Bond Price Reporting is Improving, But Many Stockbrokers Still Hide Costs.

Christopher Cannon of FirsTrust in Daytona Beach contributes to Financial Advisor Magazine as an expert in the bond markets

Flying Blind In The Bond Market - By Raymond Fazzi

Bond price reporting is improving, but many brokers still hide costs.

Lets face it: when it comes to the buying and selling of individual bonds, even the best financial advisors can walk away feeling like chumps.

Compared to the stock market, the bond market can feel like the Wild Wild West-a landscape fraught with hidden markups and secretive deals, and a pricing dynamic that basically thrives on taking advantage of the little guy. Like buying a used car.

Its a completely different culture," says Sherman Doll, a CPA/PFS and partner at Capital PerformanceAdvisors in Walnut Creek, Calif. Unlike stocks, you really dont know what youre paying. Youre committed to give your best efforts to execute these trades for clients, and its really tough."

Like many advisors, Doll makes use of bond funds and, when the need for individual bonds arises, does his shopping through a third-party trader, BAM Advisor Services in St. Louis. Before we used them, we didnt have a good solution," he says.

Theres no doubt that the bond market is opaque when it comes to pricing disclosures, but some changes are in the works that may provide a degree of clarity.

Regulators, who have been pressing for bond pricing transparency for the past ten years, say new trade reporting requirements that are gradually being implemented and will be in full effect this year will provide investors with more timely trading information. The data, however, will fall short of being real-time reporting: Instead, it will provide investors with bond trades within 15 minutes of their execution.

Its not a ticker tape, but its pretty close," says Christopher Taylor, executive director of the Municipal Securities Rulemaking Board (MSRB) in Alexandria, Va.

Whether or not the increased reporting will dramatically help investors remains to be seen. Some observers note that, even after the reporting requirements are fully effective, the bond market will still not provide the type of clarity investors are used to in the equity market.

Most notably, regulators have yet to put forth any proposals that force bond dealers to disclose their markups. The commissions still will be hidden within the prices of the bonds.

The lack of a central repository for all bond transactions, with real-time reporting, also is viewed by some as a hindrance to investors. Some experienced bond traders say that even with a 15-minute delay, it will only be seasoned professionals who will be able to make use of the data streams.

What is essentially needed, some say, is a bond market version of the New York Stock Exchange.

Whats needed is a more transparent, centralized viewing methodology that is more egalitarian," says Christopher Cannon, partner and chief investment officer with FirsTrust LLC private wealth management in Daytona Beach, Fla. You need some type of central viewing place that anybody can go to-not just people who subscribe to Bloomberg."

Yet there seems to be general agreement that the situation is improving, rather than deteriorating. The NASD has been leading the transition to a more timely trade-reporting infrastructure with its gradual phase-in of the Trade Reporting and Compliance Engine (TRACE). The trade reporting engine launched its third and final phase in October, according to the NASD, and is currently reporting pricing and transactions, within 30 minutes of their execution, on about 17,000 investment-grade and high-yield corporate bonds. (TRACE is achieving 15-minute reporting on 80% of trades, according to NASD spokesman Herb Perone).

By February 1, TRACE will publicly report on all 23,000 corporate bonds in the market, with reports on 99% of them coming within the 30-minute window. The reporting delay will be whittled down to 15 minutes on July 1, according to the NASD. The changes are certainly a step in the right direction," says Jim Schaberg, managing director at Incapital, a Chicago-based bond firm.

Bringing timely pricing data to the corporate bond market is considered a key step by NASD officials. They note that with about $4.3 trillion in outstanding debt, the corporate market is larger than the Treasury and municipal markets, which stand at $3.8 trillion and $2 trillion, respectively. Another factor: The corporate bond market is two-tiered, with institutional players and their high-volume trades on one level, and individual investors and their low-quantity trades on another. About 65% of corporate bond transactions, in fact, are in quantities of $100,000 or less, according to the NASD.

What the Treasury market has had in terms of tighter bid-ask spreads, the corporate bond market will have," Schaberg predicts. Advisors and investors need to realize the playing field is changing."

