The need for bond reform

Over the years, I have written critically on several occasions about the lack of transparency in the bond market. The fact is that individual investors are entirely at the mercy of the brokerage firms when it comes to buying and selling fixed-income securities. Small investors are, in effect, given the option to pay whatever price the brokerage chooses to charge or take a hike. No wonder many people opt for bond mutual funds instead, despite what in some cases are outrageously high MERs.

The bond issue came to my attention again last week. I was editing an article on how to buy bonds. It included a recommendation for a debenture issued by Investors Group that matures in 2011.

Unlike the stock market, there is nowhere an investor can go to obtain a complete list of up-to-the-minute quotes on bond prices. There is a useful website at however it only shows a few benchmark issues. For anything else, a potential investor has to contact a broker.

As I wanted to show the current price of the bond to show in the newsletter, I called my broker at RBC Dominion Securities for a quote. The writer dithe same with his broker at BMO Nesbitt Burns. The result of those conversations may come as a surprise to many people, although they didn’t to us.

RBC Dominion quoted a price of $108.77 for the debenture, which worked out to a yield to maturity of 5.21 per cent. BMO Nesbitt Burns, by contrast, quoted $107.70 for a yield to maturity of 5.39 per cent. Remember, this is exactly the same bond and the quotes were obtained within an hour of each other.

In the bond world, a spread of 18 basis points on yield to maturity is significant. Over a seven-year term, it translates into a difference of $17.18 for every $1,000 invested.

That may seem inconsequential if you are only investing a small amount of money. But if you are buying several thousand dollars worth of an issue, it starts to add up.

Why the discrepancy?
There is no obvious reason why there would be such a large price discrepancy between the two brokerage firms. It may have been that RBC didn’t have any of the Investors Group bonds in inventory and would have been required to buy them elsewhere, which would have entailed an additional commission. Or it may simply be a difference in the pricing structure of the two firms.

The problem for small investors is that they never see what commission they are paying when they buy a bond. Unlike a stock purchase where the commission is shown separately, when you buy or sell a bond it’s built in to the total price, along with accrued interest. So there is no way of knowing what the broker collects or how it compares with the fees charged by others.

The whole process of trading bonds is ripe for a complete overhaul. Two basic reforms would help to level the playing field and make it easier for small investors to build bond portfolios.

1. Show the sales commissions. As with a stock purchase, the confirmation slip you receive from the broker should show the cost of the bond and the commission as separate items.

2. Require the brokerage firms to post bond prices. You can get current stock market quotes on the website of any major brokerage firm. Why should bonds be different?

It doesn’t seem like a lot to ask. Yet securities regulators and industry associations have shown no sign that they even recognize there’s a problem here! It’s about time that the bond market broadened its base. Right now, it’s virtually the private preserve of the big institutions. Give the small investor a chance too.