BUSINESS

HAPPY TRADERS

CANADA'S BOND DEALERS ENJOY A LUCRATIVE YEAR THANKS TO THE RECENT PLUNGE IN INTEREST RATES

BRENDA DALGLISH November 25 1991
BUSINESS

HAPPY TRADERS

CANADA'S BOND DEALERS ENJOY A LUCRATIVE YEAR THANKS TO THE RECENT PLUNGE IN INTEREST RATES

BRENDA DALGLISH November 25 1991

HAPPY TRADERS

BUSINESS

CANADA'S BOND DEALERS ENJOY A LUCRATIVE YEAR THANKS TO THE RECENT PLUNGE IN INTEREST RATES

By the time he received his under-graduate commerce degree from the University of Toronto in 1983, Mark Wisniewski had made up his mind about a career. Months after many of his classmates had found jobs in accounting or corporate marketing, he was still calling on Bay Street investment dealers trying to land a job as a bond trader. Recalls Wisniewski, now a top trader at investment dealer Nesbitt Thomson Inc. in Toronto: “I finally had to offer to work for nothing before they would hire me.” Although he declines to reveal his current income, most traders of his calibre can expect to earn at least $400,000 this year. Even so, Wisniewski says that it puzzles him that the bond market itself attracts little public interest. “People do not understand the market,” he complains. “My own mother still thinks that I have something to do with Canada Savings Bonds.”

Despite its relative obscurity, the bond market is now attracting increasing attention from well-informed investors. In the first nine months of this year, the average return on government and corporate bonds in Canada, as measured by a widely quoted industry index that takes into account bond prices as well as annual yields, rose by 20 per cent. By contrast, the Toronto Stock Exchange’s total-return index, which measures both stock prices and dividends, increased by half that amount in the same period. At the same time, Canadian government and corporate bonds have increased in value faster this year than bonds in every other industrialized country except Australia. Says Gordon Cheesbrough, president of ScotiaMcleod Inc. of Toronto, one of the country’s biggest bond dealers: “It has been a truly phenomenal year.”

The bond market’s strength is primarily a result of the dramatic plunge in interest rates over the past 17 months. Since May, 1990, the Bank of Canada has lowered its trendsetting bank rate to 7.78 per cent from 14.05 per cent in an effort to help the struggling economy out of recession. The bank’s governor, John Crow, clearly believes that lower borrowing costs will spur new business investment and consumer spending. The drop in borrowing costs has also made older bonds more attractive to investors because they pay higher interest rates than bonds now being issued. Says Cheesbrough: “It is perverse, but everything that has been bad for the economy has been good for the bond market.”

Unfortunately for bond traders, too much of a good thing can create difficulties. On Nov. 7, the Bank of Canada surprised investors by lowering the bank rate by almost a third of a percentage point, a sharper cut than most observers had expected. For most Canadians, any decline in borrowing costs is a welcome development. But foreign investors, worried about the potential impact of dramatically lower rates on the Canadian dollar, reacted by selling Canadian bonds and other investments. By last week, most investors appeared to have regained confidence in Canadian bonds, and prices stabilized. “When you have a run of this magnitude for this long,” said Wisniewski, “people get a little nervous. They don’t want to lose it all.”

Although few novice investors follow the bond market closely, it is far larger than the stock market by almost any measure. During the first eight months of this year, $537 billion worth of government and corporate bonds changed hands in Canada. By contrast, the total value of company shares traded in Canada during the same period was only $59 billion.

The bond market itself operates according to several simple principles. To raise money, companies and governments sell bonds that pay a fixed annual rate of interest until a designated future date. When the bond matures, the issuer must repay the principal amount of the loan. Companies frequently prefer to issue bonds rather than new shares because doing so allows them to avoid diluting their ownership.

