HOWTO roll your own high-level munis fund?? Help appreciated

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longview
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HOWTO roll your own high-level munis fund?? Help appreciated

Post by longview »

So all the talk of decreased NAV in bond funds in the coming decade is getting to me :oops: , as I DCA in over this year. So...

Does anyone have a system/site/book/link/provider that would allow for buying ~1 millions worth on munis each month? Ideally it would have the following properties:

- Buy munis directly at issue. (no buy/ask, etc).
- Munis would be easily tracked on a website, similar to any brokerage website and stocks.
- Money would ACH into an account at bond maturity.
- Easy viewing of the ratings on the bonds.
- Easy searching by state.
- Easy to avoid callables.
- Easy to avoid AMT.
- Bonus points for providing stats on the portfolio as a whole.

The idea is I'd build my own muni fund, with a duration around 5 years or so (maybe some longer, some shorter). I'd always be holding to maturity, so I don't need to worry about NAV dropping should interest rates rocket. And I'll reinvest at new interest rates as bonds reach maturity. As a bonus I can prefer my own state, for further tax reduction (this is all in taxable). :beer

Any hints or tips greatly appreciated. I know the numbers are large, but I'm thinking a well-diversified portfolio of $1k bonds that anyone is building should work the same way as a well diversified portfolio of $50k bonds.

Thanks.
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
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ogd
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by ogd »

Hi longview,

Please get yourself acquainted with http://www.bogleheads.org/wiki/Rolling_ ... Bond_Funds . Bottom line is, there is no difference if you plan to keep the duration fixed. This shouldn't be surprising, because a bond fund is made up of the same individual bonds that you'd be buying, and that you'd *keep* buying. You just need to get used to the idea that the fund will make up the NAV drop with higher yields, or, alternatively, that the same price degradation would have happened to individual bonds whether you chose to ignore it or not.

Individual bonds are more appropriate if you have some fixed liabilities (e.g. known tuition expenses 10 years from now) that you want to meet in the future, in which case a bond's naturally decreasing duration is the best fit. But usually, in my mind, the fund wins on diversification, convenience (e.g. just look at your laundry list of requirements), and quite likely spreads and liquidity.

There are some on this website who disagree. Larry Swedroe, for example, thinks there are free lunches to be had in the muni bond space for small investors, and a few other advantages; you can refer to some of his recent posts. You'll probably hear a host of opinions. What I'm trying to point is out that the NAV drop / hold to maturity is mostly a red herring and it shouldn't be the basis for a big decision like starting a massive muni bond ladder.
denismurf
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by denismurf »

What you propose is out of my league, but I have a friend in the business who might be able to shed some light on how to DIY. Stick around.
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longview
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by longview »

Thanks for the response.
Bottom line is, there is no difference if you plan to keep the duration fixed.
I understand this "theoretically" -- but isn't it more than "keeping the duration fixed" but really "constantly buying new bonds?" But, technically, there are a few differences:

1) no ER (I know, small, but it's a difference)
2) The principle, while illiquid, is not decreased.
3) The bonds don't constantly mature and need constant buying.

situation 1:
ie, If I buy 5 million dollars of 5 year-munis today, and hold for 5 years, and during that 5 years interest rates just take off like a rocket, at the end of 5 years I'll be very happy to reinvest my money in those higher interest rates. Now, I did miss out on buying new bonds during that 5 year rocket-ride, but now I get to invest my full principle in the higher yield.

situation 2:
You put 5 million in tax-exempt bond fund with the same average maturity today. Interest rates take off like a rocket for the next 5 years. Aren't you left at the end of that with a lower NAV, some older lower-interest-rate bonds, and are waiting for those to mature so you can get the new higher rate? And you have less money with which to buy those higher rate bonds?

