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Portfolio > Economy & Markets > Fixed Income

A New Take On Fixed Income

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As the equity market and economy continue a downward slide, investors’ interest in bonds is on the upswing. And advisors and their clients can now get first dibs on original-issue corporate bonds through Incapital’s InterNotes, corporate bonds designed specifically for retail investors. Tom Ricketts, co-founder, president, and CEO of the year-old Chicago-based investment bank (he’s also the son of Ameritrade founder Joe Ricketts), noticed a demand for corporate bonds among individual investors while working in ABN AMRO’s bond department, where he helped to develop the GMAC SmartNotes. As SmartNotes grew in popularity among individual investors, Ricketts and his colleagues decided to open their own shop, Incapital (, so they could focus their efforts exclusively on providing individual investors with first-issue bonds. “There’s always been a latent demand for corporate bonds in the retail market,” Ricketts says, but individual investors and advisors haven’t known how to access them. Most investors and advisors have had to resort to buying less attractive bonds from the secondary market, a process that’s confusing and complex. InterNotes, which are issued at par ($1,000) and in denominations of $1,000, are rated A or higher, and are offered weekly on an ongoing basis. Incapital has three issuers so far–Bank of America, Household Finance Corporation (HFC), and DaimlerChrysler–and has sold $3.4 billion in bonds this year.

Ricketts says advisors can’t afford to ignore the corporate bond market. “For a long time it was enough to be experts in equity,” he says. “That’s no longer the case. There’s not going to be this equity euphoria again for a long time.” New York Bureau Chief Melanie Waddell sat down recently with Ricketts at IA’s New York office to discuss InterNotes.

How does the InterNotes program work? The InterNotes program is a process whereby corporate bonds are offered on an ongoing basis in a way that makes them accessible to individual investors through their advisors. So whether it’s an independent advisor or a Merrill Lynch broker, the [client] can have access to original issue corporate bonds.

What’s the advantage of offering bonds on an ongoing basis? Every Monday we take bonds from our three issuers that have a variety of maturities, from two years to as long as 25 years, some callable, some not, and we offer those to the brokerage/advisor community. From one Monday to the following Monday, the advisor has time to discuss the bond and the suitability of the investment with the client. They have until the following Monday to come back and tell us if they want the bonds, and if so, how many.

Unlike a traditional process that happens very quickly and doesn’t give individual investors a chance to participate, our process slows down the underwriting so that individuals have time to put their orders in. So the individual investor gets an original-issue corporate bond at par.

So bonds traded in the secondary market are not at par and are confusing to get? The only alternative [advisors and their clients] would have right now save for this program would be to go and buy bonds in the secondary market. And while that’s possible, it’s often confusing and unnecessarily complex. If an individual asks his advisor to buy an IBM bond, the individual has to go back to whatever desk the advisor deals with to get access to that market. The advisor has to make a bunch of phone calls, and by the time they get that bond they can’t say, “Give me a five-year.” It’s going to be a 4.1-year or a six-year [bond]. The bond is going to finally get down to them after it has been marked up a couple times and then the price is going to be 1023&Mac218;4 or 91, so you’re going to have a tax implication of amortizing that premium (or discount) over the remaining life of the bond, and there’s accrued interest to explain. If investors don’t pay par (100) for their bond, they have to account for any discrepancies between the price they pay and par on the personal taxes. So it’s relatively complicated if you buy secondary bonds for most people.

How many issuers does Incapital plan to have? We would like to have 10 well-diversified issuers on the [InterNotes] platform. We intend to add a few more over the next several months because our goal in the end is to let people make portfolios; you can’t really do it with three issuers, but you can with 10. Now our big struggle is getting more issuers to go through the process of offering bonds.

Are you seeing a huge demand for corporate bonds now? We are seeing unprecedented demand. There are a couple of reasons. There have always been people who have said that if it were simpler, and if it made sense, they would buy corporate bonds. So they’ve started to do that. Equity market volatility over the last couple of years has really made people think much more deliberately about what they are doing with their fixed-income slice of the asset allocation pie. And there’s no question that the demographics of the investing public are moving toward a life stage where bonds are an investment that they need in order to have an interest income. That’s where corporate bonds are going to be helpful. The people who buy our bonds are age 55 and older. And that segment of the population is growing.

What about yield spreads? The basis point spread between what a corporate bond will give you and what a Treasury or CD will give you is historically very high. The reason is that as economic uncertainty and liquidity concerns for institutional investors keep corporate borrowing spreads relatively wide, Treasuries have fallen. So a corporate bond that a couple of years ago would have given you 10% more return than a Treasury now has 30% to 50% more return, depending on what kind of credit you look at. The relative value of a corporate bond has gone up dramatically.

Are individuals buying shorter-term or longer-term bonds? What a lot of people are looking at now is going farther out the yield curve to get the higher yield with a pretty good slope in the yield curve. Investors that a few years ago might have been three- and five-year buyers might be seven- and 10-year buyers now. And that’s because in the aftermath of September 11, and all year, short-term Treasuries rallied dramatically, giving even more slope to the yield curve.

Why is a corporate bond more beneficial than a bond fund? Individual bonds are a coupon stream and offer a principal back. With a bond fund, you put in money and you pay a manager to manage a diversified portfolio on your behalf. A lot of people in bond funds might be better off in bonds, because [with] a bond fund you don’t know what your principal payment back is because it trades around. But with an individual bond, save for the unlikely scenario of default, you’re going to get your $1,000 back. The second thing is that bond funds charge a management fee for service, and there are capital gains distributions associated with bond funds.

So that’s the biggest difference between [Incapital's] product and bond funds–no ongoing fees? We take a nominal fee that adds up over time to make us profitable. On a five-year note, Incapital might make 15 basis points. The brokers themselves make a lot more than that, but once we make that trade, we’re done. We are not charging 75 bps per year to manage the asset.


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