Executive Summary
- 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 number reflects a substantial potential disadvantage to retail bond buying.
- These costs could potentially be avoided by accessing bonds through 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.
Hidden Risks
Owning individual bonds has its risks and rewards. However, buying a bond may also entail an unseen transaction cost that might not always be clear to purchasers. This transaction cost exists because individual 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.
