BigJohn wrote: ↑Tue Jun 21, 2022 7:54 pm
Individual bonds, on the other hand, can have bid-ask spreads of fifty to five hundred basis points. No, this isn't a typo. You will, unfortunately, have no idea that you are paying these hefty fees to the market maker. This is one of the financial industry's dirty little secrets. Okay, maybe not so little.
First, let's get terminology correct - there are no market makers in the bond markets. There is no requirement to have bids/offers on any security. There are "dealers" - analogous to car dealers if you like. They may offer to buy bonds which someone wants to sell, or they may not. Likewise, they may turn around and sell bonds which they have acquired, or they may not (generally they will). For bonds they want to sell, they may offer them for the hefty markup, which you have come to believe in, or they may sell for a loss. The latter has become more common YTD as a result of rising interest rates coupled with poor liquidity (relative to equity markets), at least in the municipal bond market. The key here is that there is no such thing as a "market order" when we are discussing bonds, and thus no such thing as a "market maker" that is always there to fill a market order.
At least in the municipal bond market, it is generally very clear what the spreads are. All trades are publicly logged and available for everyone to see. When I purchase a municipal bond, 90%+ of the time I know what the dealer paid for them, the date/time the dealer purchased them, and I can bid accordingly when that bond is being offered. Liquidity is extremely poor. Further, because (at least YTD) of volatility in interest rates coupled with the poor liquidity, it is not unusual being able to purchase bonds for less than what the dealer paid for them. I am at an advantage relative to the big institutional investor who is looking to purchase 100, 500, or 1000 or more bonds at a time. I'm more than happy with 5, 10, or 20...or not purchasing at all. The bond fund manager has to purchase or sell, I have no particular requirement any day of the week.
When we're discussing the secondary treasury market (in the follow up comments), we do not see these spreads because liquidity is extremely good - with a robust market. However, once again, there are no "market makers". What we see as far as the narrow spreads is a result of the instrument, the outstanding number of bonds, what it represents, and the security of the issuer standing behind it.
Well, I'm glad you've found a system that works for you. My comments are based on two well respected and expert forum contributors. Even if you assume you can take cost out of the equation, the diversification and liquidity benefits remain.
It is not "a system" at all. It is simply a matter of educating myself, understanding how the market works, and understanding the bond(s) I am purchasing (or very infrequently, selling - and always for a profit). These are things which the bond fundholder never does, instead deferring to the fund manager (who has ulterior motives) or gambling by deferring to the market (in the case of index funds/ETFs).
What other folks say or do is also unimportant to me. Some folks will take the words of "gurus" at face value, never investigate further (generally for fear of loss), and thus "settle" for what the market gives them - which is "gambling" and not "investing" as most would like to believe. Their favorite quotes are along the lines of "Nobody knows nothing and so I just put my money in an index fund" or "How can I know more than all the professionals and the market"? ...and then we have a period like we have this year, and we see a flood of threads questioning why folks have a bond allocation at all.
Why Rick Ferri chooses to own a municipal bond fund is good for him, and for most folks who like to think they are "investing". If you're satisfied with what the market will hand you, and are willing to sit passively and just watch it happen, I am happy that meets your objectives. My returns (i.e. lack of losses) this year have solidified my views. The amount of time/effort I choose to put in to bond research and selection has easily paid for itself. My bond portfolio will easily recover by year end, and going forward I will have increased my cash flows and yields.
When it comes to municipal bonds, bond fundholders are at a significant disadvantage. Any fees paid for management is too much - because there is very little knowledge needed to succeed in municipal bonds, the risks are that low. I will refer you to a report which Moody's updates every other year, which goes in to great depth about the municipal bond market, and how the risk of default is orders of magnitude lower than in the corporate bond market for equivalently rated bonds. Pay particular attention to Exhibit 4 on Page 12. I'd contend that if we stick to investment grade munis (A-rated or better), we could have a monkey throw darts at a wall of them to create a portfolio and never see a default (1 in 10,000 over 10 years).
https://www.fidelity.com/bin-public/060 ... l-bond.pdf
I am sure that Rick Ferri is familiar with this report and would concur that any municipal bond investor who simply sticks to investment grade munis (A-rated or better) would likely never see a single default in his/her lifetime. Bond funds wade in to the non-investment grade space, looking for yield boosters, but at higher (supposedly calculated) risk. They will claim this is why you pay for fund management, to uncover these hidden gems...and then you find that they own a nice chunk of Puerto Rico munis.
My municipal bond guru is James Klotz at FMSBonds. He will tell you everything I have just posted and vouch how municipal bond FUND investors are at a distinct disadvantage to folks who hold a portfolio of individual munis.
https://www.fmsbonds.com/news-and-persp ... nt-values/
On a positive note, holders of individual bonds have a much better outlook than investors in muni mutual funds and ETFs.
The managed mutual funds and ETFs will face a much greater challenge to return to their 2021 prices than will their individual bond counterparts.
Investors in individual bonds have a stated maturity date and fixed-income payments that cannot be altered.
Mutual Funds and ETFs have no maturity date as they contain a variety of bonds with various maturity dates. This means there is no promise to return their original principal and dividend payments are not fixed.
The decline in the Net Asset Values of these funds can be quite unsettling, considering the holders are also assessed management fees.
I've said enough. I really did not want to get in to a debate on this. I just get really tired of seeing the same, many times unjustified claims being made when it comes to bonds and funds, specifically when it comes to municipal bonds. I'll tap out. If you want to continue discussing or refuting, go for it.
Feel free to drop me a note on anything above - am happy to share my experience.