Online trading of municipal bonds is finally coming into its own. There are currently several dozen sites where individuals can buy or sell these securities, with many more under development. Sites range from those put up by small securities firms, to cyberspace adjuncts of giant trading houses, to virtual investment banks.
Increasingly, these Web sites offer retail customers more than just inventories of bonds and a trading platform. Typically there is some background on the intricacies of the municipal bond market. In addition, many also serve up advice on structuring a portfolio, and may even include sophisticated tools for calculating and comparing bond investment return.
In fact, municipal bond Web sites are growing with such speed, and offer such an abundance of information, that it's sometimes difficult for investors to get a clear sense of what they are all about.
Getting Started
Perhaps the best place to begin is with a reminder that muni bond trading is not at all like trading in stocks. In contrast to equities, which typically change hands on public exchanges at uniform prices, municipals are priced over the counter by individual brokers. This disparity is compounded because there are vastly more individual bonds than stocks, and, in general, bonds trade much less frequently.
It's also important to note that not a few investment experts are convinced individuals shouldn't be buying municipals at all online - at least for now. For example, Brad Gewehr, director, municipal bond research at PaineWebber Inc., stresses the risks of providing such products to unsophisticated individuals.
"I think you should walk before you run, there are a lot of concerns about suitability for individuals," he said. "That's why I think the first place to do (Internet trading) is on an institution-to-institution basis."
In fact, the issue of suitability has drawn the attention of the securities regulators, including the Municipal Securities Rulemaking Board, the market's self-policing agency, and the Securities and Exchange Commission. In September, the MSRB provided some guidance on possible new rules covering the topic. Suggesting that dealers would have a lower regulatory hurdle if they trade with "sophisticated market professionals," the board expressed concern about the vulnerability of novice investors. One suggestion was that the sites ask online questions in order to direct potential customers to suitable investments.
Perhaps the best defense is to be aware that there is truly a wealth of information on the Web to help you understand a difficult market before making your first online trade. One of the most useful is the site operated by The Bond Market Association (bondmarket.com), a trade organization of securities dealers. TBMA's site includes the very useful "Daily Report of Municipal Bond Transactions," which is provided by the MSRB and Standard & Poor's J.J. Kenney. It lists the munis that have traded four or more times in the previous day and displays the highest and lowest prices at which the bonds changed hands. This typically covers about 1,000 of the 1.4 million issues outstanding. Investinginbonds.com, another site from TBMA, provides useful background information, including a glossary.
It is also crucial to understand the difference in trading platforms behind the sites, what drives those platforms, and the strengths and weaknesses of each. Three points should be kept in mind.
1. Most online investment boutiques that offer municipal bond trading do not own the inventory of bonds they display to customers.
Generally the inventory offered has been assembled by an outside vendor that has lined up participating dealers that have agreed to list with it.
For investors, the advantage of these sites is that it gives them access at wholesale prices to a large commingled collection of bonds owned by many participating brokers. For example, most of the online bond boutiques - such as Bond Agent, BondPage, MuniDirect, and TradeBonds - use Bond Express, a large bond-inventory provider based in San Diego. Bond Express includes an average of about 15,000 fixed-income items (including about 8,000 municipal bonds) provided by about 400 broker-dealers.
The disadvantage to these sites is that it puts investors at the mercy of the inventory provider and the participating dealers that supply bonds to the inventory. Prices are only as live as those provided by participants. Because of this, by the time an investor decides to buy a bond, prices may have changed, or the bonds may not be available at all. In addition, these sites typically do not purchase bonds from investors.
Arthur Sinkler, president of MuniDirect, an online broker set up in Atlanta in 1999, acknowledges the limitations of using an outside commingled inventory.He says MuniDirect hopes to supplement the inventory it receives from BondExpress with a bonds from new-issue deals it plans to underwrite, and by providing an on-site auction. Sinkler also recommends that online brokerages using this type of service need to be straight with investors about commissions added to the wholesale price of the bond. MuniDirect stipulates that its commission be no more than $.50 a bond.
