Municipal Market Data Suggests Retail Investors May Be at a Disadvantage | Lord Abbett
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Fixed-Income Insights

Missed opportunities and lower yields on purchases are evident.

Read time: 3 minutes

Investors have shown a lot of interest in municipal bonds over the past few years. But while some investors have opted for mutual funds and separately managed accounts (SMA), others have purchased individual bonds.  Is there any evidence that one means of investing is better than the other? Each year the Municipal Securities Rulemaking Board (MSRB) compiles a fact book on the municipal bond market that can shed some light on this question.  (Unless otherwise indicated, all data in this article are from the MSRB fact book.)

According to the latest edition of the fact book, in 2019 the average daily trading volume of municipal bonds (by par value) was $12 billion. Of that, trades of more than $2 million amounted to $8 billion, and trades of $1 million to $2 million totaled $1 billion. This means that approximately three quarters of trades (by par value) were of $1 million or more.  In contrast, trades of $75,000 or less came to just $0.6 billion. Though some retail investors buy in large amounts, this data suggests that most trading occurs among institutional investors.

Looking just at purchases, $4.5 billion out of $6.1 billion were in trades of $2 million or more in par value, and another $0.5 billion was between $1 million and $2 million of par value. This means that more than 80% of purchases (by par value) were by institutional buyers.

The hours when large trades occur hint at a possible advantage for institutional investors. According to the MSRB data, the highest trading volumes occur between 11 am and noon, with about 6,000 trades (See Chart 1). The average size of these trades, however, is small, about $350,000. In contrast, prior to 8 am, only about 90 trades occur, but they average $1 million. Between 8 am and 9 am, the average trade is over $700,000.   

This data suggest that institutional buyers are dominating the markets early in the day, while retail investors get involved later.  This means that institutional investors might be buying the best offerings before individuals even see what’s available. Large buyers might also get the best available bids on sales.

 

Figure 1. Institutional Investors Dominate Early in the Day

Average daily trade size by time of day in 2019

1 Trades executed within 15 minutes prior to the time shown, Eastern time

2 Trades reported after 6:30 pm and before 7:30 am.

Source: Municipal Securities Rulemaking Board.

 

The information on purchase yields is also instructive. The average yield on a purchase of $25,000 or less was just 1.98%, while the average on those of more than $2,000,000 was 2.33%. This could be due to differences in maturities, with larger trades buying longer bonds, and by differences in credit quality, with larger buyers purchasing lower-rated bonds. The 35 basis-point difference in yields could mean that institutional buyers get better prices on comparable purchases. But it may also suggest their diverse portfolios allow them to take on risks associated with longer bonds, and their research capabilities enable them to evaluate lower-quality credits to obtain higher yields prudently.  

With bond sales, the situation is somewhat reversed.  The average yield on sales of $25,000 or less was 2.33%, while the yield on a sale between $1 million and $2 million was 2.10%.  The average on a sale of more than $2 million was 2.27%.

This is interesting. If institutional investors are obtaining higher yields due to longer maturities and lower average credit quality, why are larger trades being sold at lower yields?  In our view, this clearly suggests that the price for liquidity in selling smaller bond positions is considerably higher than it is for larger trades.  

 

Figure 2. Yields Are Lower on Small Buys, Higher on Small Sales

Average daily yields by customer trade type and size, 2019

Source: Municipal Securities Rulemaking Board. Data are for transactions involving tax-exempt, fixed rate securities.

 

The fact book also shows that the sector with the most trades and the largest par value was education, meaning mostly universities. Second was utilities. For retail investors, who may focus primarily on general obligation bonds, this means they may miss many opportunities.

Summing Up  

  1. While opportunities are available throughout the day, the average trade is larger earlier in the day. This suggests that institutional buyers are generally making moves before individuals are.    
  2. Although individual investors are making more trades, the vast majority by par value occurs among institutional investors.
  3. On their bond purchases, larger investors are getting higher yields. This could reflect receiving better prices, but it could also mean they can take more risk with longer and lower-quality bonds because their diversified portfolios and research resources afford them this opportunity.
  4. On their bond sales, larger investors are getting lower yields, which means higher prices. This could reflect lower costs for liquidity for institutional investors.
  5.  Most trading occurs in revenue bonds. This suggests that investors who focus only on general obligation bonds are missing opportunities.   

In summary, when investing in municipal bonds, retail investors may be at a disadvantage. Large, professional investors appear to enjoy certain benefits, including access to a wider range of opportunities. The end result:  returns may differ widely between institutional and retail investors.

 

A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government in case it provides financial support to the municipality. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Because many municipal instruments are issued to finance similar projects, conditions in these industries can significantly affect an investment. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply. High-yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Lower-rated investments may be subject to greater price volatility than higher-rated investments. A portion of the income derived from a municipal bond may be subject to the alternative minimum tax. Any capital gains realized may be subject to taxation. Federal, state, and local taxes may apply. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Investments in Puerto Rico and other territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems.

The information provided is for general informational purposes only. References to any specific securities, sectors or investment themes are for illustrative purposes only and should not be considered an individualized recommendation or personalized investment advice, and should not be used as the basis for any investment decision. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future. Past performance is not a reliable indicator of future results.

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

A basis point is one one-hundredth of a percentage point.

Yield refers to the earnings generated and realized on an investment over a particular period of time and iss expressed as a percentage based on the invested amount, current market value, or face value of the security. The tax-equivalent yield is the pretax yield that a taxable bond needs to possess for its yield to be equal to that of the tax-exempt yield on a municipal bond. This calculation can be used to fairly compare the yield of a tax-free bond to that of a taxable bond to see which bond has a higher applicable yield.

The credit quality of the securities in a portfolio is assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor's, Moody's, or Fitch, as an indication of an issuer's creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer's ability to pay interest and principal on these securities.

Bloomberg Barclays Index Information:

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education.  None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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