Bond trading and investing work a lot better when brokers and portfolio managers don’t take your dinner off the table. Instead of paying for the privilege of being retail customers, savvy investors and advisors can buy Government of Canada bonds and treasury bills and U.S. government debt direct from issuers with no spreads between the wholesale price dealers pay and what they sell debt for at retail.

The Bank of Canada will do direct sales at the price major dealers get at weekly auctions. The U.S. Treasury has a Web-based system called Treasury Direct that lets anyone bid with the biggest dealers on Wall Street and get the yields they get. In a field of investing in which portfolio managers and investors sweat to get an extra 25 basis points of yield, trading with issuers is an important way to improve performance. It can be done every week at the issuers’ auctions.

“People spend more time researching the purchase of a toaster oven than they do their financial future,” says Tom Czitron, who runs $2 billion in bonds and income trusts for Sceptre Investment Counsel Ltd. in Toronto. “If you just want to buy a 10-year Canada
bond, the best deal is the one with the lowest fees or even no fees.”

Buying bonds through the Bank of Canada’s retail process or from U.S. Treasury Direct (www.treasurydirect.gov) saves the wholesale retail spreads of 20- to 50-bps yield charged by securities dealers and the average 1.8% MER of Canadian bond mutual funds and the 2.2% MER charged by foreign bond funds. The total charges are higher, because fund trading also generates costs through the spreads dealers pay. Bond spreads are not part of MERs, making the full cost of bond funds higher than the reported MERs.

In Canada, one can make a bid on a bond order as small as $100,000 through a competitive bid on yield. Forty minutes before each auction closes, the Bank of Canada issues a statement accessible on its Web site (www.bankofcanada.ca) updating what it expects to be the reasonable range of acceptable bids of 20 bps on either side of an expected yield at the auction. That prevents an uninformed investor from being taken advantage of in an auction, but within the 40-bps total range, the investor’s bid would be accepted, says a spokesman for the Bank.

Alternatively, the buyer may bid for a quantity of bonds with no price specified. At the end of the auction, the buyer gets the average price of the auctioned bonds. Small institutional investors often take the non-competitive bid route, the spokesman adds. The limit on the non-competitive bid is $3 million at any one auction. Above that, one has to make a competitive bid at the auction, the Bank says.

For federal bonds purchased at auction of five, 10 and 30 years’ duration, settlement is in three days; for bonds of three years or less, including T-bills, settlement is in two days.
Payment is through a government securities distributor — they are the big brokers, which also submit bids for the investor who has an account at the Bank of Canada. A fee cannot be charged for handling the payment, the Bank of Canada spokesman says.

Bonds are listed by the Canadian Depository for Securities. Investors pay for bonds and receive payments for matured bonds through the securities dealer the investor has chosen.
It would be a good idea to have other business with the dealer, as the dealer is not allowed to charge for its service of pipelining money in and out of bonds sold without fees or spreads by the Bank of Canada.

The U.S. Treasury’s more extensive system makes it possible for retail investors to participate in auctions of U.S. T-bills, notes and bonds. Treasury Direct supports purchases within the range of US$1,000 to US$5 million per household at any one auction. Participants can enter competitive bids or submit a non-competitive bid that will purchase bonds at whatever the auction price turns out to be.

The investor who puts in a non-competitive bid for an issue gets the same deal as the bond desk at Goldman Sachs, the 900-kilogram gorilla of the bond market. It doesn’t get any cheaper than that.

There is a downside to direct purchasing, Czitron says. “You don’t get to shop the Street when you purchase directly, and you may miss the chance to buy from a dealer who offers an obscure but sound bond or an off-the-run [less liquid] Canada or a provincial bond that actually yields more than the bonds at the cur rent auction. But the bottom line remains the direct sale price, which is the lowest attainable for the [specific] issue on sale.”

@page_break@Selling bonds in a portfolio of direct purchases can be done through investment dealers in Canada at whatever prices and spreads are available. In the U.S., Treasury Direct will sell U.S. bonds in its accounts through the Federal Reserve Bank of Chicago, obtaining the best price available at the time of offer. It then transfers the amount received to the investor’s bank account, says a spokesman for Treasury Direct.

Do-it-yourself bond buying is not well known. Canadian investors and advisors have not shown much interest in it, the Bank of Canada says in a paper on debt distribution framework consultations available at www.bankofcanada.ca/en/notices_fmd/2005/not210305_distribution.htm.

The Bank of Canada says the larger securities dealers are “in favour of maintaining the current system of … access to bond auctions, which they [view] as fair, given their larger shares of the market and larger capital commitments.”

The dealers’ argument could be summed up as a justification for their spreads and the threat that, without the returns the spreads generate, they might not put up capital to make markets in government bonds.

However, odds are that even if a few more informed investors or advisors made use of direct sales, the vast majority of bond investors, operating through mutual funds and brokerage accounts, would still reward investment dealers with abundant profits.

The value of participating in auctions and arranging settlement of deals lies partly in one’s education. Saving 25 bps on a $100,000 bond trade amounts to $250 — good money for a few minutes of work, although it may be a headache the first time around.

Move up the learning curve, however, and the bond market will become more intelligible and potential deals easier to evaluate. IE