2. When sites own the bonds they list, the number of bonds offered generally is relatively small.
This is particularly true of regional retail firms, but it's also the case with the online bond lists of some large Wall Street firms. But limited lists can have their advantages. Firms can - and do - devote a lot of care to providing information about the bonds they do own.
For example, Stone & Youngberg, a San Francisco-based regional that launched a Web site (styo.com) in 1997 and generally lists about a 100 bonds a day, has given a great deal of attention to providing details about its bonds, according to chief information officer Mark Rodgers. For example, it recently added a client research library that provides research reports and links to offering statements. It also added a system that allows customers to participate in new- issue deals. Stone & Youngberg is also considering providing a bond auction site.
EbondTrade, an online bond specialist that opened for business in January 2000, also provides detailed information about its bonds, including offer/bid pricing, as well as reports from Fitch. The California-based firm owns its inventory, which comes from underwriting as well as secondary market trades.
3. Real-time pricing with live execution is coming, but individual investors will have limited access to these systems.
Large Wall Street-based investment banks are rushing to develop massive shared inventory, real-time bond pricing, and virtually instantaneous processing of trades. These groups also seek to capitalize on the efficiencies of online trading to cut the cost of maintaining and trading their existing inventories.
There are three main alliances: MuniCenter, sponsored by group that includes Merrill Lynch, Salomon Smith Barney Inc., Morgan Stanley Dean Witter, and Chapdelaine; BondDesk, sponsored by a group including Goldman Sachs, Bear Stearns, and PaineWebber; and Market Axess, sponsored by a group including C.S. First Boston, Lehman Brothers, Chase, and J.P Morgan. Retail bond investors, however, must go through the individual broker dealer participating in the consortium, and will not be allowed to directly access these systems.
"This will make bonds much more accessible to retail, but we stop just shy of mom and pop," says Paul Palmeri, chief operating officer of the MuniCenter. He said MuniCenter can confirm a trade in under six seconds and has 420 participating firms.
These large sites furthermore will also provide electronic issuance of bonds, allowing for a seamless processing from issuance to secondary market trading. Palmeri, a former executive at Merrill Lynch, argues that the efficiencies generated by streamlined electronic processing will enable consortiums like MuniCenter to provide bonds to participating firms at lower prices.
However, there are some powerful real-time bond trading systems that will be accessible to individuals. Several months ago, Charles Schwab rolled out an enhanced site that is being linked with ValuBond, an Atlanta-based bond platform that focuses on retail investors. The new system will also include a portfolio tool to track bonds in real time and alert investor to key events, including ratings upgrades, calls, and sinking-fund activity, according to John Ladensack, senior vice president of Schwab Capital Markets and head of the firm's retail bond operation.
Schwab's alliance with ValuBond will allow it to dramatically increase the $25 million to $30 million inventory of bonds it offers individuals.
The Future of
Online Bonds
During the next few years there will be dramatic growth in online bond trading, experts say. Andy Nybo, an analyst with the Tower Group, predicts that volume of municipals changing hands on the Internet, now at less than 1% of the total, will surge to about 30% by 2004.
"Trading in munis is going to explode," Nybo said.
Driving that growth, certainly, will be the development of powerful new trading platforms from consortiums of Wall Street firms, who certainly will not be shy about seeking to head off their cyber-competitors and maintain their longstanding control of the municipal market trading. Todd Eyler, an analyst with Forrester Research and the author of a recent report "Bonds Get Wired," predicts that four major platforms will evolve and emerge to the forefront by 2004. These platforms, he said, will further transform the municipal market by favoring standardized bond structures and benchmark transactions.
Prodded by the regulators concerned about the suitability issue, Web sites will be diligent in developing screen-based inquiries to determine the preferences and sophistication of their customers, Eyler said. Sites like Muni- Direct, for example, have developed online questionnaires. And increasingly, sites will connect online trading with content that helps investors manage their overall securities portfolios.
Another development is the launch of sites that seek to create inventory by enticing institutional muni investors to list bonds online as well as obtaining bonds through underwriting and commingled inventory. Municipal Trade, an Atlanta-based firm that hoped to launch in November, is favoring this approach. The services are targeted at investment managers, trust and estate executors, investment advisers, and financial planners - but also at high- net- worth individuals.
