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Individual Bonds-Ugh!

By Louis P. Stanasolovich, CFP®, CCO, CEO and President of Legend Financial Advisors, Inc.®and EmergingWealth Investment Management, Inc.®

 

For most individual investors, individual bonds do not make a whole lot of sense to own for many reasons.  While clients may transfer in individual bond positions, generally individual positions are never recommended due to the following points.  It is best to attempt to sell them periodically or let them mature if they mature in a few years.

First, individual bonds are difficult to obtain good pricing on both the bid and the asked sides of the trade.  Individuals are charged as much as 5.0% commission on both sides of the trade.  However, this is buried into the bid and asked prices of the trade.  PIMCO suggests that any trade needs to be at least $1,000,000.00 to obtain good pricing (They first made this statement about ten years ago.).  Therefore, for most investors and advisors due to size constraints it is difficult to obtain any type of bond at reasonable costs other than Treasury securities.

Second, it is especially difficult to obtain reasonably priced bids on bonds other than Treasuries when you go to sell them.  Usually, in the menagerie of municipal bond market types, the bid price is often 15.0% or more below the stated price that is listed at the custodian, if there is a price listed at all.  Given the small sizes of most bonds being issued and the complexities of each issue, this often results in liquidity problems.  The same reality applies to corporate bonds.  Also, it may take several days, weeks, or even months to find buyers, especially those willing to purchase less than $1,000,000.00 amounts.

Third, buying individual bond issues realistically does not allow individual investors and/or advisory firms to purchase fixed income investments such as high yield/junk bonds, both variable rate and fixed rate agency and non-agency mortgages, bank loans, foreign developed market bonds in their home currency or have the ability to hedge them into the U.S. Dollar, emerging market bonds in either U.S. Dollar-based currency and/or local market currencies.  Most investors and/or advisors simply don’t have the expertise or dozens of bond research staff members, nor the traders that major bond management firms like PIMCO, Blackrock, Loomis Sayles, Vanguard, Fidelity, T. Rowe Price, DoubleLine, Metropolitan West, Eaton Vance, Franklin Templeton, Guggenheim, Invesco and J.P. Morgan to name a few, have. 

Fourth, if an investor or advisor really wanted to trade individual bonds, they would need to employ their own bond trader, since this is such a specialty (Good bond traders typically have access to dozens of potential bond buyers in order to trade individual bonds on a regular basis.  Oftentimes, bond traders specialize in certain types of bonds as well.).  Moreover, most firms just like the big boys probably need two or three bond traders to ensure continuity in a firm’s bond trading staffing.  In order to justify this cost, almost any firm would probably need to trade at least a few hundred million dollars in bonds annually, but probably more like billions.  Just another point, very few small mutual fund groups have an outstanding bond fund offerings these days.  Bond investing has become a large scale investing strategy due to the complexity, quantity, variety of bond issues and, in some cases, the currency in which they are issued. 

Fifth, open-end mutual funds (notice I did not say Exchange-Traded Funds and/or Notes—we’ll talk about them below) offer the ability to access all of these fixed income type investments for as little as $1,000.00.  In addition, when selling, the investor/advisor can sell their bond fund in a matter of hours.  In other words, they can “put” the fixed income investments back to the mutual fund and make the liquidity problem the mutual fund’s.  Therefore, it’s no longer the investor’s/advisor’s problem anymore.  The mutual fund's role is to provide liquidity to the underlying investor.  Given, the underlying investor's ability to relieve themselves of liquidity issues, it is well worth the small fee that the open-end mutual fund fees (assuming the investor or advisor is buying institutional share classes). 

Sixth, the reason Exchange-Traded Funds and/or Notes leave a lot to be desired is because many of the liquidity issues of the underlying holdings are still the owner’s because these vehicles’ liquidity is based on the underlying securities.  Furthermore, ETF portfolios are, for the most part, stagnant.  In other words, there isn’t a lot of turnover, shortening or lengthening of duration, buying higher quality or lower quality issues, etc.  Therefore, the underlying investor or advisor would have to trade ETF securities in order to protect themselves or take advantage of investment opportunities—something that open-end mutual fund managers do for them.  ETN portfolios are composed of a single note. 

COPYRIGHT 2017 LEGEND FINANCIAL ADVISORS, INC.®

REPRINTED WITH PERMISSION OF LEGEND FINANCIAL ADVISORS, INC.®




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