Of course, this is all moot anyway if there is no convenient way to actually buy lots of munis. Anyone?
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
Sidney
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by Sidney »

longview wrote:situation 1:
ie, If I buy 5 million dollars of 5 year-munis today, and hold for 5 years, and during that 5 years interest rates just take off like a rocket, at the end of 5 years I'll be very happy to reinvest my money in those higher interest rates. Now, I did miss out on buying new bonds during that 5 year rocket-ride, but now I get to invest my full principle in the higher yield.
This is not what you stated in your OP. You have changed the game. This is a declining duration situation. The OP was constant duration.
I always wanted to be a procrastinator.
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longview
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by longview »

Sidney wrote: This is not what you stated in your OP. You have changed the game. This is a declining duration situation. The OP was constant duration.
Well, I don't know if there is a technical term for it, but isn't it really a "spikey" duration. At the end of the 5 years I'm going to reinvest for another batch of 5 years. It just isn't continual. So I guess my average duration is decreasing until it suddenly increases again? Hmmm. But I am buying 5 year bonds.

So, what would be wrong with that in today's bond market? :idea:
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
denismurf
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by denismurf »

Here's what my friend wrote, longview. I thought you were asking if you could buy new issues directly from the issuer. Looks like you can't.

"Actually individuals can buy new issue munis. They are available through Charles Schwab, but other brokerage houses offer them too. I am wondering why they have to be new issue though? S/he could definitely get an account with Goldman Sachs, JP Morgan, B of A/Merrill Lynch, or Morgan Stanley with that kind of money and buy all the new issue munis he/she wants. Obviously you want to be careful about the credits you are buying though."

Note that she wonders, as I do, why you limit your field to new issues. I understand your concern over bid-ask spreads on the secondary market, but I don't think they adversely affect the retail buyer's yield-to-maturity on essentially identical bonds. Please, somebody straighten me out on this question.

Note also her concern about quality. I know from conversations with her that she's cautioning against reaching for increased yield by going below AA for individuals. She thinks AA- is too risky for us small fry. She acknowledges that the rating companies screwed up big time back in 07/08, but thinks they have cleaned up their act by now.
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ogd
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by ogd »

Hi longview -- sorry to keep pounding on this argument, but you're about to embark on a lot of work if you do decide to go ahead with the individual munis and I think it's worth spending a little more time on that decision.
longview wrote: Well, I don't know if there is a technical term for it, but isn't it really a "spikey" duration. At the end of the 5 years I'm going to reinvest for another batch of 5 years. It just isn't continual. So I guess my average duration is decreasing until it suddenly increases again? Hmmm. But I am buying 5 year bonds.
Your average duration for the holding period would be about 2.5 years, so of course you're going to be affected less by interest rate risk. In return, you're giving up some yield in comparison with the bond fund, which keeps "lengthening" the duration by rolling the ladder forward to the same 5 years that it started with. You said you were okay with 5 years at current yields, why wouldn't you be okay with the same duration in a year or two? Particularly if the yields do get higher.

But look, it's easy to get lost in scenarios and argue endlessly about duration curve this, interest curve that. Instead, how about we look at the big picture, considering in isolation the components of bond ownership to see what affects returns. We have:
A) Selecting bonds
B) Buying bonds
C) Selling bonds (or holding till maturity, which is a special case of selling at duration zero)
D) Yield changes (due to interest rate or credit changes)

If you think about it, B) and C) are really what a fund does very differently. But in a liquid enough market, buying or selling a bond does not by itself lose money, it just realizes losses that already happened. Or to put it another way: if selling depreciated bonds early was a clear money loser, then somebody's getting free, easy money on the other side of the transaction. And the market just doesn't work like that.

As for D), the yield changes that everyone's so afraid of, it's something that affects bonds held individually and similar bonds held in a fund in the exact same way. It's just that the fund is required to mark the bonds down, reduce the NAV and increase the %yield to be the same as new issue bonds, whereas the individual bondholder can pretend nothing happened and both the principal and the yield are unchanged. But the returns will be exactly the same.

Which leaves us with A), selecting bonds. I prefer to be humble and assume the professionals will do a better job at it than me, not to mention that I don't have the slightest inclination to spend hours and hours bond-hunting and credit-checking every few years. And the minuscule ER of something like VCADX is well worth the time I save.

Fundamentally, the bond funds really are made of the same "stuff", and it shouldn't be a surprise they behave the same as a collection of individual bonds.

