Dan Wiener: Hello, this is Dan Wiener, chairman and co-founder of Adviser Investments, with another of our “Adviser You Can Talk To” podcasts. Today as my guest, I’ve got Jen Zebniak, who’s a member of our research team who works closely with our fixed income manager Chris Keith and helps build portfolios of individual bonds for investors with particularly large allocations to bonds or those who have special needs. Jen, I wanted to speak with you specifically about a particular subset of the bond market that you and Chris have focused on for many of our clients. You call them odd-lot bonds. Can you tell me a bit about what these are and why you’re interested in them?
Jen Zebniak: Sure, yeah. So odd-lot bonds are just smaller-size positions, such as maybe $10, $15, $20,000 increments. They’re more effective in an individual investor’s portfolio than an institutional-size fund. Institutional-size funds would normally buy bigger positions, like, in the millions.
Dan Wiener: So the positions you’re buying, though, are of bond issues that are quite small. Is that right? I mean, when you say $10 or $15 million, that’s the total size of the issue itself.
Jen Zebniak: So that would be the size of a deal itself, but you can buy a smaller position size. Increments go down to, for taxable bonds. Usually you can buy in increments of $5,000. Sometimes it can be as low as $1 or $2,000 depending upon the issue.
Dan Wiener: Right, so you might buy $5,000 worth of a $5 or $6 million or $10 million deal.
Jen Zebniak: Yes. Correct.
Dan Wiener: And the pension funds, the mutual funds have no interest in these.
Jen Zebniak: The smaller positions, no, they wouldn’t have much interest. If you have a fund that’s a billion dollars and you buy a $15,000 piece, it’s not going to move the needle much, whereas if you have an individual investor with a portfolio of, say, half a million dollars it’s going to move the needle much more and mean much more to that individual person.
Dan Wiener: Now, a pension fund could buy the entire issue, couldn’t it?
Jen Zebniak: Yeah, they could.
Dan Wiener: They could buy a $5 or $10 million position and own the whole thing. Jen Zebniak: Yeah. Dan Wiener: Why wouldn’t they do that?
Jen Zebniak: So, they could. A pension fund would if they had the money and it’s something that they were interested in. But sometimes they can sell off pieces of it, or if a new issue, second market, you will find these smaller positions. It all just depends.
Dan Wiener: And what’s the appeal, then, for an individual investor in buying an odd-lot bond?
Jen Zebniak: The appeal would be that they can oftentimes get more yield, and that’s obviously more beneficial to the investor. It’s more income for them in their pocket.
Dan Wiener: Um-hum. So the appeal of these to the small investor is that you’ve got more yield and that the issuer is providing that yield because the big fish don’t want to bite.
Jen Zebniak: So it’s not that the big fish don’t want to bite. It’s that in order for these large institutions to sell these smaller size odd-lot bonds, they offer more yield so that smaller, like, investors that need smaller pieces in order to be meaningful to them will want to pick them up and the big institutions can get them off of their books quicker. If they are sitting on their books for much longer and the market moves, they could end up losing money. So sometimes it’s just so that they can move them quicker.
Dan Wiener: Are we talking primarily, then, corporate bonds, or are we talking about muni bonds?
Jen Zebniak: It could be both. You can find odd-lot bonds in corporates and munis.
Dan Wiener: And are these buy and hold until maturity type bonds for the individual investor, or is it the kind of bond that you and Chris trade around?
Jen Zebniak: So for our clients, we don’t tend to trade around. When we invest in a bond, we tend to hold, the intent is to hold it to maturity. There are times when we would sell, and the two times I can think of are if we invest in an investment-grade bond and then the credit quality deteriorates quickly, we will review the position and sell if we feel it’s necessary. Or if a client requests money and we don’t have cash on hand, then we’ll sell a bond, as well. Dan Wiener: Okay. Well, that’s a need-driven selling, isn’t it?
Jen Zebniak: Yes.
Dan Wiener: Since we’re talking about selling, trading bonds is, it’s not like trading stocks, right? We, you can’t just look up a price on your personal computer, you know, pop it up on your iPhone…
Jen Zebniak: So…
Dan Wiener: …and see what’s, what the price of a bond is.
Jen Zebniak: No, not really. I mean, a lot of it is relationship-making. We do have an electronic platform that we can use. That’s more of the science of it. But the art part would be the relationships that we form with these dealers, and it just makes it easier to be able to negotiate with them. If we see they have a bond at a certain yield, we’re able to call them up and say, hey, we see a similar piece just a little bit cheaper, like, what can you do for me? And sometimes they’ll come back and give us a better price, and it helps us add value.
Dan Wiener: And the flip side, of course, is if it’s a cheaper price, it typically is a little higher yield, right?
Jen Zebniak: Yes. Yeah. The inverse relationship.
Dan Wiener: I mean, this is the inverse of price and yield that I think a lot of individual investors don’t always pick up on.
Dan Wiener: And it’s my understanding that when you’re working with the dealers who actually have these bonds in their possession, everything is fungible, right? There is no set price, and that’s why it’s hard to just see it on the screen of your bond site.
Jen Zebniak: Yeah, so, I mean, we look at a lot of different things, too, in order to make sure we are getting a fair price, and dealing with someone directly versus just an electronic platform helps us to make sure we are getting the best price possible.
Dan Wiener: So how do you do that? Do you have multiple dealers that you’re playing off of one another, or…
Jen Zebniak: Yeah, I would say we have upwards of 30 different dealers that we do have relationships with. Some we use more than others. But it does depend on who can offer us the best price.
Dan Wiener: In buying individual bonds, what’s the difference between that and, say, an investor going out and buying a bond mutual fund a bond ETF?
Jen Zebniak: I would say one of the biggest differences is when an investor owns an individual bond, that has a set maturity date, and at that maturity date, they get their principle back, whereas with a bond fund or an ETF, the investor themselves, if they want that money back, they have to go in and sell the shares in order to get their money, and with an individual bond, it happens automatically.
Dan Wiener: And you are selling at the market. You don’t know what the price is until the day you go and sell.
Jen Zebniak: Correct. Yes. And you know what you’re getting back with an individual bond.
Dan Wiener: Great, great. What is the, what are the risks, then, of owning an individual bond versus, say, a bond fund?
Jen Zebniak: Well, the risk of default, which is why we focus on buying investment-grade bonds. We buy anything rated A or higher at the time we invest.
Dan Wiener: Right. Whereas a fund typically has a very broad-based portfolio. Even a default or two or seven in a big diversified portfolio is probably not going to move the needle much for the individual investor.
Jen Zebniak: Correct. Yeah.
Dan Wiener: All right, well, I want to thank you, Jen, for joining me today. This is Dan Wiener. I’m the chairman and co-founder of Adviser Investments, and I’ve been speaking with Jen Zebniak, and works on building portfolios of individual bonds for our clients.
Jen Zebniak: Thanks, Dan.