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On Bonds in Retail Accounts

One small added benefit that I offer clients is extra advice.  The following would be an example:

By the by, I wonder if I can ask you for some bond advice.  I currently use Fidelity for most of our investments, but have become quite dissatisfied with the breadth of their individual bond offerings.  Can you suggest an alternative that would have better bond breadth along with reasonable bid/ask spreads?  I’m not particularly interested in bond funds as I want to be in control of buy/sell timing for tax purposes.

Regarding bonds – bonds are tough in a retail context.  I grew up spoiled as a bond manager, having never done bonds in a retail context, but reading horror stories from those who were “getting their eyeballs ripped out” by their brokers.  Now, from what I heard, Fidelity was among the better in the retail bond area, but I know that most retail bond areas are the “home for misfit bonds.”  Odd lots, tag ends, bonds that are cheap for a reason… and whatever is allocated to retail for those that can or want to ask for bonds that are newly issued, for which you have to be on your toes, in the right place at the right time.

So, I’m used to the relatively good liquidity available on the institutional side, where once you get up to trading $1 million at a time, the bid/ask spread is around 3 basis points in yield, and selection and other tools are considerable.  If I were forced to manage the bonds of a smaller portfolio (which I did for a prior employer… only had $7 million in bonds), I would do one of the following:

  • Outsource it to Vanguard, PIMCO, or Loomis Sayles.
  • Or, what I actually did… buy Treasuries directly, and use closed-end funds and ETFs to allocate the rest.  If I had less than $20 million of bonds under management, that’s what I as a manager would do… even with the added fees and limited palette of colors to paint with, it beats the costs and limitations of retail bonds.

Now, someday I’d like to bring out a bond fund/strategy, but I want to get this portfolio established first.  Now, I could try to crowdsource the opinions of others, and ask where others think they get a good deal in retail bonds by turning this into a blog post (leaving your name out of course).  Would you like me to do that?


So with that, I ask my readers, what would you do?  Are there better alternatives for retail investors in bonds?  Let us all know in the comments.

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4 Responses to On Bonds in Retail Accounts

  1. RichL says:

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    Individual Bonds are a fool’s game for retail, given the opacity of the markets. I’d suggest adding bank CD’s and the competitive online savings accounts as a taxable fixed income component of a portfolio.

    Until 2 years ago I’ve had money in the Vanguard money market funds, but at present the wholesale money market yields less than the most competitive retail deposit products.

    The best offers are now at Alliant Credit Union, Capital One (Costco), and American Express Bank. They are paying 1.15- 1.4%, which is rather better than the 15 bps of the typical money fund.

    The pricing, from the standpoint of the banks, isn’t irrational. Typical retail deposits are quite sticky, and though they are available on demand, if the banks pay full rates the actual term of the deposits can stretch out for years.

    A similar logic applies to CDs. The FDIC/NCUA insurance minimizes the credit risk, and by using EDIE- the tool for maximizing deposit insurance, and CDARS, which allows the use of multiple banks for a deposit, one can invest serious money.

  2. The people I’m working with nowadays never used 3d party money managers for anything, except for FI. We are all make-your-own sausage type of people. We don’t believe in sending out assets to subadvisors and just adding fees on top of fees, but this is one space where it makes sense. The pricing that big guys get alone makes up for the fees, the markups you get by the time it hits a customer are ridiculous. In the last BD I worked at, by the time the bond hit an account, the broker had taken a bite, our “bond desk” had taken a bite, and the guys our “bond desk” bought from in the street (usually a real bond desk) had taken a bite. It made my blood boil with anger and is one of the many reasons I no longer work there.

    As far as sub advisors go, I know people that used and loved Cincinnati Asset Management as subadvisors in the past and loved them.

    I do agree that it’s one of the bigger challenges. Our clients are mostly foreign, so the distinction between interest and dividend is the difference between gvmt withholding or a full coupon. We lack the size to really do business outside of a handful of issues, so I’ve been dealing with it by using closed-end funds. We have a number of funds we like and we rotate them constantly depending on where we find relative value and if possible swapping divs for cap gains. We’ve found that the extra return more than makes up for the commissions.

    We are at IB, like you, and so what I do is I create a combo security for the desired trade and enter the limit as a total debit or credit. So, for example, if I were to switch from BTZ to PSW (basically identical portfolios) and they were trading at 12.00 and 8.80 respectively, and 9.00 was the break-even for PSW, I would create a combo that sells 3 BTZ and buys 4 PSW and set it to execute only if I could get a 0.76 per-combo–you need to give it a little wiggle room or else you’ll never get an execution–and then in a few days, if the pricing switches, reverse the trade. In actual practice I have a large number of funds and slightly more complicated rules, but we’ve found this sort of strategy adds considerable value to client accounts for a very small cost. Closed ends trading is thin, so there’s a limit to these opportunities, but I’m currently doing it successfully in muni, BABs and corps and sometimes there’s opportunities in mtges too. I also tried programming it in through the API to basically do what I guess you’d call stat arb, but getting a borrow is not trivial and so it’s generally a pointless strategy. There’s no actual money in it at the volumes that one can realistically do.

    Anyway, back to the topic at hand, what I would really be willing to pay for is an SMA-like strategy, that wasn’t an SMA. In my mind, the 3d party would buy in size to get discounts and then allocate the trades to his advisor clients. So, let’s say I have 3 clients worth 10MM each who want 2MM invested in bonds each. I call this guy, we set something up where he knows what kind of money I’m looking to invest and whenever there’s a change to the portfolio, I get a call and buy from or sell to him. He can act as principal to get paid a reasonable fee for picking the individual holdings and taking the small inventory risk and my clients get his expertise and access to superior pricing. Obviously there’s room for abuse so you’d have to really trust this person, but that comes with the territory.

  3. piefarmer says:

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    Although I agree with David to avoid individual bond purchases in retail and even small institutional accounts, we utilizes both Fidelity and Schwab when it was necessary. For example, 100% pre-refunded muni bonds, with US Treasuries in escrow were quite cheap in 2008. We found lots of available issues via Schwab, but nothing via Fidelity. Fidelity’s lack of offerings was evident in other sectors of the bond markets, but we didn’t invest there.
    If a retail client insists on individual issues, I suggest Schwab over Fido.

  4. [...] Merkel at the Aleph Blog discusses the options available to individual investors interested in [...]


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.

Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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