Nearly every day, I see municipal bonds trading on various platforms at higher prices than I've been watching them trade elsewhere.
And what bothers me most is that I know that behind those trades are real people for whom the stakes of making good investments decisions are high. So here, in my experience, are three things independent advisers can do to avoid common pitfalls of municipal bond buying.
ESTABLISH A CHECKLIST
One of the most frequent mistakes I see advisers make is that they focus on finding a bond with specific structural characteristics their client wants, and neglect to evaluate other potentially negative attributes. In doing so, they risk paying too much or purchasing a bond that turns out to be a poor investment. Therefore, I recommend that advisers establish evaluation criteria and a consistent process for vetting every bond.
From a structural standpoint, consider all attributes of the bond. Make sure to note a sinking fund provision, or any discrete or extraordinary calls. In some cases, you may need to check the official statement to clarify any ambiguity.
From a credit standpoint, make sure you're comfortable with the issuer's balance sheet and that you've checked for any relevant state and local news. Finally, I recommend looking up a bond's geographical location. Typically, more affluent areas have stronger balance sheets and credit profiles. If the area is less affluent, make sure you're getting paid in yield for the risk.
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Candidly, pricing is the hardest aspect of a bond to evaluate. But you can often do so by looking at where the bond has recently traded. Professional traders like to know its trading patterns over the last five or six days. If that reference point isn't available to you, check to see where similar bonds are trading.
And if you can, always look at interdealer trades. They occur between professionals, typically after lengthy due diligence on both sides, and they tend to be the best indication of a bond's true market value.
EMBRACE TECHNOLOGY
Admittedly, performing a thorough evaluation of bond characteristics can be time consuming. However, technology can ease this process and provide improved access and transparency. In addition to EMMA, there are now a number of platforms and online resources that can assist in this process.
Today, information tends to be fairly fragmented, so you may need to use more than one platform to complete your checklist. Remember that technology by itself isn't a panacea for effective investing, but it is a great tool to help advisers make more informed choices.
Once you've evaluated a bond for structural and credit pitfalls, you'll want to compare its price across as many platforms as possible. Bondholders are not required to offer bonds at the same price on every platform. Pricing can differ significantly between them.
TRADING PLATFORM
Execute trades with a platform aligned with your clients' best interest. While transactional platforms can offer an efficient way to buy bonds, many don't feature a price negotiation tool. And regardless, bond buyers often lack the market leverage and professional guidance to know how to negotiate effectively.
Therefore, I always recommend that independent advisers execute their trades through a platform in which every trade is touched by an experienced fixed income professional. Think of this as an extra set of eyes looking out for you and your client's best interest.
These specialists may see potential pitfalls that are not easily visible, and they have extensive tools and resources to evaluate potential risks and opportunities. Further, they can negotiate the best price possible, given real-time trading dynamics and market insights.
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When choosing the right firm, look for those aligned with the needs of the independent adviser and incentivized to work on your behalf; you're more likely to get better service and attention. Ask them to articulate their process for evaluating and negotiating bonds, and make sure you're comfortable with it. You want to know that they're in touch with the many exchanges that exist for any individual security.
And finally, any reputable firm should be transparent about what it is charging you on behalf of your client. You have a right to expect this, and you should.
Jason T. Ware is a co-founder and Managing Director at 280 CapMarkets.
