Choosing Your Bond Dealer

There are literally hundreds of brokerage firms, banks, and municipal bond specialist firms you can choose to do business with. How you decide where to do business is important - much too important to leave to chance or to allow convenience to be the deciding factor. As the Forbes article suggests, don’t buy from your stockbroker just because you have an established relationship with them unless they are prepared to do the best job for you. There are much more important factors to help you decide.

Obviously, we would put the professional business ethics of the company number one, and while fortunately almost all brokerage firms, bankers and bond dealers are of good character, there are certain clues to look for that will help you decide who may be a little more equal than the others.

Here are some things you should look for.

What are the company’s policies if any, and how closely do they adhere to them? We think that one important company policy should be to stress suitability. A good bond dealer should do all it can to select the right type of bond for each investor, based upon their personal circumstances and goals. In the extremely competitive financial industry, too many bonds and bond funds are sold on the basis of profitability rather than on the basis of suitability.

Another important company policy should be to guarantee a fair market bid for all the bonds it sells. Few dealers, brokers and banks give you that assurance under all circumstances. But it is very important, because the commitment to buy back any bond at the market value also ensures care in selling you the right bonds and a properly diversified portfolio in the first place.

And education is a must. The education of all investors should be a matter of company policy.

How long has the company been around? The age of a company indicates competence, consistency, reliability, and ethics.

Of course the dealer’s prices are also very important, and there are several basic facts you should know to determine how to get the most for your money. To begin with, remember that the municipal market is comprised of two closely related markets the primary market is where bonds are purchased directly from the issuer. The secondary market includes all bonds that are remarketed. The secondary market is about 80% of the total marketplace, but from an investors point of view, the most important difference is that the best buys are to be found in the secondary market. The primary market is invariably higher priced, and that’s why sophisticated investors usually buy their bonds in the secondary market.

Bond dealers cannot buy municipal bonds from a distributor, manufacturer, or at a central auction like a stock exchange. It is not that easy! A company’s bond traders must bid competitively for bonds in the open market, and that is why prices can vary substantially from one firm to another.The price difference between firms is directly dependent upon a combination of the expertise of their traders and the firm’s transactional costs. So what you should want to know is the experience level of the firm’s traders plus the reasons their costs may be lower. Transactional cost differences are essentially determined by two factors: (1) Does the firm process and clear all transactions internally, and (2) Is their trading department set up as a separate profit center? Broker Dealers that use outside clearing firms pay more for that convenience, and that cost is passed along to you in the form of higher prices (lower yields). It will cost you even more to deal with a firm that considers its trading department a profit center.That is because a trading department becomes a profit center by keeping a percentage of the profit for themselves before they show the bonds to their sales force at a marked up price.

That is how all the large stock brokerages do it. To double check, ask your broker if their salespeople see every purchase ticket at the price the traders paid for their bonds, or does their municipal bond inventory show a set price with a sales credit. If the answer is the latter, it means they are seeing a marked up price, and you are almost certainly paying too much. To learn more about bond pricing, ask for our special report, “The Reasons Stoever Glass Is Known For Better Municipal Bond Prices.”

Consider the net capital ratios of a company too. These liabilities to assets ratios usually give a more accurate indication of the firm’s financial condition than do the total assets of the company. And the ratios certainly provide more insight into how soundly the company is run. As registered broker/dealers, aggregate liabilities may not exceed net capital by more than 15 to 1. That’s the law. In actual practice, anything less than 3 to 1 would indicate a very tight ship.

Next look at the degree of variety in the firm’s inventory. Is the inventory wide and diversified or are most of the listings high yielding bonds and/or bond funds? If they contain a high percentage of bond funds or high yielding bonds, that should give you some indication of the dealer’s priorities. Because these tax-exempt products are the easiest to sell to unsophisticated investors and the most profitable for the dealer, but they are usually not the best for you. The dealer you want is the one whose inventory contains a variety of bonds that are suitable for a wide range of investors - high yields, bond funds, discount bonds, premium bonds, high quality bonds, long-term bonds, short-term bonds and everything in between.

Next, strongly consider the quality of the advice they give you. This is an area where you will find another big difference between stockbrokers and municipal bond specialists. As the Forbes article suggests, your stockbroker is usually the wrong place for a sophisticated bond buyer. As the world of finance becomes more complex, the more important specialization becomes. While it is true that most large brokerage firms have municipal bond experts, you’ll never talk to them, because they market bonds through their brokers who usually know very little about municipals. That’s why they are encouraged to sell bond funds to the individual investor. You don’t have to know much to sell bond funds, especially if you sell only the funds of the house; they’re more profitable for the broker than the bonds themselves. But they are not the best investments for most people who end up with them. (See our special report, "How to Tell If Bond Funds Are Right For You Or Not.") In all fairness to stockbrokers, we cannot understand how they can be expected to know a great deal about the number of different stocks and other investments they are asked to be experts in. And to their credit many of them do respond to our ads and those of other bond specialists, requesting our information in an attempt to learn more about municipal bonds.

