Bond markets are massive, as they pretty much dwarf equities in their sheer size. By how much? Well, by a-booooooooooo-ut this much. But let’s not get hung up on numbers, let’s see how you, the private investor, are not getting a fair deal from your bank when it comes to bonds.
Equities/stocks/shares or whatever you want to call them are traded on a stock exchange, which is actually a brilliant invention and a fair one to the investor. At all times, the people who want to sell their shares can get the highest possible price (known as the bid) and the people who want to buy the shares get the lowest possible price (known as the ask or offer). These prices are there for all to see, out in the public. Lovely, right?
With bonds, it’s another story. The bond market is OTC, no not OTT!!! It’s “OhTeeSee” as in Over The Counter, which implies that somehow it can be seen, but it’s not. Actually, it’s more under the counter, because you as a private investor have very few ways of finding the best possible price. Think of it like this: since bonds are not traded in a single place, you have to be able to shop around, the price may be and is different depending on who you buy or sell it to.
It works like this: Let’s say you want to buy some corporate bonds for a company called Brenda’s Bouncy Castles Inc. Brenda makes the best and bounciest bouncy castles in the land, and their balance sheet is plenty buoyant. For our example, let’s say, there are three bond traders called Huey, Dewey, and Louie, and they all work for different bond desks. Huey is the trader who works for your bank, which is called the Bank of Bohica. So, a typical bond purchase would look like this: You call up your contact at the bank, let’s call him Donald, and ask him for a price on Brenda’s Bouncy Castle bonds. The only thing Donald can do is call Huey at his bank’s bond desk. And this is where it gets interesting.
Huey doesn’t have any of Brenda’s Bouncy Castle bonds in his book, so he tells Donald to hold the line. Huey then calls Dewey and asks for a price. Dewey quotes him a price of 100. Huey calls back Donald and says the price is 102. Donald tells you the price is 102 plus commission of 0.25%. What do you do? You buy it of course, because that’s the price, and you know no better. The Bank of Bohica did what it does best and bohicad you. You ended up paying 2% over the market price.
So what happened to Louie? Louie would have sold his Brenda’s Bouncy Castle bonds to you for a price of 99. So, in fact, you ended up paying substantially more simply for not knowing all the market participants. This, ladies and gentlemen, is the reality for the private investor of buying and selling bonds. You have no choice but to buy from your own bank’s bond desk and as a result you are getting taken to the cleaners. It simply isn’t fair.
So what can you do about it? This is where we private bankers come in to it (yes, I am about to explain why we are so wonderful). Most private banks do not have their own bond book. What they do have is an extensive list of counterparties who they trade bonds with. This means that they really can shop around for you to find the best price. If you transacted the trade through a private banker, he would have called Huey, Dewey, and Louie, and then he would have called all the Chipmunks as well to find the best possible price for you. You would probably have had to pay a higher commission than your own bank (0.5%), but in total you would have paid far less than with your own bank, who in effect hid their own profit inside the price. What you get is the best price and transparent pricing.
I was going to finish this post with a cheeky little trick we private bankers like to do when buying bonds for our clients. Since this post became such a long one, I’ll save that for next time. Stay tuned.