In Your Best Interest. W. H. (Hank) Cunningham
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calculators, portfolio-building strategies, and, of course, offerings of all the various products.
There are also an increasing number of institutional bond salespeople who, late in their careers, become retail advisors. They can be of immense assistance to the individual investor given their knowledge of the entire fixed-income spectrum, as well as their ability to take advantage of how the bond market functions. If you are talking to a branch manager of an FI, ask if there is an IA there who specializes in fixed-income products or has a strong knowledge of and a client base in these products. Typically, IAs with only a passing knowledge of bonds are timid and unsure in approaching the trading desk personnel, who, to such IAs, appear to be a bunch of fast-talking, untrustworthy types. Unsure of themselves and of how to interact with the market, they may shy away. However, skillful handling of the information, services, and expert personnel of the typical well-staffed fixed-income department by a person steeped in the knowledge of how this market functions can produce measurable rewards for fortunate clients. Knowledgeable IAs will have access to bargain lists, and will know of important economic releases and the upcoming borrowing calendar. These IAs are well placed to add income and yield to your portfolios. The experienced advisor also gains the respect of the traders, lets them know what his or her specific areas of interest are, and thus gets calls when specific offerings appear.
Following are some representative questions and comments that IAs will use with their bond-trading department.
Q: My client can buy those bonds cheaper somewhere else.
A: This is a loaded one; most of these apparent discrepancies can be explained because this is not an apples-to-apples comparison. In other words, the client (or IA) may be comparing the identical security, but one yield may be quoted in annual terms and the other one in semi-annual terms. At 5 percent this difference is 6.25 basis points even though the price is the same (see the chapter on basic math). As well, the comparison may be hours or days old, and bond prices do change minute by minute. The securities being compared may not be exactly alike; there may be slight differences in maturity, credit, or features that may affect the relative yield between different fixed-income products. Another explanation could be that another investment dealer is offering a special sale. Worse yet, advisors may be trying to get a lower transfer price (the price at which the trading department transfers bonds to IAs). This is the IAs’ cost and they add a markup to earn a commission. If they do obtain a lower price from the trader, that improvement is not necessarily passed on to clients. Needless to say, traders become wise to ploys such as these and handle the offending parties appropriately.
The relevance of this is that it is an over-the-counter market and there are inefficiencies. Clients may receive, or say that they receive, better prices from another FI. It may be because one IA is charging more commission than the other or that one firm’s bond desk is running a special on a certain bond. It does underscore the point that the more experienced your IA is, the better the treatment you will receive.
Q: Why can I not buy this bond at the same price as quoted in the weekend newspaper?
A: This is a very common question. The newspaper quotations are snapshots of market prices at a particular instant, typically 4:00 p.m. the previous business day. They are quotations representing only the market for transactions larger than $1 million and before any brokerage or commissions are added. The large lists of bond quotations in, for example, the weekend Toronto Star or the Globe and Mail are matrix-priced, meaning that each bond is not priced individually but in relationship to the benchmark issues. In such cases, there is no allowance for any idiosyncrasies or features of a bond that could affect its price. What happens is that a keen client, eager to learn the ways of the bond market and therefore studiously following everything, discovers a few really high-yielding bonds in the weekend paper and phones an IA on Monday morning to scoop up these bargains before those slow-moving bond traders catch on. The advisor, of course, smelling a sale, rushes to the bond desk asking for offerings without a shred of thought. In almost every case, these bonds have certain features — usually call features — that mean that the issuer may redeem those bonds before maturity and the advertised yield in the newspaper may not be realized. (The papers may not have the inclination or the space to show the yield to call.) In addition, the issue may also be small, or a private placement, in the hands of foreigners, or the whole issue could have been stripped with no public float at all. There is a public site (www.canadianfixedincome.ca) where you can obtain live wholesale markets. These are also not prices at which individuals will be able to transact, but they do offer valuable market information.
Q: My client just inherited $350,000. What do I do?
A: A good retail fixed-income desk will ask the IA more questions as to quality and maturity preferences and then construct a customized portfolio. If an IA just recommends a bond fund, then this IA is not doing his or her job.
How to Get Along With a Bond Desk
I have seen all aspects of human behaviour in managing retail fixed-income trading desks. I have built and managed three retail-oriented fixed-income trading desks since 1988. The first was for Dean Witter Canada, which was eventually sold to Midland Walwyn, which got taken over by Merrill Lynch, whose retail arm was sold off to CIBC Wood Gundy, where many of the Dean Witter IAs had come from when Wood Gundy got out of retail. What a business! The second one was built for First Marathon Securities, which needed a retail-oriented bond-trading desk to service the fixed-income needs of its rapidly growing Correspondent Network, which today clears and trades for a very large number of financial organizations: some small investment dealers, some large ones, some investment counselling firms, and some investment subsidiaries of very large FIs. First Marathon was purchased by the National Bank in 1999 and merged with Lévesque, Beaubien. NBCN became the abbreviation for the National Bank Correspondent Network. And finally, the third was another retail-focused fixed-income trading desk, this time for Blackmont Capital Inc., an independent investment dealer focused on the individual investor. MacQuarie,a prominent Australian bank, bought Blackmont from CI Financial and renamed it MacQuarie Private Wealth. To all of MacQuarie’s IAs, my former department offers a complete array of fixed-income securities via an online, real-time order entry system. It also offers customized portfolio design, market commentary, and research. As well, it offers fixed-income securities to some of the more than two hundred IIROC members that do not have their own inventories.
Each of these trading desks has had the same philosophy — to be in charge of its own destiny and to be driven and compensated primarily by the growth in the retail fixed-income business. In this way, IAs know that their bond-trading desk is served by helping their business to grow.
On the one hand, I have observed thoughtless, short-term-oriented IAs adversely affecting clients’ returns while alienating the trading desk at the same time. On the other, I have had the pleasure of working with enlightened, informed, intelligent, long-term-oriented IAs who reap huge benefits for their clients by adroit use of the market and the desk. No more than 10 percent of any sales force falls into this latter category — hence my focus on selecting the right advisor.
I have seen and heard it all: IAs looking for an ask when they really wanted a bid; strange trades initiated at month end with the sole motive of generating commission; outright lies (e.g., saying XYZ broker is offering something cheaper), pleading for a lower price only to keep the difference and not pass the savings on to the client; apples and oranges comparisons, days or hours apart; confusing annual and semi-annual yield, yelling and screaming when the price cannot be matched or has changed. To a person, these IAs say they cannot trust the desk and are getting ripped off, when really it is they who are hurting themselves and their clients through this time-wasting, counterproductive behaviour.
Trading desks make or take a thousand calls a day and execute more than a thousand trades per day. They know what they are doing, what the prices are right now. Some IAs attempt to outsmart them; what they should be doing is being straight with them, and they will receive the same treatment in return. IAs should also be spending more time with their clients. I am always amazed when an acquaintance tells me that not only does he not understand what his money is invested in, but that he does not see his advisor routinely, perhaps once a year at best! At stake here is the return to the client, as consistently bad behaviour makes us leery of certain IAs, and therefore their clients will suffer.