On May 14, the municipal-bond market’s biggest investors may be in for a shock.
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 percent 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 percent, 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 percent, of the 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 tax-exempt income.
(Related: New Platform Lets Indie Advisors Trade Bonds)
It comes as the shift toward professionally managed accounts has already gained steam as the record setting bankruptcies of Jefferson County, Alabama, Detroit and Puerto Rico heightened investors awareness of the risks associated with individual bonds. Mutual-fund holdings of state and local debt has nearly doubled since the end of 2008, during the height of the credit-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 mark ups 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.