Rule changes show potential benefits of municipal bond funds

April 5, 2018

 

Changes to regulations governing municipal securities transactions will require brokerage firms to disclose markups, or markdowns, of trades made for retail clients.

Those amendments, which take effect May 14, 2018, offer advisors the opportunity to reconsider the potential benefits for client portfolios of municipal bond funds and ETFs: lower costs, greater diversification, professional management, and liquidity.

The changes to the rules—which were passed by the Municipal Securities Rulemaking Board and approved by the Securities and Exchange Commission—are aimed at offering investors greater transparency.

Pricing details will need to be posted on clients' trade-confirmation statements when municipal bonds are bought and sold by their brokers on the same trading day. Those details include:

  • Price charged to the client.
  • Price incurred by the firm for a same-day trade.
  • The difference between the two prices.
  • The difference as both a total dollar amount and a percentage amount of the prevailing market price.

Many advisors have traditionally purchased individual bonds as a way to build bond ladders that can offer clients a potential stream of income and attempt to hedge against interest rate risk.

However, the market for individual municipal securities remains largely over-the-counter. Higher transaction costs can be common, and trading may be illiquid.

Now is an opportune time for advisors to reassess the potential benefits of municipal, and taxable, bond funds and ETFs for advised clients.

Lower costs: Municipal bond funds and ETFs can cost little. A $100,000 investment in a product with a 0.09% expense ratio would cost about $90 a year.

Greater diversification: Actively managed or index bond funds and ETFs typically offer clients exposure to hundreds or even thousands of bonds. That can significantly diversify their investment risk. Advisors can still target duration by using funds designed around short-, intermediate-, and long-term mandates.

Professional management: Bond funds offer the benefit of in-depth research and management expertise that provide sophisticated risk and credit analyses and cash-flow control, which can potentially lead to higher returns. Large asset managers can also leverage their relationships with issuers, as well as their expertise and scale, to benefit advisors and their clients.

Liquidity: Municipal bond funds and ETFs usually provide a considerably higher level of liquidity than individual muni bonds. In addition, bond ETFs feature intraday trading, which allows them to be bought and sold even when the underlying bonds are not trading.

Vanguard offers a wide variety of low-cost, tax-exempt bond funds, as well as a tax-exempt bond ETF, designed to fit clients' active and passive fixed income investment needs. For more information, select Investments above.

This client-approved brochure can help clients understand the basic features of bond funds and ETFs.

Notes:

  • All investing is subject to risk, including possible loss of principal.
  • Investments in bonds are subject to interest rate, credit, and inflation risk.
  • Diversification does not ensure a profit or protect against a loss.
  • Although the income from a municipal bond fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund's trading or through your own redemption of shares. For some investors, a portion of the fund's income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax.
  • Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

 

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