of pricing information than retail. But that is only one of the reasons that my executions are likely much better than the typical retail investor
. I will explain below.
As you know, there has been widespread deflation in equity commissions on the retail and institutional level. I can execute 100,000 shares of SPDR S&P 500 ETF Trust if I want to now for $9.95. 10 years ago, that commission may have been $6,000, or 0.06 per share. So, the brokerage firms need to pick up the slack someplace, right? My humble opinion suggests it is made up (at least in the retail world) in bond trading. When I go to sell a block of $1,000,000 of municipal or mortgage-backed bonds, I usually ask 10 dealers to bid the bond simultaneously "in competition." Of course, I usually have a price in mind before putting the bond out for bid, but you would be amazed at how wide the spread of bids one can get, even at the round lot level for a high quality bond. In fact, we used to ask 5 firms to bid, but have increased to 10 as the inefficiencies mount. Our job as investment advisors is to try to generate the highest rate of return to our investors, so excellent trade execution goes a long way to increasing those rates of return, particularly in a world of low yields.
Let's examine why the bids can be so far apart. One dealer may have just had an argument with his wife. Another may have a cold. Another may have reached his maximum credit line and can't buy any more bonds. One just took a big loss the day before a hopes to make it back today from me. After all, these desks are profit centers for their firms. Then, low and behold, one of the dealers has a customer that has an inquiry to buy the exact bond I am trying to sell and comes in 3 points higher than the dealer who had the argument with his wife. Sound impossible? Nope. It happens every day. The difference of course is that as an institutional investor
with 26 years of experience, I know how to get good execution without disturbing the relationships I have developed with these traders and salesman over the years. I know how that game is played because I have played it from both sides of the field. I also know that, unfortunately, we have a big edge over retail and why we are in business in the first place -- to generate superior rates of return.
How can the retail investor get better prices? First of all, I would suggest visiting www.investinginbonds.com
. There is now a rule that I believe was instituted by the MSRB in order to provide more transparency for all investors. Basically, the trader has 15 minutes to post a trade just executed. Just find the CUSIP of the bond, and punch it in to the site and you will see all the recent trades that have taken place in that bond. You may also notice quite a large difference in price between 25m and 2MM lots. Then ask for the bid, and see how close your bid is (obviously brokers don't work for free and deserve some sort of reasonable mark-up or mark-down). If you don't like the bid, simply ask the broker politely to get you a "Street bid." Who knows? The trader at your firm may be the one that had the argument with his wife and was three points too low! Believe me, most retail brokers I know are frustrated by the poor execution, and they are generally a good bunch that wants to do their best for you. Either way, they will get a mark-up or mark-down, and they want to perform well.
I hope that this article has not offended anyone on the trading side of the world, but it is just meant to be a way to educate people how to get more out of their bond portfolios