Having toiled in the municipal bond market for more than 40 years, we are accustomed to the financial media’s focus on the stock market and its often mistaken notions of muni intricacies and nuances.
We let most of these distorted reports pass without comment, primarily due to the lack of credibility of the author or the publications that publish them.
However, a combination of the Wall Street Journal, a veteran financial columnist and numerous emails to our offices compelled us to weigh in on last week’s “Intelligent Investor” column, “How Muni Bonds ‘Yield’ 4% in a 2% World.”
Let’s start with that headline and how the author determines that the muni bond market is in a 2.00% world.
He quotes the Barclays Municipal Bond Index as showing a yield of 2.20% without describing how this index is compiled or the bonds it tracks. He also cites the Vanguard Long-Term Tax-Exempt Fund as yielding 2.30%, overlooking the fact that this fund contains bonds that mature in 6-10 years.
Obviously, this particular fund is long term in name only.
As our clients know, we currently offer AA-rated, insured, long-term bonds with 4.00% coupons that sell at 100.00. So logic dictates that when retail investors can buy high-quality 4.00% bonds at 100.00, they are not in a 2.00% world.
Munis are a fixed-income investment
The opening line of the column suggests that “overstating the expected income on municipal bonds in brokerage or advisory accounts is one of the most pervasive and persistent ways the financial industry fools the investing public.”
As even novice bond investors know, munis are a “fixed-income” investment. If one buys a bond with a 4.00% coupon, it invariably pays 4.00% until it is either called or matures. In other words, the income is fixed at 4.00%. This is not an illusion and cannot be overstated.
As the author should remember from his early days as a bond reporter, the only figure actually printed on bearer or registered bonds was the coupon amount. It never changes.
Yes, premium bonds mature at par
We are also confused as to how to interpret the example of an investor who bought into a portfolio of tax-free bonds and claims to have received a lower return than he was promised, presumably because he was sold premium bonds without knowing that they would, by definition, mature for less than his original investment.
It is difficult to understand how this could occur if he was buying individual bonds, not some type of fund. The column doesn’t specify.
We do know, however, securities regulations require brokerage firms selling premium bonds to state the “worst case yield” on the client’s confirmation of purchase. This worst case yield accounts for the potential of a premium bond being retired before maturity for any reason.
The columnist suggests investors should “ask your broker what the ‘yield to worst’ is on your munis and if she can’t tell you, maybe you need a new advisor.”
That’s a provocative closing line to the story. But the columnist, who said he’s been a bond market reporter since 1988, should know, and probably does, that since December 1977, MSRB rules G-12 and G-15 require the “yield to worst” figure be printed clearly on customers’ confirmations by brokerage firms.
As for advisory accounts mentioned in the column, we can’t comment. We don’t offer managed accounts because we don’t believe that munis need to be managed, which is why we provide assistance and information to investors for building their own bond portfolios without the recurring fees attendant to managed accounts.
In fairness to the columnist, if the brokerage statements to which he refers display yields based on current market value (as many do), these are bogus calculations and in fact are materially misleading. But he misses the point when he writes that this is overstating income; actually, it’s overstating the yield.
Again, the income is fixed. Yield and income are not coterminous.
Statements that routinely quote this current yield are misleading because this yield is calculated by dividing the coupon interest rate by the current market value of the bond (cash on cash). So if you own a bond that is declining in price, the yield would rise. In fact, the yield would be higher for a new investor purchasing these bonds at the current price but not for you. Your yields are still as stated on your confirmation at the time of purchase.
That’s the key: The figures on investors’ confirmations reflect the true yields they can expect to receive over the life of their bonds. Plain and simple.
Although we applaud the columnist’s intention to protect investors, his suggestion that this is “one of the ways the financial industry fools the public” is painting all industry participants with the same brush. Some of us have better intentions.
Misleading investors is never a virtue, but the columnist comes perilously close to doing exactly what he cautions his readers to avoid.