The Truth About Municipal Bond Costs

Last Updated Jun 27, 2010 11:40 PM EDT

Last Monday, my MoneyWatch colleague Allan Roth wrote about the dirty secrets of municipal bonds. Allan wrapped up his post by saying:
"I've heard many financial firms claim that their bond desk can sell munis for less than one percent. Yet when I push for more details, the conversation always seems to come to an abrupt end."
The implication here is that no bond desk is able to buy and sell municipal bonds in client portfolios for less than 1 percent. This statement is patently false.

I asked our bond desk to analyze the last several municipal bond trades they've made to see what the markup has been. Using a Bloomberg terminal, they can do post-trade analysis of where a municipal bond we bought or sold was traded in the inter-dealer (i.e., between dealers) market prior to us buying or selling the bond. When we buy (or sell) a bond, we try to buy (or sell) that bond as close to where that bond would trade in the inter-dealer market as possible.

This inter-dealer price also becomes the benchmark for comparison of the costs effectively paid on a bond trade. For example, if we bought the bond for a client at $102.10 and the bond traded in the inter-dealer market a short time before that at $102.00, then we effectively paid a markup of $0.10. In percentage terms, this is 0.09 percent and would be considered very good execution.

The bond desk analyzed our municipal bond trades in June that had a matching inter-dealer trade. This way, we could see what percentage costs we were paying and how that compares to Allan's statement. Here are the results:
  • Average cost -- 0.17%
  • Standard deviation -- 0.09%
  • Maximum Cost -- 0.50%
  • Minimum Cost -- 0.04%
As you can see, our fixed income desk isn't paying costs anywhere near 1 percent. In fact, there wasn't a single trade where our desk paid costs of 1 percent. This is exactly what I expected to see, as our desk monitors markup costs regularly to ensure our clients get the best execution possible. We feel that's part of our duty as fiduciaries to always act in our clients' best interests. So contrary to what Allan is saying there are certainly firms who are buying and selling municipals bond for less than 1 percent.

For further reading on municipal bonds, see my post on the current state of the municipal bond market.
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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.

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