A new rule intended to increase transparency in the municipal bond market is instead creating some fog.
The rule, which takes effect next month, attempts to assist investors in understanding dealer markups, yet some are dramatically misconstruing its impact.
Consider, for example, a recent doozy published on the Bloomberg financial website written by Martin Z. Braun.
The article attempts to make the case that disclosing fees on investment-grade bonds, which it says averaged 1.1% in 2016, would prompt investors to move out of individual munis and into mutual funds.
“That’s because the fees they (mutual funds) charge will look cheap compared with what it costs for individuals to trade on their own,” the article states.
Muni fund fees are ongoing
What’s missing, of course, is a crucial fact. As another writer, Cate Long, points out, the median municipal mutual fund fee in 2016 was .78%, according to the Investment Company Institute, a fund association.
Such fees, of course, are charged annually, while the markup on individual bonds is a one-time fee.
“If retail investor(s) plan to hold either for years, (it’s) hard to justify the mutual fund unless the managers really outperform,” tweeted Long, a muni analyst formerly of Reuters.
So based on the figures cited, fees incurred by investors in mutual funds would far exceed the fees for individual bonds. Of course, neither is a trading vehicle and investors tend to hold them for long periods of time.
Muni laddering and other myths
But the cockeyed reasoning from the Bloomberg article doesn’t stop with one dubious prediction. It further piles on this faux doomsday scenario by saying the transparency rule is being implemented at the same time a “shift toward professionally managed accounts has already gained steam” due to some high-profile bankruptcies.
It’s unclear where the steam is being generated. As our decades in the municipal bond market have taught us, it makes no sense for investors to enlist professional managers who continually buy and sell munis on their behalf (“Successfully Managing Your Municipal Bonds”). It adds a layer of complexity and cost to the fundamental and straightforward goal of owning munis: reaping a dependable stream of tax-free income.
And those high-profile bankruptcies mentioned are simply that: high profile. Default rates among investment-grade tax-free bonds were, and continue to be, negligible.
Finally, the Braun article contends, the rule will drive investors from individual bonds once they learn the cost of constructing a bond ladder.
Again, we question the premise. As clients and friends know, we’ve long rejected ladders (“A Strategy for All”) for very simple reasons: They don’t work and they sacrifice a substantial amount of tax-free income, which is why investors are attracted to muni bonds in the first place.
What remains for muni investors
Such misinformation is disappointing but not surprising. Reports on the municipal bond market are rife with drama but not insight. Apparently, it’s challenging to write about unexciting though reliably profitable securities.
As for individual investors, they see through the fog. They will continue to focus on credit quality and yield and enjoy their tax-free income and peace of mind.
Q&A with James A. Klotz on the new pricing regulation and what it means to municipal bond investors.