Because dealers typically charge higher commissions on low-volume trades, individual investors are getting hit with higher fees in a market where many small investors seem oblivious to fees. A recent NASD survey, for example, showed that 34% of individual investors think there is no fee for buying or selling a bond, or did not know whether they were paying a fee for bond transactions. The goal is to make the market transparent," says Perone.

Similar changes are taking place in the municipal bond market, where the MSRB has been producing data that reports on municipal bond trading on a next-day basis. On January 31, dealers will be required to report their trades within 15 minutes of their execution, Taylor says.

The MSRB charges an annual fee of $5,000 for access to the raw data, but he noted it is widely available through wire services such as Dow Jones and Bloomberg, and free from the Bond Market Association at www.investinginbonds.com.

In the overall sense, it is very good for anybody either buying or selling municipal bonds," Taylor says. It gives a much better sense of where price levels are."

The municipal bond market, on average, produces about 30,000 trades a day in about 11,000 issues, he says, adding that there are about 1.5 million issues in total. The push for bond pricing transparency is also leading to some changes in the private sector. Fidelity, for example, announced in September the introduction of a new pricing and disclosure setup for its inventory of 5,000 investment-grade bonds.

Under the new program, the price of the bond and the bond markup are listed separately, instead of bundled. Fidelity also announced that markups will be charged at a flat rate, depending on the type of bond purchased.

The new pricing charges investors $1 per bond for U.S. treasuries, $2 for government agency bonds, Treasury strips and certificates of deposit, $3 for municipals, $4 for corporates and $5 for mortgage-backed securities. The fees are reduced 50% for online purchases, according to Fidelity.

Fidelity will also provide access to the TRACE and MSRB databases, as well as data from Interactive Data Corp., which produces bond price estimates.

Buying bonds in todays market is a lot like buying a used car," says Sanjiv Mirchandani, executive vice president of product management with Fidelitys retail brokerage. This is designed to make it more like buying equities."

Some say that such clarity and ease will still be missing from the bond market, even with the addition of improved trade reporting data.

Advisors note, for example, that bond dealers are still not compelled by any regulations to disclose their markups, or to treat institutional and small investors equally when calculating markups.

Better reporting data, they add, does not address the fact that many investors are being charged high markups without even being aware that the markups are embedded in the bond price.

Ive been in this business 22 years, and I wish I had a dime every time a potential client came in and said, 'I never paid anything for this bond," says Thomas Meyer, CEO and president of Meyer Capital Group in Marlton, N.J. Bonds are quirky enough instruments for investors to have to know how a broker gets paid."

Meyer feels that the disclosure on bond pricing should be as clear-cut as it is with the disclosures required on load mutual funds.

I dont care if the markups are 10%. All I ask is that they make it transparent," he says.

An NASD panel issued a report on the corporate debt market in September that recommended the enactment of disclosure requirements on bond trades, but the NASD has not yet followed up with any proposals.

Perone says rule-change proposals are in the works, but could not say when they may be presented.

Among the panels recommendations were that more information, including a disclosure of price and how brokers are being compensated, needs to be disclosed to investors before and at the point of purchase. The panel specifically recommended that each bond trade confirmation include a separate line listing brokerage charges, and that the NASD provide industry benchmarks for individual investors to use to compare the price, yield and return they receive from their bonds.

For principal transactions, there is no indication on a confirmation statement that the dealer or sales person has received any compensation for conducting the trade," the panel wrote.

Advisors say markups on corporate issues usually run anywhere from 1% to 5%, but some said theyve encountered higher. In any case, they say the markup usually isnt evident until after the fact, rather than at the point of sale.

Bert Whitehead, president of Cambridge Connection Inc. in Franklin, Mich., recalls the time a client had to do a quick turnaround on a bond. They bought a bond, sold it the next day, and lost about 5%-which was basically the spread," he says.

John Rice, investment officer at Keats, Connelly and Associates Inc. in Phoenix, has gone through about five different bond dealers in the past two years. Although some dealers disclose their fees, its just as often that they will keep them hidden, he says.

Ive gotten different responses when Ive come out and asked, 'How much are you making on this trade?" he says. Its a bit of an uncomfortable discussion, but one I feel necessary to have."

Comparison shopping, by comparing quotes from one dealer to another, is of little value because its impossible to tell if the price differences are the result of market movements or markups.

It is a little like flying blind," he says.

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