Tuesday, December 15, 2009

Online Junk

Since I’ve written quite a bit about fixed income, I’ve gotten some inquiries (well, ONE) about how one goes about trading bonds as an individual investor.
I’ve looked around a bit for some family members and myself and I’d like to share some of those findings.

There are of course, the full service brokers: Merrill, Goldman, Morgan(s), European banks, Asian Banks/Brokers…etc. etc. If you have an account at one of these, you can usually call up your rep and get him/her to get you some bonds. They will mostly likely balk at your request for junk, trying to guide you towards some other lower-yielding safer fixed income alternative. Preferably one that makes more money for them. In the end, if you’re lucky, they will comply to your wishes, after telling you more than once that “the bank doesn’t recommend this” to cover their Armani-draped butts.

When you get your fill, you’ll pay a nice commission, but you may never know exactly what the bond actually cost, since the price was most likely marked up along the way, either by your broker or the dealer(s) through which the bond was bought.

I know this sounds like a rip-off, but dealers make their living working these sometimes illiquid markets and its only fair that they get some compensation for that and the risk of carrying inventory in some of these exotic assets.

Remember, however, that everything is negotiable and since there may not be a “market” per se, it makes no sense to place “market” orders. You can always haggle a bit or limit your bid. And you can always say no. Never forget to use this power.

That certainly sounds like a lot of work and hassle. But if the idea is to hold these positions for relatively long periods of time (years), it doesn’t turn into a job.
The back and forth can be a bit annoying and unless you have a Bloomberg or other access, your rep/broker will usually have a better beat on market conditions than you.

If you are like me, you tolerate this process, but you hate it and avoid it if possible. Which is why I buy my cars used at Carmax where the prices are fixed and I’m not locked into a battle of wits with a salesman, with his children’s new shoes at stake.

And it’s why I’ve been trading stocks online since the early ‘90s (CompuServe, remember that?). There is nothing I like better than a simple click, instead of having to chat for half an hour with some person over the phone, before you can get them to put in an order to buy 100 shares of IBM for the account (or something equally insipid).

Unfortunately, buying bonds online is not as easy as buying shares. But it can be done. If you have experience buying stocks online, you should be able to make the adjustments. If you have never transacted through an online broker, bonds are not the place to start.

For beginners, most of the online discount brokers get their offerings through a platform called “Bonddesk” (http://www.bonddeskgroup.com), which specializes in odd-lots (less than 1 million) offerings. They may include (or not) other sources. But if you look for a specific bond on several discount broker sites, you will likely find the same offers (amounts) and bids. Prices MAY vary as several of these online brokers add a markup (usually 0.5%) to the price they get through BondDesk.

What you will find are munis, corporates and government bonds. My particular interest is corporates, so I can’t tell you how the munis or government bond trading works (I’ll assume it’s similar).

The offerings are mainly US corporate bonds, although you may find some sovereign and foreign issuer bonds (yes, even Venezuelan Globals) sprinkled in. All in US dollars. You won’t find a Naftogaz or Hong Kong real estate companies’ bonds here (darn!). No Dubai. No Turmekistan.

Online brokers have search tools, with which you can narrow down the offerings. This is particularly useful, since you may be looking for a particular issuer (which has many bonds), maturity, yield etc. This is important, because it is not like stocks, there is not an offer on every single bond. Some things may not be available today (but maybe tomorrow).

There isn’t much room for haggling online, the price on the board is usually it, but some brokers will allow you to solicit an “ask” quote, which on occasion can be better than the executable price on the board. (Here’s a good description of the process. LINK).
If it is a bit complicated, you can call customer service and they will work you through the process of buying and selling.

Now here’s a rundown of the online brokers I’ve used or researched. Not supposed to be comprehensive or a plug for any one in particular and reader feedback is encouraged.

E*Trade Securities. I have been a client for years, so I’m biased, but this online broker has really gone after the retail bond investor and actually advertises the fact prominently on their site. No markups (from the BondDesk offerings) and commissions of $1/bond, with a $10 min and a $250 maximum. There are other brokers offering lower commissions, but not really low enough for me to switch.
The search tool is good and you can even access a particular bond's trading history with a link to the TRACE system.
Investment Grade, High Yield and even defaulted bonds are available for purchase.

Fidelity. From what I’ve seen on the “outside”, the workings of the fidelity online bond site is similar to E*Trades. The price is also $1/bond with a $250 max. Their fee schedule, however, states that below-investment grade bond trades must be placed through a representative, which defeats in part the whole online deal. Their search tool excludes D-rated bonds (defaulted), so these may not be available to trade. (Would you want to? Why not?). LINK

Schwab and TD Ameritrade limit online trading to investment grade bonds (BBB or better). Schwab marks up prices over the BondDesk ask price but has a similar commission schedule to E*Trade. ($1/bond, $10 min, $250 max). TD Ameritrade is just the markup apparently (I called them), but I was told elsewhere that there was a $3/bond commission also. FirstTrade also works on a markup basis.

OptionsXPress isn’t very expressive in the bond market. They offer the fixed income alternative, but at $5/bond with a $14.95 min, and a markup on the price, its obvious from their name what business they are really after. TradeKing is similar.

Interactive Brokers. This is one of best options in terms of commissions. The inventory appears to be BondDesk’s, but the commission is lower: $1/bond on the first 10 and $0.25/bond thereafter, with a $5 min. ($n250,000 is only $70 vs. $250 for E*Trade).

The “problem” with Interactive Brokers is that the interface is a complex trading station and it takes getting used to. Some bonds, which show up on the other brokers search tools may not show up here (I have not been able to find convertibles). And they expect you to trade; so if you don’t you’ll get a monthly charge assessed (not much, $10 IIRC).
For my Venezuelan friends, this is an option, since E*Trade no longer opens accounts for Venezuelan nationals. (They say they can’t verify identities…go figure).

Zion’s Direct is another alternative. They claim not to charge markups and there is a flat $10.95 per trade also using the BondDesk inventory. They call the service “Bonds for Less” and they seem to be interested in developing the niche. Only US Residents, however. LINK

A number of online discount houses don’t even bother with bonds: Zecco, First Trade, Sogotrade and others are not interested. They are after the stock day traders.

In conclusion, the retail investor CAN find a way to trade some corporate bonds online. It’s not easy, but it can be done.

The retail fixed income online trading landscape seems to be evolving and we should see changes as investor interest picks up. We could compare it perhaps to online stock trading circa 1992. Ah…who can forget those modem connection tones!
If so, we can expect it to evolve and the market for bonds and credits in general could become more transparent, liquid and accessible (although it may not be in Wall Street’s best interest).

One reader pointed out to me in my blog about my wife’s junk bond portfolio: Why bother? Just buy a bond fund and be over with it. Let someone else bother with defaults, tenders, calls, bid/ask spreads, credit ratings and the like. I promise I will get to that post. This one is already too long.


  1. Thank you Alex, nice post about bonds.
    The Barron's online brokers annual review also have some information about it.

    One question about that IB charge for not to trade... is it just for bonds? or stocks, funds, etc are also included?

    Thanks, NH

  2. Thanks, NH.
    IB charges you if you don't have activity in the account. If you trade something (stocks, futures, forex, etc), they're pretty much fine with that.
    But bonds tend to just 'sit" in accounts. Not something you trade much, so that's why I brought it up.