Municipal

Blog March 17, 2017

Trading Effectively in an Inefficient Municipal Market

Successful investing always requires skillful trading, but it’s especially critical in the inefficient and opaque municipal market. Since our inception, Breckinridge has worked very hard to develop the best possible capabilities in municipal trading. Today, we believe that the expertise of our trading team, supported by our proprietary technology and extensive network of strong dealer relationships, provides considerable value to our client portfolios. To fully appreciate the potential benefit of good municipal trading, it’s important to understand some unique aspects of the municipal market.

In some ways, buying a municipal bond is a lot like buying a house. Municipal bonds, like houses, trade very infrequently. Only 11 percent of the municipal issues in the Barclays Index traded in the first nine months of 2016.1 Consequently, as with a house, a municipal bond’s price is rarely determined by an active trading history. Instead, a bond buyer must look all around the “neighborhood” to analyze recent comparable activity in buying and selling. Similar to the real estate market, the municipal market’s most knowledgeable and well-connected buyers will be best positioned to identify value and take advantage of the best potential opportunities. Of course, the best opportunities also trade the most quickly. We believe that, by being poised to exploit those opportunities, Breckinridge’s traders have a significant advantage.

In other ways, buying a municipal bond is actually much more challenging than buying a house. First, buyers in the housing market can search a central database, the Multiple Listing Service (MLS), that lists almost every house for sale. In contrast, while there are some large internet platforms in the municipal market there is no central repository of all offerings – especially not for new issues. Moreover, municipal dealers are normally reluctant to post their most attractive bonds on market platforms before first offering these bonds directly to more valued customers. Not surprisingly, dealers’ most valued customers are those who buy the most bonds. With a weekly trading volume averaging well above $100 million,2 we believe that Breckinridge obtains more opportunities to find value in the municipal market for our clients.

The other significant factor that makes buying a municipal bond more challenging than buying a house is that dealers typically act as principals and own the bonds they offer, unlike real estate agents who act as brokers. Nor are municipal bond dealers obliged to disclose markups. This can clearly motivate a dealer to recommend a particular bond at a higher price in order to achieve a higher markup and profit. The only effective way a buyer can protect against this is by having at least as much market knowledge as the dealer, and by putting all dealers in competition with each other when buying and selling bonds. Breckinridge does exactly that through a network of over 150 municipal dealers. In this way, we work to minimize dealer markups and execute more efficiently than is typical for the market, as reflected in the graph below.

Most investors would agree that the greater the market’s inefficiency, the greater the potential value that can be added through more-proficient trading. In the municipal market, inefficiency often means one side of a trade is significantly better or worse than the other. Our goal at Breckinridge is to have the best trading capabilities, and thereby to always be on the right side of every trade for our clients.

 

[1] Breckinridge Capital Advisors and the Municipal Securities Rulemaking Board (MSRB), as of September 30, 2016. Index refers to the Barclays Five-Year (4-6) Municipal Index.
[2] Breckinridge Capital Advisors. Trading volume calculated as total par amount of weekly buys and sells (between January 1, 2016 and March 12, 2017) for Breckinridge trading desks.

DISCLAIMER: The material in this document is prepared for our clients and other interested parties and contains the opinions of Breckinridge Capital Advisors. Nothing in this document should be construed or relied upon as legal or financial advice. Any specific securities or portfolio characteristics listed above are for illustrative purposes and example only. They may not reflect actual investments in a client portfolio. All investments involve risk – including loss of principal. An investor should consult with an investment professional before making any investment decisions. This document may contain material directly taken from unaffiliated third party sources, including but not limited to federal and various state & local government documents, official financial reports, academic articles, and other public materials. If third party material is included, it is believed to be accurate, and reliable. However, none of the third party information should be relied upon without independent verification. All information contained in this document is current as of the date(s) indicated, and is subject to change without notice. No assurance can be given that any forward looking statements or estimates will prove accurate or profitable.