Bond traders could receive a reprieve on the fees they pay under a new rule from the Securities and Exchange Commission requiring greater transparency.
The ruling revised rules on the fees brokers have to disclose on bond trades. The rule implemented by the SEC on May 14 requires brokers to disclose the fees they receive from corporate, municipal and agency bond transactions.
This ruling could spur brokers to lower their fees as investors should find it easier to compare fees across the major brokerage firms. The recent price wars enacted by the online brokerages only benefited equity traders as it slashed the cost of each stock purchase.
Another benefit for bond investors, especially for retail ones, is that they are also notified of the exact execution time of the transaction.
Many brokers still charge many high fees which are hidden, even though they are claiming they are commission free, says Andrew Wilkinson, chief market analyst at Interactive Brokers Group (Nasdaq: IBKR), a global electronic broker in Greenwich, Connecticut. Some brokers had steep markups on bonds. The trend of hiding fees in their spreads impacts both institutional and retail investors.
"This new ruling levels the playing field for average investors and lets them compare apples to apples when buying bonds," he says. "We are behind this initiative from the SEC."
Most investors, especially Main Street ones, fail to realize there are many hidden fees, says Ron McCoy, president and CEO at Freedom Capital Advisors in Winter Garden, Florida.
"Often knowing what to look for is a complicated task for most investors and this can involve big spreads and markups," he says.
In the bond market, spreads between the bid and the ask can vary between 1 percent to 3 percent and often brokers will mark up the bond, which is unbeknownst to the client and can add up quickly to thousands of dollars in a retirement portfolio.
"If you are dealing with a fee-based advisor and paying a management fee, you should be in good hands since fee-based advisors cannot charge a management fee and collect a commission/markup," McCoy says.
Some online brokers can and will mark up a bond from 0.5 percent to 2 or 3 percent, depending on the order size.
"Any rule that increases transparency is good for the investor and can save thousands of dollars over time," McCoy says.
Brokers should be clear about their pricing so investors can compare fees at other brokerages easily, Wilkinson says.
"This rule benefits us also because it makes it easy to see how our prices compare to competitors," he says.
In the past, brokerages often hid the fees in spreads by as much as $50 to $75 a trade, which lowers the yield for an investor, Wilkinson says. Before the advent of online trading, the fees varied widely and were often $100 per trade.
"Today with online trading being pervasive, the fees are getting narrower due to increased competition and investors might be paying less than half a penny per share," he says. "It's a good thing they are peeling back those layers."
The new ruling will hopefully encourage more investors to determine the amount of fees their broker is charging them, Wilkinson says. While bond trading remains more expensive than buying and selling stocks, most investors tend to keep their fixed income holdings longer.
"There is not a lot of churn in bond trading since bonds attract more long-term investors who seek it for income generation," he says.
The changes in the bond industry's electronic trading will help lower fees the same way equities have gone through fee compression from digitization, says Yale Bock, president of YH&C Investments in Las Vegas.
"With the emergence of blockchain technology, you are going to see the bond market become more efficient and the spreads will compress, including syndicates when bonds get issued initially as the blockchain can make that more efficient, too," he says.
Wirehouses are still charging $1 to $20 per $1,000 bond and the longer dated, higher yielding bonds tend to be at the high end of that range, says Todd J. Lerner, a registered investment advisor with LBW Financial Services in Valencia, California, who is thrilled with the new disclosure requirements.
"This represents up to a 2 percent sales charge at time of purchase and this is agnostic to trade size," he says. "A stock trader's sales charge at a wirehouse can also be over 1 percent."
All but one of these market gauges are broadcasting the same message.
Discount brokers have already been working to compress fees in the bond market, Lerner says. For instance, Charles Schwab brokers offer free trades on Treasurys and $1 per bond on most other bonds with a $10 minimum fee.
"After a decade of improvements on transparency, bond spreads were really the last domino to fall," he says. "I've always felt that the opaqueness of the bond market was intentional by the finance industry, as if to say, 'Hey retail, this is our playground, not yours. Buyer beware.'"
The lack of disclosure on bonds meant that brokers tended to sell them on a yield quote, Lerner says.
"I can get you the JP Morgan 2020s at a yield to maturity of 3.2 percent," he says. "It was left to the buyer to ask how much of a spread was being added in and how much higher the yield would be without the broker commission added in."
Since bonds don't trade nearly as often as stocks do in the open market, up-to-date bond prices are not readily available for all but the most liquid issues such as Treasurys.
"A retail buyer was at a disadvantage as they can't readily compare a broker's quote against market prices and yields," Lerner says.