From the November 2010 issue of Investment Advisor • Subscribe!

November 1, 2010

Using Bond Ladders to Stave Off a Corporate Bond Bubble

Incapital president Radtke wants to reach more RIAs and BDs

Some analysts speculate that the corporate bond market is a bubble that’s about to burst. John Radtke, president of Chicago-based Incapital, which distributes fixed income securities and structured notes through more than 900 broker-dealers, banks, RIAs, and institutions, argues that using a laddered bond portfolio is a good strategy for fixed-income investors to use whether we’re headed for a corporate bond bubble or not.

“A laddered bond portfolio consisting of individual municipal and corporate bonds is always a good strategy, but particularly at this time by allowing financial professionals and investors to address both inflation and deflation concerns,” Radtke says. “Advantages of this strategy include defined maturity and interest payment schedules, control over exactly which bonds are held, and tax efficiency.” Radtke goes on to explain that “intermediate and longer-dated municipal and corporate bonds typically perform well in a slow growth and mild deflation environment.” If there is a bond bubble, and should inflation pressures return, Radtke argues that “short-dated bonds will roll off to enable reinvestment at higher rates.”

Radtke has been president of Incapital for several years now, taking over the reins from Tom Ricketts, who still serves as chairman and CEO, but has increasingly focused more of his time in managing the Chicago Cubs. The Ricketts family—Tom’s father Joe Ricketts founded TD Ameritrade Holding Corp.—bought the Cubs last year for $845 million.

Bond Business Is Booming
As of September, Incapital’s business by asset class comprised 43% in corporate notes; 24% in U.S. agency debt; 12% in CDs; 11% in structured products; 5% in municipals; and 5% in mortgage-backed securities (MBS).
Investment sales at Incapital have nearly quadrupled from 2007 to 2010, Radtke says. The amount of securities that have flowed through the Incapital system has gone from about $15 billion in 2007, he says, to, he estimates, somewhere between $65 billion and $70 billion this year.

Incapital is also focused on expanding its reach to RIAs and broker-dealers. The firm now does business with about 400 fee-based advisors and about 700 BDs.

“We recognize the growth in the RIA space,” Radtke says, adding that the firm has plans to expand Incapital’s platform to better reach the RIA market, noting that Incapital now has six salespeople “calling on RIAs.”

[Read about the SEC's switch from federal to state oversight of advisors.]

I talked with Radtke in early October about the fixed income market and Incapital’s strategy to reach advisors going forward.

Corporate notes includes Incapital’s InterNotes. The Incapital website says that InterNotes are “designed to make investing in corporate bonds and other investment grade securities a simpler process.” Are InterNotes the most important product in terms of advisor interest?
It varies, but InterNotes are still extremely important, and have become one of many products over the course of the last three years [that advisors are using].


What other fixed-income products are popular with advisors now?
After October 2008 with the dislocation in the market many people had come out of credit-sensitive corporates or equity and moved into CDs and other FDIC- or money-market-insured-type products, basically waiting to see what might happen. So we’ve seen a huge surge in the amount of money that has flowed into broker deposits, which now is starting to come out. Getting back to your question about [the popularity of] corporate [bonds], with yields on three-year notes and five-year notes—government securities being below 1% and CDs hovering at 0.05% or lower—and with the credit concerns, I wouldn’t say they are completely gone, but for many companies they’ve subsided. The broker-dealers that we service are moving a little further out the credit curve and a little further out the maturity curve in an effort now to obtain yield. So between high-grade corporates, agencies, and CDs there’s been a significant interest from advisors.

Explain the strategy behind Incapital’s recent deal with Goldman Sachs, in which Incapital will be the sole distributor of Goldman’s underwritten municipal bonds for the retail market.
The deal that we struck with Goldman was mutually beneficial. It gives Incapital access to an asset class that we think will be even more interesting for retail over the course of the next two or three years—for one, the tax-advantaged nature of the investment in light of what most people feel will be a rising tax environment. Although a few [municipals] have been discussed recently that are failing, the vast majority of municipals—most of them are high grade—gives people an alternative asset class or an alternative to corporate bonds.

With Goldman in particular, they had no true retail distribution … so they discussed the opportunity with us about six or seven months ago based on our ability to reach more than 700 broker-dealers through our current platform, giving them access indirectly to retail. So it seemed to be ideal for both of us—it was an asset class we wanted more business in, and it gave Goldman retail distribution. We will reach broker-dealers, small asset managers, and even trust departments.

What’s Incapital’s strategy going forward in working with RIA firms and BDs?
We’ve done business with around 700 regional broker-dealers—large and small—and through our structured products platform have been engaged by approximately 400 fee-based advisors or RIAs who are looking for more information about structured products or products that could be customized for their individual customers’ needs.

We recognize the independent [advisor], and we’ve had some success. We recognize the growth in the RIA space and we have been examining how we could expand that platform and reach them in a more meaningful way, so over the last two months we’ve started hiring specialists in that field—now we have about six—that are calling on RIAs. [We are looking at ways] to expand our platform and distribution, and we are looking at the municipal opportunity as a way to reach [RIAs] as they’ve come to us looking for more and more information. Our structured products have historically been purchased by RIAs.
We are also working with RIAs on bond ladders, as well as ways of enhancing our platform to make it more meaningful to an RIA; that’s definitely an initiative for us that started about six months ago and will continue.

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