For the record, I'm in a similar position as you: my alloc calls for a *lot* of munis (though not quite the same $$ ballpark), I am wary of interest rate bumps, and I've given this a lot of thought -- but I couldn't come up with a good reason to go the individual bond route. I've heard from our respectable Larry Swedroe, among others, a few reasonable arguments: that liquidity problems affecting bond fund sales can be quite significant, e.g. in a stampede out of bonds, or that there are bond issuances too small for the big funds, yielding more as a result, that the individual investor can take advantage of. But still, I am unconvinced that any of this is worth the hassle, and in any event you will notice that these are *subtle*, *marginal* effects and not a clear-cut "holding to maturity is good in times of rising rates" mantra, which is just not true.
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longview
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by longview »

Thanks for the reply. I think here is the crux...
It's just that the fund is required to mark the bonds down, reduce the NAV and increase the %yield to be the same as new issue bonds, whereas the individual bondholder can pretend nothing happened and both the principal and the yield are unchanged. But the returns will be exactly the same.
Upon re-thinking what I'm considering... I'm really talking about market timing the bond market... but with munis rather than CDs (because CDs lose in taxable). The reasoning is:

- I'm pretty sure interest rates will go up on the next 5 years. or maybe 10.
- If I miss NAV increase from "mis-timing" and interest rates keep going down for awhile I don't really care.
- The goal is to get the "full principle" into bonds once interest rates are "back to reasonable."

I do think it's a nobrainer that interest rates will go up, the way I thought it was a nobrainer in 2005 that house prices would fall. I don't know exactly when, but it's going to happen in the short-term (vs a 40-year time horizon). So I'm trying to avoid that "large NAV decrease at the beginning of retirement hurts your long-term returns greatly" and would prioritize preserving principle until rates increase.

Or, with another spin, the bond return is not worth the risk of NAV decrease in the short-term. Especially given if there is an option to get a similar return without NAV decrease (even with the opportunity cost of the low-probability of missing continued capital gains in bonds).

I'm not looking to increase yield, or get out of bonds. But I would like to avoid decreasing NAV in the short-term, so I can come back in once rates increase. (And, if rates have really still crashed in 5-years, I'll re-evaluate -- since it's possible at that time CDs may be the better play if rates are really even lower.)

Make sense?


All that said... it doesn't really seem like there is an awesome bond-portfolio-tracker website. Seems like there would be a market there. I've been to Fidelity's muni buying website, and it seems like I'd be living in excel a lot.
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
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ogd
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by ogd »

longview, I think that even if you're market timing it still makes better sense to use bond funds, you'd just use smaller duration and shift in/out as needed. It's just that the NAV markdown thing makes this terribly confusing. Here's a simplified scenario that I played with when I was making my own version of your decision: suppose today, three of our fellow citizens hold the following assets:

Citizen A, afraid of interest rates but desiring yield, holds muni bonds maturing in 5 years.
Citizen B, being lazy, holds VCADX, with roughly 5 years duration.
Citizen C, being even more afraid of rate increases, holds cash.

Now suppose interest rates rise tomorrow. Just once, decisively and brutally, by like 5%. It hurts like hell, but it's enough to satisfy citizen A's gut instinct that there are no more rate hikes coming. What happens to the three portfolios?

Citizen A has suffered no apparent loss, but will have to wait 5 years to take advantage of the higher rates.
Citizen B has suffered about 25% NAV loss, but his depreciated fund shares are yielding more (on the depreciated basis). The effects of the rate hike will be gone after about 5 years.
Citizen C has suffered no loss and he can buy new bonds and start making the higher yield immediately.

From this it's clear to me that citizen A, although he'd like to think he's in the same boat as citizen C, is actually in the same boat as citizen B. They both suffered a loss, realized or not, whereas citizen C hasn't. To put it another way, citizen A and citizen B's assets are still interchangeable after the rate event, e.g. citizen B can sell his fund at a loss and *buy* the same depreciated bonds that A holds, on the market. By contrast, A and C's portfolios are clearly not interchangeable, there's no way that A can go back to the same amount of cash *now*.

What if the rate event takes place 1 year into the maturity period, you ask? In that case, A indeed loses less than B, but the same as B's cousin, Bprime, who was holding a bond fund with duration four years. And you can push the date further, to the point where if the rate hike happens the day before bond maturity, citizen A's holdings are indeed the same as cash, i.e. no loss. So if you want to play some sort of game of rate hike probability over time, you can still do it with bond funds of different durations and cash, and you aren't even limited to linearly decreasing duration.

