On May 14, the municipal-bond market's biggest investors may be in for a
That's when new rules will require brokerage firms to start disclosing
some of the fees they charge individuals to buy and sell state and local
government debt. Those fees, which firms build into the trades by marking the
price up or down, can be substantial: They averaged about 1.1% on
investment-grade bonds in 2016, or $1,100 for a $100,000 bond, according to
S&P Global. With 10-year AAA bonds yielding 2.5%, those transaction costs
can eat up several months of a returns.
The revelation could accelerate a shift toward mutual funds and other
fee-based accounts by individual investors who own about $1.6 trillion, or 40%,
of outstanding municipal securities, more than any other group. That's because
the fees they charge will look cheap compared with what it costs for
individuals to trade on their own.
"Why pay a point to buy bonds when you can pay a few basis points a
year to a mutual-fund provider and you get diversification and you don't have
to worry about a singular credit risk that comes with munis," said Matt
Fabian, a managing director at Municipal Market Analytics.
The new regulation from the Municipal Securities Rulemaking Board is the
result of a push to inject more transparency into
the state and local market, a haven for individuals seeking a safe source of
It comes as the shift toward professionally managed accounts has already
gained steam as the record-setting bankruptcies of Jefferson County, Ala., Detroit and
Puerto Rico heightened investors' awareness of the risks associated with
individual bonds. Mutual fund holdings of state and local debt have nearly
doubled since the end of 2008, during the height of the credi -market crisis,
according to Federal Reserve Board figures.
But the impact of the fee disclosures may be limited in part by
loopholes that regulators left in the new rules. Disclosure of markups to
retail investors — both as a dollar amount and as a percentage of the
prevailing market price — are required only when the dealer trades the same
security that day. Moreover, the size of the dealer's trading must equal or
exceed the size of the customer's transaction. If a dealer had a bond in
inventory and then sells it to a customer, that markup won't be disclosed. Nor
will it be when a customer buys bonds issued on the first day of an initial
Still, the requirements will affect a sizable number of trades. The
MSRB, which writes regulations for the market, said it may affect more than
8,000 retail transactions each day.
The exceptions may cause some initial confusion as markups are disclosed
on some trades but not others. Brokers will need to spend time explaining the
discrepancy and how the markups are calculated, said Patrick Luby, an analyst
who follows the municipal securities industry for CreditSights Inc. And
determining the market price used to gauge the markups can be complicated
depending on when the trades occur.
"Asking them to take more time to explain a municipal bond trade
isn't a welcome proposition, because they're already stretched pretty
thin," Mr. Luby said. Time pressures on brokers may also lead them to
pitch clients fee-based accounts, he said.
Municipal bond fund managers have welcomed the rule, anticipating that
new clients may emerge when they see how costly it can be to build a portfolio
of sequentially maturing bonds — a practice known as laddering — on their own.
"The perception up to this point is that laddering a municipal
portfolio is 'cheaper' than hiring an active manager," said Andrew
Clinton, founder of Clinton Investment Management, which oversees $430 million
of municipal bonds. "The clients never saw the actual transaction costs and
assumed, inappropriately, that they were getting that service for free."
Gurtin Municipal Bond Management charges 0.14 percentage point to ladder
a portfolio, depending on the strategy, said CEO Bill Gurtin. His firm oversees
$14 billion municipal assets.
"Not only are you getting proper execution and proper value, you're
also getting ongoing surveillance," transparency of fees and returns, and
a manager who, unlike a broker, is legally required to act in a client's best
interest, Mr. Gurtin said.
"It's hard to argue that the resources behind a professional
manager aren't substantially greater than behind a broker buying bonds on
behalf of a client," he said.
Click here for the original article from Investment News.