Unlike Canada Savings Bonds, a conventional bond cannot be cashed in by its holder before its maturity date. Instead, investors who no longer want their bonds can sell them on the open market, at prices that fluctuate according to prevailing interest rates. When rates fall, as they have this year, the price of existing bonds rises because they offer higher returns than newly issued bonds. But when interest rates rise, bond prices fall. In effect, the price of a bond rises or falls until its yield—a combination of interest rate, bond price and maturity date—matches the return on similar, newly issued bonds. (So-called junk bonds, which carry a far higher degree of risk because they are issued by companies whose financial positions are comparatively weak, are not traded on the conventional bond market.)

Over the years, bond trading has grown increasingly complex as new types of bonds are invented to cater to different kinds of issuers and investors. Meanwhile, traders themselves have developed a wide assortment of trading strategies. Wisniewski, for one, specializes in “zero-coupon” or “strip” bonds. Those are bonds that have been stripped of their interest coupons so that they no longer pay an annual rate of return. Because of that, they sell for much less than their face values, and their prices fluctuate dramatically whenever interest rates rise or fall. Explains Wisniewski: “You get a huge degree of leverage.” Another attraction for investors is the fact that zerocoupon bonds require a relatively small initial investment. For example, a zero-coupon bond that in 30 years’ time would be worth $1 million would sell for about $42,000 today, based on a prevailing interest rate of 11 per cent. If rates fell, the same bond would be worth substantially more—but its value could drop sharply if rates began to rise.

The introduction of sophisticated computer and communication technology has also changed the face of the bond market. In the past, bond traders tended to rely on experience and gut instinct to predict the market’s response to everything from bad unemployment statistics to rumors that a leading political figure had been shot. Ivor Quaggin, 59, began trading bonds more than 30 years ago and continues to trade for his own account now. He recalls the old style of trading with nostalgic affection. “We were buccaneers in the old days,” recalls Quaggin, president of Mannin Corp. of Toronto. “But it was not as volatile then. The market did not move as viciously against you.”

Now, most traders follow a so-called value approach. Instead of focusing almost exclusively on interest-rate trends, they analyse each issue’s features carefully and search for tiny disparities among bond prices. Armed with that information, they attempt to sell the bonds they believe are overvalued and buy others that appear undervalued. As a result, bond dealers are hiring traders with strong mathematical skills and the ability to discern seemingly minor differences in value that, because of the immense scale of most transactions, can yield huge profits. Among the traders at Goldman Sachs and Co. in New York City who specialize in Canadian bonds are two people who were educated as physicists and one who has a degree in oceanography. Says Russell Morgan, a 42-year-old former trader who now manages ScotiaMcLeod Inc.’s bond sales department: “They are trying to develop people with trading personality who also have a mathematical bent.”

But old traditions die hard. As in the past, the most successful bond traders pride themselves on their aggressive nature and their ability to make quick decisions on the spur of the moment under constant pressure. James Kieman, president of Goldman Sachs’ Canadian subsidiary, worked briefly as a trader before becoming a bond salesman, responsible for advising the firm’s large institutional clients on their investments. He says that he switched to sales after deciding that he was not tough enough to succeed as a trader. Said Kieman: “My problem was that I was able to see the other side. I was able to be convinced of another person’s position.”

The stresses of bond trading, including the danger of losing millions of dollars of an investment firm’s money, are indeed formidable. Still, most traders say that the exhilaration of dealing in such huge sums every day is worth the pressure. Says Kiernan: “It is an enormous high. You do not need drugs if you can trade bonds.” Morgan, for his part, expresses regret about the time his company asked him to give up trading and become a salesman. “They practically had to drag me away from my desk,” he adds.

Not surprisingly, traders are as fiercely competitive about their incomes as they are about concluding a successful trade. Most earn only a modest annual salary, supplemented by a bonus that is awarded by their employer once a year based on each trader’s performance and the profits generated by his department or firm.