So I'd say lower your duration if that makes you more comfortable, and just go with a fund. It will save you a lot of headache. Play timing games if you must, but at least you can do it with 2-3 clicks in your favorite brokerage, rather than a massive bond hunt.
frequentT
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by frequentT »

All of your requirements can be done via the Fidelity website. There are adequate new issue bonds to build your portfolio over time. Their bond portfolio analysis tool is excellent and will allow you to slice and dice your portfolio to look at it in a way that works for you. Graphic or tabular. They will also message you with regulatory filings and status changes.

If you are going for $millions as your post said, be sure to shop around for other benefits. With new issues, the issuer pays the distribution costs and commissions, however, the custodians and wire houses will be jumping for your business. Good luck.
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tigerman3
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by tigerman3 »

FYI, I just came across an "automatic muni bond investment ladder" investment at Charles Schwab. Managed by PIMCO, they select investment-grade municipal bonds with an average credit quality rating of A- or better at purchase. These are assembled in laddered portfolios with 1- to 6-year and 1 to 12 year maturity rungs. PIMCO regularly monitors the credit quality of the bonds, and replaces them upon payout of principal. Fees range between .25 and .35 for this separately managed account. See the following for more information.

https://investing.schwab.com/secure/cc/ ... nvestments
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longview
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by longview »

ogd wrote:longview, I think that even if you're market timing it still makes better sense to use bond funds, you'd just use smaller duration and shift in/out as needed. It's just that the NAV markdown thing makes this terribly confusing. Here's a simplified scenario that I played with when I was making my own version of your decision: suppose today, three of our fellow citizens hold the following assets:

Citizen A, afraid of interest rates but desiring yield, holds muni bonds maturing in 5 years.
Citizen B, being lazy, holds VCADX, with roughly 5 years duration.
Citizen C, being even more afraid of rate increases, holds cash.

Now suppose interest rates rise tomorrow. Just once, decisively and brutally, by like 5%. It hurts like hell, but it's enough to satisfy citizen A's gut instinct that there are no more rate hikes coming. What happens to the three portfolios?

Citizen A has suffered no apparent loss, but will have to wait 5 years to take advantage of the higher rates.
Citizen B has suffered about 25% NAV loss, but his depreciated fund shares are yielding more (on the depreciated basis). The effects of the rate hike will be gone after about 5 years.
Citizen C has suffered no loss and he can buy new bonds and start making the higher yield immediately.

From this it's clear to me that citizen A, although he'd like to think he's in the same boat as citizen C, is actually in the same boat as citizen B. They both suffered a loss, realized or not, whereas citizen C hasn't. To put it another way, citizen A and citizen B's assets are still interchangeable after the rate event, e.g. citizen B can sell his fund at a loss and *buy* the same depreciated bonds that A holds, on the market. By contrast, A and C's portfolios are clearly not interchangeable, there's no way that A can go back to the same amount of cash *now*.

What if the rate event takes place 1 year into the maturity period, you ask? In that case, A indeed loses less than B, but the same as B's cousin, Bprime, who was holding a bond fund with duration four years. And you can push the date further, to the point where if the rate hike happens the day before bond maturity, citizen A's holdings are indeed the same as cash, i.e. no loss. So if you want to play some sort of game of rate hike probability over time, you can still do it with bond funds of different durations and cash, and you aren't even limited to linearly decreasing duration.

So I'd say lower your duration if that makes you more comfortable, and just go with a fund. It will save you a lot of headache. Play timing games if you must, but at least you can do it with 2-3 clicks in your favorite brokerage, rather than a massive bond hunt.
Thanks for this write-up. Is there a resource that goes into some heavy mathmatical examples on this? I'm wondering if person B actually makes money (the difference in interest rates) -- or does he just get back to original NAV in 5 years? What are the net gains of the three scenarios at the end of 5 years -- assuming that big rate hike at the end of year one?
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
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longview
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by longview »

tigerman3 wrote:FYI, I just came across an "automatic muni bond investment ladder" investment at Charles Schwab. Managed by PIMCO, they select investment-grade municipal bonds with an average credit quality rating of A- or better at purchase. These are assembled in laddered portfolios with 1- to 6-year and 1 to 12 year maturity rungs. PIMCO regularly monitors the credit quality of the bonds, and replaces them upon payout of principal. Fees range between .25 and .35 for this separately managed account. See the following for more information.

