On May 14, new Municipal Securities Rulemaking Board (MSRB) regulations will require the disclosure of the often dramatic markups, or transaction costs, that retail investors are subject to when buying individual municipal bonds.
Specifically, the new regulations will require confirmation statements to show both the dollar and percentage amount of the markup (or markdown), the date and time of the trade, and a link to emma.msrb.org, where the public can get more investor-friendly information about muni bond prices, market trends and more. All of this is good.
And yet, it’s likely to outrage many investors. Why? Because until now, many of them thought they’d been getting something for nothing, and as is clear from the above Display,that isn’t so.
Not All Prices Are Equal
It’s not uncommon for individual investors to think that their execution price—the “price paid” that they see on their pre-May 14 confirmation statement—is the price procured by all municipal bond investors at that time. Many believe that there is no fee or cost associated with their transaction. But that’s not the case.
The reason there’s a cost has to do with volume and convenience, and it’s a familiar story. The brand-name specialty dog or cat food on the shelves of your local boutique pet store is expensive. But the exact same brand of pet food is also available in a large bag from Amazon.com, where it costs a whole lot less—a function of both quantity and conveyance.
Similarly, there’s a significant markup on small trades made in the bond market compared with the large-block trades made by mutual funds, ETFs and separately managed accounts (SMAs). When a dealer sells a small block to a retail investor, it’s priced higher than a large block sold to an institutional investor such as an asset manager, because of the volume and inconvenience of trading to multiple partners.
What constitutes a large trade versus a small trade? Large blocks are measured in the millions of dollars, with $5 million blocks a frequently traded unit. Individual (retail) investors commonly trade in lots of $20,000 or $25,000. While that’s unquestionably a lot of money, even lots running up to $100,000 are not large enough to avoid big markup penalties.