Radical Guide to Online Bond Investing: Will Anyone Turn on the Lights in the Bond Market?

By and large, retail bond investors are left in the dark on costs and have a very hard time finding bond products.  Bond investors can be easy prey for price gouging by dealers. 

Look at this example. We checked the Municipal Securities Rulemaking Boards (MSRB) trade reports for a New York Port Authority municipal bond issue (CUSIP #7335817Y2).  On May 16, 2005, a retail customer bought $25,000 of this Port Authority bond at a price of 104.883.  Twenty minutes later, another customer bought $25,000 of the same bond at a price of 105.973 --- costing another $273 for the second customer.

It happens every trading day: price differences for the same bond are reported in the market.  These price differences happen in markets with very little intraday price changes.  Dealer costs explain the differences.

Retail bond markets are difficult ones for investors.  We see three overriding reasons for the difficulties:

  • Dealer costs are hidden.  Dealers will quote you net prices and yields including their undisclosed costs (otherwise called “dealer spreads”).  You will not see dealer costs broken out on your trade confirm.
  • Trading can thin out.  Trading falls off quickly on new bonds issued into the markets.  For smaller-sized bonds, or ones with dubious credits, the number of dealers supporting those bonds can be very small.
  • For any bond type, it is flat-out impossible to say which broker (full-service, discount or online) is the most inexpensive.  Net prices, which include all dealer costs, vary too much for any given bond item.  Another way to say it is that dealer costs vary too much to say which dealer is the lowest-cost provider.

The disadvantages of the retail bond market will not go away.  These are structural and long-standing.

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June 3, 2005 | Permalink


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