TSC's Guide to Bonds Online: How the Biggest Online Brokers Stack Up

The biggest online brokers offer plenty in the way of bond trading, but except for E*Trade (EGRP) and Morgan Stanley Dean Witter's (MWD) Discover Brokerage Direct, they're offering very little of it online.

Of the nine biggest online brokers by market share, according to Credit Suisse First Boston's latest accounting -- Charles Schwab (SCH), Toronto Dominion's (TD) Waterhouse Securities, E*Trade, Datek Online, Fidelity Investments, Ameritrade (AMTD), Donaldson Lufkin & Jenrette's (DLJ) DLJdirect, Fleet Financial's (FLT) Quick & Reilly and Discover -- only Datek doesn't offer any bond services at all. But in most cases, the amount of bond business that can be transacted online (as opposed to on the phone with a broker) is extremely limited.

Waterhouse, Ameritrade and Quick & Reilly, for example, offer only the ability to place orders for Treasury auctions online (for a fee, which, as we've discussed, you don't need to pay if you place your order through Treasury Direct). All other bond transactions require broker assistance.

At the next level are Schwab, Fidelity and DLJdirect. Schwab allows online buying and selling of only the most recently issued Treasuries and of exchange-listed corporate bonds, which represent a mere sliver of the corporate bond market. Fidelity lets you buy Treasuries and municipals online, but if you want to sell them, you need to talk to a broker. DLJdirect allows online buying and selling of Treasury securities only.

Moreover, none of these services lets customers compare the prices at which bonds are offered with the prices the firms would currently pay for them, or makes clear what it's costing the customer to do a relatively small, or odd-lot, transaction. Like any market, the bond market prefers large, round lots, so bids are higher and offers may be lower for them.

Much to Be Desired Electronic bond-trading capabilities of the biggest online brokers
Broker (Rank)*	Treas.	Munis	Corp.	Buy/Sell	Commissions	Notes
Discover (9)	Y	Y	N	both	$14.95 to $49.95 for Treasuries on top of markup/down; markup/down only for munis	Treasury prices quoted for $1 million par amount; less favorable prices for smaller transactions not spelled out; muni selection limited
DLJdirect (7)	Y	N	N	both	Markup/down only	Treasury prices quoted for $100,000 par amount; less favorable prices for smaller transactions not spelled out
E*Trade (3)	Y	Y	Y	both	$40 for less than 20 Treasuries or less than 10 munis or corporates on top of markup/down; otherwise, markup/down only	The most comprehensive infrastructure and widest selection of executable quotes so far
Fidelity (5)	Y	Y	N	buy only	$50 for up to 20 Treasuries on top of markup; markup only for larger quantities and munis	Bonds available for sale not listed; customer must enter CUSIP and specify limit price if any. Market price shown at the order verification stage if the bond is available online
Schwab (1)	active issues only	N	exchange- listed issues only	both	$39.20 for Treasuries on top of markup; scale for corporates	Treasury prices quoted for up to $100,000 par amount; buyer of $100,000 par pays same price as buyer of $10,000 par
*Brokers ranked by market share, according to Credit Suisse First Boston. Ameritrade (6), Datek (4), Quick & Reilly (8) and Waterhouse (2) don't offer online bond trading beyond the ability to place orders for Treasury auctions, which investors can do at lower cost through Treasury Direct.

In a recent interview, Schwab fixed-income head John Ladensack told TheStreet.com that his firm during the third quarter will overhaul its bond-trading system to let odd-lot investors buy and sell Treasuries at the same, more favorable prices that larger, round-lot investors pay and receive. It will lower its fee for those trades to $29.95, Schwab's standard commission for online stock trades.

In the meantime, Discover and E*Trade are at the top of the heap in terms of bond services, with E*Trade being the clear leader, at least in terms of the infrastructure it has in place.

Discover offers online buying and selling of Treasuries and munis. Its system has a couple of big shortcomings. It's not possible to simply enter the CUSIP for a bond you want to sell and receive a bid on it. You can only liquidate online issues that it's possible to buy online. This isn't really an issue for Treasuries, since the full curve of active and off-the-run issues and a long list of STRIPS are for sale.

But for muni bonds, very few issues are available to buy, and therefore to sell, online. A recent search for all munis available for sale online turned up just 66 bonds. (Remember, most muni investors have a strong preference for bonds issued in their states. For New York, one of the biggest issuers, there were just five bonds on the list.) Discover President Tom O'Connell conceded the point in a recent email interview with TheStreet.com. "We are expanding the inventory from just very active issues to a much broader list as the muni desk gets experience settling trades on our system," he wrote. "Expect a gradual expansion of the number of issues over the summer."

As for the liquidation issue, O'Connell said: "We guarantee a competitive bid [over the phone] for any issue purchased online, whether the bond is still on the offering list or not."

In addition, for both Treasuries and munis, the quotes are for transactions of a certain (typically large) size, and it isn't spelled out how transacting smaller amounts will affect the price.

But while Discover's system is lacking in these respects, it takes the giant step of displaying both bid and offered prices for all bonds. (Unfortunately, the site's demo doesn't let you see what the bond pages look like.) The importance of this information can't be underestimated. If investors can see both sides of the market -- something it's always been extremely difficult for individual bond investors to do -- they can be confident they are not paying too much.

E*Trade also displays bid and offered prices for Treasuries and many of the other bonds in its system, which is easily the most comprehensive among the biggest online brokers. (It can be accessed in demo mode through the Web site of Bond Exchange, the software company that built it.)

E*Trade's system allows customers to buy or sell bonds of all types through Web links with three to five major dealers in each product category, according to Charles Almond, president of Bond Exchange. (For municipals, each of 10 regions counts as a separate category.) At any given time, the system displays at least 5,000 executable items -- at least 400 Treasuries, 800 federal agency issues, 2500 corporates and 1200 munis -- and customers can solicit bids and offers on other issues. For Treasuries, the higher offered and lower bid prices that apply to small transactions are spelled out.

There's also a really neat bond-ladder-building function which, while still a bit buggy (you have to narrow your search to the point where all the bonds you're going to select for your ladder appear on one page) will graphically analyze a portfolio of bonds and its income payment schedule, and calculate its average maturity and duration.

Not every quote in the system is live and executable, and Bond Exchange could benefit from wider participation by the dealer community. In the meantime, E*Trade has the infrastructure in place to offer as much variety on the bid side and liquidity on the offered side as a full-service brokerage firm is capable of, and may be doing so already.

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