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...municipal bond portfolio managers would add Detroit or Puerto Rico to the mix to boost yield. Now that those credits have been exposed, what will managers buy today in order to boost yields? The answer, it seems, is largely anything.

A Point & Click World

March 7th, 2014 by Kurt L. Smith
  • I found myself thinking I have lived through this time before.  Stocks are at all-time highs (again), homes are being torn down for new ones (again), internet stocks and their firms are cool (or hot, again) and the idea of trading municipal bonds via point and click is not only a reality but seemingly continues to gain momentum.

    I was reminded (again) of municipal bonds and their growing presence on internet trading platforms during a visit by one of my vendors last week.  I have used his internet based trading system for many years, indeed since stocks were last at an all-time high, houses were being torn down and internet companies were cool.  While he was showing me the latest and greatest features of the system I remembered my fears of where the municipal bond market may be heading.

    Point & Click trading of municipal bonds wasn’t my fear.  We have benefited greatly from a more transparent, wider reach of internet trading platforms in bringing us worthwhile bond opportunities.  My fear was that municipal bonds would move towards a corporate bond type model in which fewer individual bonds would be issued but those that were would be of greater size, more similarity, and trading would be on the basis of a spread.  In other words, every ten year bond would begin to look and trade like every other ten year bond, just that some would have a better sounding name than others (sorry Louisiana).

    Fifteen years ago I figured municipal bond insurance was the key to making the municipal market more generic and easier to trade.  Tell me the difference between the municipal bond insurers in 2000?  With insurance, every ten year insured bond was indeed like every other insured ten year bond and by golly they should trade similarly too.  This was the approach taken by the huge players in the municipal market (they were working it well with corporate bonds) and if this was the case then you didn’t need a lot of talent to trade municipal bonds nor did you need to pay expensive salespeople to move the product either.  If ten year insured paper was trading at a 15 basis point spread then even a monkey could price, bid and buy ten year insured municipal bonds.  Soon I believed they would.

    Under such a system, talent scatters.  No longer do you need many talented people to work in the municipal marketplace; you soon needed few.  Let the monkeys and near monkeys work in the systems to keep the municipal market functioning.  Let them trade what they can; I will trade the rest, or more accurately, I will use “the rest” as my starting point.

    Back to my vendor visit, I was somewhat surprised that his platform recently accounted for one third of municipal bond trades in the fourth quarter of 2013.  This internet thing is working better (and faster) than I had imagined.  But wait a minute. Wasn’t it municipal bond insurance the catalyst for making municipal bonds generic and hadn’t municipal bond insurance all but disappeared after 2008?  Well, my bad.  Seems investors look at ten year municipal bonds similarly sans insurance.  And why shouldn’t they?  Aren’t all ten year bonds similar?  The answer of course is that all ten year municipal bonds are indeed similar IF they pay off (similarly).

    Much has transpired in the almost fifteen years since Point & Click municipal bond trading systems hit the scene.  On a computer screen, municipal bonds appear as names and numbers but they are sorted by maturity and spreads and seemingly this makes the Point & Click experience so…easy.  We are more efficient.  We see more and can get more done so there is seemingly the need for fewer of us.  Buyers of municipal bonds have much greater access, fewer gatekeepers and more trading is occurring on the internet platforms.

    Every month I attach the yields of a recent municipal bond sale.  To simplify, this is what generic looks like.  If you didn’t like those yields (or those yields were not enough to pay your manager and still be positive) municipal bond portfolio managers would add Detroit or Puerto Rico to the mix to boost yield.  Now that those credits have been exposed, what will managers buy today in order to boost yields?  The answer, it seems, is largely anything.

    Every day I power up my workstation, connect to the internet and see any and everything the municipal market has to offer.  I have tools that can show me bonds that are offered slightly cheaper than their peers.  Again, this is the power of my app.  I also can (or more correctly, I watch others) bid for bonds at or near a so-called benchmark yield.  Even a monkey, or another machine, could be programmed to do it.  Perhaps that is why I see bonds that I and others deem as speculative and non-investment grade trade as if they will pay off as scheduled.

    The progression to more Point & Click, in my opinion, does not make the municipal bond market stronger or better.   Better machines and fewer people will beget better machines and fewer people – that is the trend over the past umpteen years.  But our concern isn’t with the strength or even the resilience of the municipal bond market.  Our concern is with the bonds we buy and whether they will be able to perform as scheduled and whether we can continue to find more worthwhile opportunities.  Let others Point & Click and perhaps overpay for bonds that have a chance at performing.  I will continue to sift through the marketplace as I have done for years and utilize The Select ApproachTM to continue to bring value to your municipal bond portfolio.

    Northside Independent School District, TX
    Moody: Aaa (Aa1 Underlying) S&P: AAA (AA+ Underlying)
    Permanent School Fund Guaranteed
    DUE 6/15 DATED 3/1/14 MATURITY: 6/15/2033
    SALE AMOUNT: $74,175,000

    1 2015 2.00% 0.18%
    2 2016 5.00% 0.30%
    3 2017 2.00% 0.51%
    4 2018 2.00% 0.81%
    5 2019 2.50% 1.09%
    6 2020 4.00% 1.56%
    7 2021 5.00% 1.91%
    8 2022 5.00% 2.21%
    9 2023 5.00% 2.44%
    10 2024** 5.00% 2.61%
    11 2025** 5.00% 2.74%
    12 2026** 3.00% 3.12%
    13 2027** 3.00% 3.28%
    14 2028** 5.00% 3.06%
    15 2029** 5.00% 3.17%
    16 2030** 5.00% 3.27%
    17 2031** 5.00% 3.36%
    18 2032** 4.50% 3.63%
    19 2033** 4.50% 3.70%

    *Yield to Worst (Call or Maturity) **Par Call: 6/15/2023
    Source: Bloomberg
    This is an example of a new issue priced the week of 3/3/14
    Prices, yields and availability subject to change


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