Municipal Bond Forum
Mismanagement when bonds are called?
Q
As a trustee of a non-profit organization and without financial background, I am frequently confused at the discussions about the $30 million portfolio. Are there any rules that would point to carelessness? Twenty years ago, I was told that if bonds are called on a regular basis, it indicates a lack of attention because we should be selling them before they are called. What should I look for to determine if our broker’s buy/sell recommendations are maximizing his commissions? If, for instance, we are investing $150,000, would it be better to buy one bond or three $50,000 bonds? I understand diversity is an issue, but are commissions and fees based on the total dollar amount or the number of bonds purchased?
A
James A. Klotz responds:
Having bonds called does not reflect a poorly managed portfolio. Since most calls are announced 30 days prior to taking place, the bonds could not be sold at a high enough price to allow replacement of the income lost on the bonds about to be called.
Issues that are advance refunded (refinanced) to the call date are a different story. There is usually ample time to find an adequate replacement for these bonds since most pre-refundings are announced years before the actual call date.
Typically, when a bond is pre-refunded, its maturity is shortened to the call date and the quality is enhanced because the bond to be called is escrowed in Treasury bonds. This causes a rise in the bond’s value and a reduction of its yield, making an exchange for higher yield much more feasible. In most cases, this will also result in capturing a profit on the sale. We recommend replacing bonds in these instances because it allows the investor to execute a buy and sell under the same market conditions, rather than being subject to unknown future market conditions at the time the actual call occurs.
Although it is difficult to give hard and fast rules for appropriate block sizes, $150,000 in one bond is not considered a large purchase in a $30 million bond portfolio.
Yes, brokers compensation is typically determined by the size of the transaction. The number of bonds purchased usually equates to the total dollar amount.
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The responses provided in this forum are meant to address specific questions posed by investors about their municipal bonds and to provide market insight for our general audience. Please note, your investments, objectives, results and experience may differ significantly. Our answers and any potential strategies discussed should not be construed as a solicitation to buy nor sell any security or investment product. All investing entails risk.