“Money is their report card, the yardstick by which they judge themselves,” says Kieman. ScotiaMcLeod’s Cheesbrough, a former bond trader who has been on both sides of the pay negotiations that take place each fall as the investment dealers close their books, says that it is the worst time of the year. “They get so emotional over it,” he adds. “It is as though you are putting a dollar value on the person and saying, ‘You’re worth this, you’re not worth that.’ What a horrible way to price yourself every year.” Declared another senior Bay Street bond department manager: “I just had a 28-year-old in my office yelling at me because he was only going to make $400,000 this year.”

In fact, many traders appear to have concluded that the good times will not last much longer. “People are being very cautious this year,” says Wisniewski. “When you have a run that’s this long, you start to look over your shoulder and wonder whether it could be over tomorrow. The economy might do better and bonds might tum a little sour and we might have to dig in for a little bit.” As a result, he says, many traders are saving their bonuses rather than embarking on reckless spending binges.

Despite the managers’ complaints, the best Canadian bond traders still earn considerably less than their U.S. counterparts, whose excesses have been chronicled in best-selling books such as Tom Wolfe’s 1987 novel, The Bonfire of the Vanities. Last year, one bond trader at Salomon Inc. in New York, Lawrence Hilibrand, gained fame by receiving $23 million in salary and bonuses for his efforts.

By contrast, Canadian investment dealers say that they are more inclined to spread trading profits around a large group of people on the premise that traders are heavily dependent upon fellow employees—including researchers and other traders—to make money. By most accounts, the highest-paid bond traders on Bay Street make between $700,000 and $900,000 a year when the market is strong.

But Wisniewski is not complaining. “This is the greatest job,” he said. “You have the ability to invest this much money into an idea, and when you actually make a big profit doing it, the thrill is incredible—there’s nothing like it.” And for traders, few years have been more profitable than 1991.

BRENDA DALGLISH

FOREIGN BUYERS SHOP CANADIAN

BUSINESS

The rare private meeting was aimed at reassuring foreign investors that Canada continues to be a safe—and profitable— haven for their money. In Ottawa last month, Finance Minister Donald Mazankowski, Bank of Canada governor John Crow and an array of other government officials sat down with 40 major U.S. lenders to brief them on Ottawa’s economic plans and answer questions about the country’s problems. The fact that those lenders, most of whom represent large institutional investors such as pension funds, travelled to Ottawa for the daylong sales pitch underscores the importance of Canada in international debt markets.

Foreign lenders have been attracted to Canadian bonds by relatively high interest rates and the strong Canadian dollar, both products of Crow’s unyielding fight against inflation. In the first half of 1991, the latest period for which figures are available, foreign investors purchased $37 billion worth of Canadian government and corporate bonds, almost as much as they bought in all of 1990. Says James Kieman, president of the Toronto-based Canadian subsidiary of Goldman Sachs and Co., one of the largest international bond dealers: “When I look at this lending in aggregate, it is mind-boggling. It has been a benchmark year for the ability of Canada to finance itself globally.” Foreigners—mostly in the United States, Europe and Japan—now own 33 per cent of all Canadian bonds.

The surge of foreign investment is taking place while many Canadians are pessimistic about the country's future. But bond dealers, whose income depends in part on their ability to sell Canadian bonds, express a very different view. According to Kieman, “The farther away you get from Canada, the smaller its problems seem compared with those of other countries.” Added Sherry Cooper, manager of bond sales at Bums Fry Inc. in Toronto: “There is no one in the world more bearish on Canada than Canadians.”

But foreign investors can withdraw from the Canadian marketplace just as quickly and dramatically as they entered it. Said Kieman: “If, for any reason, foreign investors do not like what is happening in Canada and they start to sell off debt, interest rates will have to go up dramatically.” And Canadians, heavily dependent on foreign investors to finance large public debts, will have little choice but to pay the higher cost of borrowing.

In the meantime, however, Canadian bond dealers are thriving on Crow’s tight monetary policies. Added Kieman: “I guess we have to thank the governments of Canada for giving us the opportunity to sell all of this damn debt.” For bond dealers, at least, Ottawa’s large and growing debt comes with an attractive silver lining.

B. D.