- Despite recent innovations providing greater access to bond markets, the tax-exempt municipal bond investor base is still dominated by retail buyers.
- Independent research on retail transactions has shown an average loss in income of 0.55%. In a low-rate environment, this presents a substantial disadvantage to retail bond buying.
- Retail investors can avoid these punitive charges by buying mutual funds or ETFs. ETFs have a distinct advantage in that shares of the fund can be exchanged without the need to incur any transactions in the institutional market.
- In a low-yield environment, retail transaction costs can be a significant cause of erosion of potential returns.
INDIVIDUAL INVESTORS ARE AT A DISADVANTAGE
Owning individual bonds has its risks and rewards. However, buying a bond entails an unseen transaction cost, which may not always be clear to retail investors. This transaction cost exists because bonds are not typically sold with a commission. Instead, a markup is built into the bond price.
This report offers a transparent look at these hidden transaction costs for U.S. municipal bonds. To determine these costs, we used large, recently issued investment-grade bonds tracked by the S&P National AMT-Free Municipal Bond Index and the S&P AMT-Free Municipal Index Series, and high-yield municipal bonds tracked by the S&P Municipal Bond High Yield Index, in conjunction with bond transaction data provided by the Municipal Securities Rulemaking Board (MSRB). This information can help market participants compare the cost of buying individual bonds to the cost of investing in bond alternatives, such as mutual funds and ETFs.
From Jan. 1, 2020, through Sept. 30, 2020, the average implied transaction cost of buying an individual municipal bond of investment-grade quality was 0.72% for retail investors, compared with the average implied transaction cost of 0.17% for institutional trades. With yields on investment-grade municipal bonds averaging less than 2% during this timeframe, the difference of 0.55% in trade costs represents a significant, and immediate, loss of potential income.