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Unveiling the Hidden Cost of Retail Bond Buying & Selling Learn about the markup built into retail bond prices and its implications.
BY James Rieger

WHAT'S THE CATCH?

Owning individual bonds has its risks and rewards. However, buying a bond entails an unseen transaction cost, which may not always be clear to retail investors. This transaction cost exists because bonds are not typically sold with a commission. Instead, a markup is built into the bond price.

This report offers a transparent look at these hidden transaction costs for U.S. municipal and corporate bonds. To determine these costs, we used the investment-grade bonds tracked by the S&P National AMT-Free Municipal Bond Index, the S&P AMT-Free Municipal Series, high-yield municipal bonds tracked by the S&P Municipal Bond High Yield Index, investment-grade corporate bonds tracked by the S&P U.S. Issued Investment Grade Corporate Bond Index, and high-yield corporate bonds tracked by the S&P U.S. Issued High Yield Corporate Bond Index, in conjunction with bond transaction data provided by the Municipal Securities Rulemaking Board (MSRB) and the Financial Industry Regulatory Authority (FINRA). Based on this data, we have determined the average implied transaction cost of municipal bonds since May 2011 and that of corporate bonds since July 2011. This information can help investors compare the cost of buying individual bonds to the cost of investing in bond alternatives, such as mutual funds and exchange-traded funds (ETFs).

Year-to-date as of June 2016, the average implied transaction cost of buying an individual municipal bond of investment-grade quality was 1.11% for retail investors. The average implied transaction cost for high-yield municipal bonds was 1.93%. Investment-grade corporate bond transaction costs were lower, at 1.01%, and high-yield corporate bonds had an implied transaction cost of 1.74%.

Some Trade Data as Illustrations Only

On April 11, 2016, an investment-grade municipal bond with CUSIP #650009ZB2 was purchased from a retail bond holder at a price of USD 110.85. On that same day, a similar retail size position in this bond was sold to an individual at a price of USD 116.70 (a difference of USD 5.85).

Also on April 11, 2016, an investment-grade corporate bond with CUSIP #68268NAL7 was purchased from a retail bond holder at a price of USD 95.98. On that same day, a similar retail size position in this bond was sold to an individual at a price of USD 100.94 (a difference of USD 4.96).

WHAT ARE THE IMPLICATIONS?

Individual bond transactions may not always be efficient when compared with buying or selling mutual funds or ETFs, for which there may be lower, or no, transaction costs.If an investor were to buy a municipal bond with a face value of USD 10,000, the implied cost of that transaction would be USD 111. If the bond had a face value of USD 50,000, the implied transaction cost would be USD 555. If an investor were to buy a corporate bond of similar size, that cost would be USD 505.

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