But that’s not the second hand advice you should want. A firm’s advice in a specialized product is indeed very valuable to you. To an investor, more knowledge means more money because that is the key to successful investing. Knowledge helps you avoid costly mistakes and helps you exploit some of the inefficiencies in the market so that you can profit more from municipals. (See our special report "An Inside Look At The Rating Game" for example.)

So the company that provides you with free education is making you more self-reliant - better able to avoid mistakes and better able to make more profitable investment decisions. Isn’t that the firm that deserves your business? Shouldn’t it be the one that provides you with a total package that includes free education, sound advice, better prices and insured safekeeping-free of charge?

Research is an important adjunct to the quality of a firm’s advice. A really good bond dealer should have the ability to pluck the under- valued bonds from the marketplace and pass those values along to you. But the other side of the coin is just as important. They must also avoid or bid down overvalued bonds. And those skills require years of experience and specialization.

Service is another area that should help you decide which firm is good for you. Of course free educational material is one very important type of service you should always look for.

 

Forbes                                                                             Capital Markets It’s a simple but important rule: Buy Stocks from a stockbroker, bonds from a Bond house. There’s a good reason. SOMEBODY CARES __________________________________ By Ben Weberman __________________________________ Individual investors represent the largest group of buyers of tax-free bonds, accounting last year for 82% of all new municipal bond sales, including those in unit investment trusts and mutual funds. Yet these buyers, who generate billions of dollars in transactions, often get advice that is frequently, if not usually, incompetent and almost always overpriced. Why? For a very understandable, although unjustified reason: Thousands of investors buy their tax-frees through a stockbroker, and stockbrokers often couldn’t care less. After all, they reason, investors who buy stocks ultimately will sell those shares and be back for more; those who order bonds are far more inclined to hold them. So, most brokers reason, it hardly pays to build a lasting relationship with a bond buyer. Not all stock houses feel this way, but the ones that don’t are the exception, not the rule. So search out a bond dealer, and one who specializes in tax-exempts. Keep in mind that a round lot for tax-exempts is $100,000 face value of bonds selling close to par. On a round lot, most reputable dealers will have a spread between bid and asked of about ½ to 1 point for a longer-term issue. That comes to a difference of $ 5 to $ 10 per $1,000. The spread may be only ¼ point on a one-to-ten-year bond. Despite that relatively small markup, a responsible bond seller will provide advice, and it is usually informed. Enormous sophistication is required nowadays to Ben Weberman is economics editor ofForbesmagazine. understand the tax-exempt market. In the old days it was good enough to know the difference between general obligation (full faith and credit) and revenue bonds (backed by specific revenues). Today there are industrial revenue bonds based on lease revenue, pollution control bonds backed by revenues from industrial companies, and such strange breeds as put bonds, which can be turned in at specified times for redemption. Some bonds are insured, some have the backing a of a bank letter of credit, some are zero coupons, some have variable rates and some have a combination of those features. Also, the municipal bond yield curve has a slope all it’s own that does not bear a constant relationship to the slope for Treasuries or other taxable issues. Dealers have access to typical yields for various qualities of tax-free bonds, as calculated by the analytical firm Delphis Hanover Corp., and a good one can use yield-curve data like these to help you plot investment strategy. Even though I don’t recommend stock salesmen or stock wire houses for the reasons outlined to the beginning of this column, some are exceptions to the rule. Firms such as RBC Dain Rauscher, for example, have departments staffed with specialists in retail tax-exempts. These specialists, like those at bond houses, are well versed in the intricacies of tax-frees and know what is available at the best price. The general rule, though, is that if you buy bonds, buy from someone whose business is bonds.

A more subtle form of service to you is the close working relationship between the firm’s salespeople and traders. It is much better for you if they have the traders in the same room with all of the salespeople where they have easy access to one another. That way the traders who see thousands of different items "up for the bid" each and every day are able to select the bonds from the market- place that best fit your parameters. How different from most brokerage houses and banks where trading departments may be located on another floor, in another building, or even in another city! And where even top salespeople must usually deal with the trading department through liaison personnel rather than directly with the traders themselves! That’s why many bonds originally intended for institutional accounts often end up being sold to people for whom some other type of bond would have been much more suitable, and why most brokerage firms push prepackaged municipals in a bond fund and market them in an easy to sell one-size-fits-all concept. But once again that’s efficient and profitable for them, but usually not best for you.

Finally, a skilled self clearing firm can keep the number of problems to a minimum. Like the traders, the back office personnel should also be readily accessible to the salespeople. That enables a firm to accommodate personalized methods of transacting business, helps prevent problems and solves the problems that do occur much more efficiently.

Carefully evaluate your choice of a dealer on the basis of their sound advice, pricing structure, and service, because that choice will determine your success as an investor.

© Copyright 1988, Stoever Glass & Co., Inc

Although the above information and statistics are not guaranteed, they have been obtained from reliable sources and are believed to be accurate.