https://investing.schwab.com/secure/cc/ ... nvestments
Thanks -- but it looks like the link wants a log-in?
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
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Re: HOWTO roll your own high-level munis fund?? Help appreci

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ogd
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Post by ogd »

longview wrote: Is there a resource that goes into some heavy mathmatical examples on this? I'm wondering if person B actually makes money (the difference in interest rates) -- or does he just get back to original NAV in 5 years?
I can't find an article heavy on data, maybe you can do some more googling and post here. The wiki entry by Allan Roth that I posted in the beginning has a lot of discussion, and I particularly like the section about duration http://www.bogleheads.org/wiki/Individu ... d#Duration , which answers your second question: B gets (as total return, NAV + dividends) not just the original NAV, but the yield he was promised before the rate increase.
longview wrote:What are the net gains of the three scenarios at the end of 5 years -- assuming that big rate hike at the end of year one?
Technically, the rate hike in my example was at the beginning of year one, to keep duration comparison fair. So B, as mentioned, gets the original yield, after the duration elapses. A gets somewhat less, because he keeps [passively] shortening duration down to zero, getting less term premium; exactly how much less depends on the shape of the yield curve after the rate event. Citizen C, if he buys a bond fund immediately after the rate event, will come out ahead of both by some 25% (i.e. 5% a year). Of course, if he stays in cash waiting for another rate hike, he'll do the worst :)
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ogd
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Post by ogd »

longview: I should also say that it's easy to get lost in all kinds of rate and curve scenarios, but at a higher level there's a simple principle from which all else follows: that bonds of equal credit and interest risk are priced correctly at any given point in time. If you accept this, then it's obvious to me that a bond fund, with all that extra trading, will still not lose you money vs the comparable bonds, other than expenses. Then you can look at the "holding to maturity" strategy as no more than a mathematical curiosity: here you have a particular curve of duration over time that guarantees you a lump $X payment in Y years. Interesting, but hardly worth making it the foundation of my bond portfolio with all the hassle that it implies.

An interesting addendum: see grok87's recent post about how retail investors can be taken advantage of by institutionals when it comes to the finer points like capital gains tax: http://www.bogleheads.org/forum/viewtop ... 0#p1699693 . The big funds do have some advantages.
gerrym51
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by gerrym51 »

these might be for you they are munis defined maturity muni funds


https://www.fidelity.com/mutual-funds/n ... rity-funds
jdb
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Post by jdb »

As an investor who has patiently built individual small lot muni bond ladder over past 7 years with bonds from almost all states there is no free lunch. Just bought two separate small lot non callable muni bonds on secondary market of 5 and 7 year durations of about $25K each in last two days using proceeds from matured bonds, there are decent products on market. Need to learn EMMA inside out, great tool. Need to know about derivative debt and how it can mess up muni bond finances. Need to read available literature including Larry Swedroe. Need to actually read the prospectuses of issues on Emma. Need to do some due diligence on municipal issuers that you are not familiar with above and beyond EMMA (actually easy to do on Google searches). Need to learn when to hold and when to fold, and what to avoid at all costs (never invest in Florida or California dirt bonds or property redevelopment or physician owned medical facilities anywhere). I buy less than one of every 20 that I read, after filtering for the ones I review. Silly to focus on new bond issues only, such a huge market you would be disregarding all the good secondary market issues. It is work, but very interesting and worth it if you spend time patiently leaning the ropes before investing. Otherwise better off picking good bond funds (I like Vanguard) and save energy for other more important things in life.
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Re: HOWTO roll your own high-level munis fund?? Help appreci

Post by abuss368 »

I understand your post, however before I would administer and manage such an account, I would prefer the simplicity, diversified, low cost admiral, and effectiveness of the Vanguard Intermediate Term Tax Exempt Bond Fund.
John C. Bogle: “Simplicity is the master key to financial success."
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