At a conference that I attended recently, the topic of odd lots came up.
“What is the future of odd lots?”, was the question posed. And, how are they trading versus round lots?
One reply was that trade reports indicate that there’s not much difference between the inter-dealer trade price of a $50m piece and a $1mm piece of that same cusip. The difference occurs in the markup charged to the retail investor, versus the price that an institutional buyer pays for the block. A suggested result of this disparity will be the re-allocation of odd lots into SMA accounts.
Retail will still own the smaller pieces, and the lack of mark-up will cause the data to show less disparity in the prices that retail and institutional customers pay. Problem solved.
I’m on the outside, looking in, but I wonder, will this new business model really represent Best Execution? A one-time markup on a bond may cost less, over time, than the annual fee that will be charged to “manage” that bond over the many years until it matures.
For example, a retail investor that purchases a 10m piece of a bond at 92, with the rep working for $15 per bond, pays a commission of $150. This represents a 1.65% markup on the bond (assuming that the PMP was 90.50).
If that same bond is placed into an SMA account, it will pay a 1% fee every year until it matures, which could be ten, twenty, or more years.
Current examinations being done by regulators, looking into how firms are complying with the MSRB’s Rule G-18, Best Execution, (and G-15 and G-30, Mark-up, and PMP) may cause firms to avoid the appearance of “bad behavior” on their part by discontinuing the use mark-ups as a way to generate revenue.
This solution of taking the easy way out (by not having to explain the mark-up to the customer, or to a regulator) may not the “best execution” that the customer deserves.
Being on the outside, looking in, I welcome any comments, corrections, criticisms, or elucidation on this topic.