Fee-Based Advisors Clamoring for Muni Bond Ladders

Are fee-based advisors looking to move more managed account assets into municipal bonds?  There is evidence that this is the case and that muni bonds as a percentage of managed account assets could grow over the next few years.

Research from MMI/Dover shows consistent growth of fixed-income SMA objectives that corresponds to a consistent decline in domestic equity objectives. In mid-2010, domestic equity held a scant lead, 40% to 37%. Among model portfolios, taxable fixed income leads the list with 22.4% of assets, ahead of large-cap value (19.1%) and large-cap growth (17.8%).

Some of the broad investment trends that have surfaced in recent years–alternative investments and tactical asset allocation–can be found in managed accounts.  Jean Sullivan, from Dover Research, says that these programs generally have become more conservative, with an increase in fixed-income strategies.

While taxable fixed-income SMAs are the leaders, municipal fixed income doesn’t even make the top 10, holding less than 2% of portfolio assets. “Many investors in fixed-income SMAs are nontaxable, such as 401(k)s and pension plans,” says  “They hold taxable bonds, Treasuries, agencies, corporates and some asset-backed securities.”

Why would investors want to hold bonds via managed accounts instead of a bond mutual fund or a low-cost ETF that tracks a bond index? Financial Planning Magazine quotes Randy Dry, managing director of the institutional group at Thornburg Investment Management in Santa Fe, N.M.:

“For the same reasons that you’d use separate accounts for equities,” Dry responds. “Investors own the underlying securities, not shares in a fund. You can make trades that improve your tax position. And you avoid the ‘flow shock’ that may affect mutual funds.”

Dry explains that investors get bond ladders with his firm’s fixed-income SMAs. About one-tenth of the portfolio matures every year and the proceeds are reinvested in 10-year bonds. This strategy, which some other fixed-income SMAs also follow, can protect long-term bond investors against rising interest rates because money would be available for reinvestment at the higher rates.

Thornburg, which offers muni bond SMAs, has a $2 million minimum. With smaller amounts, investors may have less diversification and face wider spreads on trades, Dry says.

One of my previous blog postings, Current Challenges for UMA Sponsors, covered a session from the MMI 2011 Spring Convention. Representatives from both UBS and Merrill Lynch both reported that their advisors had requested the ability to provide muni bond ladders to their managed account clients.  However, there are issues that have blocked these offerings being made available, such as determining the proper minimum account size and the amount of alpha that muni managers can bring.

While UBS and Merrill are still considering bond ladders, other large sponsors have moved ahead to make them available on their managed account platforms.

For example, in March 2010, Schwab Managed Account Services™ partnered with PIMCO and launched a bond ladder offering called the PIMCO Municipal Bond Ladder Separately Managed Accounts—five professionally managed strategies that seek to generate income by leveraging investment opportunities in the municipal bond market.

According to Schwab:

PIMCO conducts continual credit surveillance, reinvests maturing securities, and provides institutional purchasing power, all for a highly competitive fee. The SMAs have an investment minimum of $250,000 and a program management fee of 0.35% for the first $1 million invested, 0.30% for the next $4 million and 0.25% for investments above $5 million.

PIMCO selects investment-grade municipal bonds with an average credit quality rating of A- or better at purchase. These are assembled in laddered portfolios with 1- to 6-year, 1- to 12-year, or 1- to 18-year maturity rungs.

Some of the benefits of adding a muni bond strategy to a managed account include:

  • Periodic income generation—The strategies seek to generate tax-efficient, periodic interest payments, which can be distributed as they accrue1 or reinvested into new bonds in the ladder. Of course, investing in bonds carries risks, including the risk that a bond may fail to pay interest or principal, and the risk that it may lose value.
  • Ongoing credit monitoring—The manager selects investment-grade municipal bonds and regularly monitors the credit quality of your account holdings.
  • Bond replacement—When a bond matures, the manager will reinvest the principal by purchasing a new bond, typically at the longest maturity range or “rung” of the ladder. The ladder is extended until you request a payout of principal or your account balance falls below the $250,000 minimum.
  • Direct ownership and transparency—Unlike fixed income mutual funds, a municipal bond ladder offers direct ownership of the underlying bonds.

LPL Financial also claims that their proprietary fixed income trading platform that allows financial advisors to build bond ladders, select products, and process trades online for municipal bonds, corporate bonds, new issue corporate notes, and FDIC-insured CDs.

An article from AdvisorOne.com, Trends in Separately Managed Accounts: UMAs, ETFs and Alternatives, confirms that Envestnet is also seeing an uptick in requests for bond ladders.  The article quotes Mike Henkel, managing director of Envestnet/PMC and Tom Simutis, an Envestnet/PMC senior VP in charge of relations with SMA managers:

Fixed income alternatives are of particular interest to advisors now—“no one wants to be on the long side of fixed income,” says Henkel. Simutis confirms that Envestnet/PMC is always getting requests for strategies that are “noncorrelated” to the broader stock indexes, but also “replacements for fixed income. SMA managers are using ETFs, they can use synthetic shorts, can buy bundles of equities.”  There’s a growing use of ETFs as a component of a SMA manager’s strategy, he says, “where the rest of the portfolio may be invested in stocks or bonds.”

What else are advisors looking for? Simutis says that on the fixed income side, in addition to alternatives “it almost seems like a move toward a more traditional approach; we’re getting a lot of calls” for bond ladders, because “they’re cheap and easily understood.”

While this evidence is far from conclusive, it does appear to be a trend that should be monitored.  It would advisable for sponsors to investigate offering muni bond strategies on their platforms, so that they will be ready to respond when their advisors start demanding it.

0 Responses

  1. Hello-

    My firm has four municipal bond laddered strategies on the envestnet platform, a 5 year tax exempt and a five year taxable, and a ten year tex exempt and a ten year taxable.

    We have a very aggressive management fee, 15 basis points.

    Harris May
    Strategic Partners

    1. Harris,

      Thanks for commenting. Hopefully, any advisors who read this post will take a look at your strategies.

      I just published an article on Envestnet called, A Sneak Peak at Envestnet’s Upgraded iPad App. I think Envestnet is doing an excellent job improving the user experience for advisors and making it easier for them to find the best investments for their clients.




The Wealth Tech Today blog is published by Craig Iskowitz, founder and CEO of Ezra Group, a boutique consulting firm that caters to banks, broker-dealers, RIA’s, asset managers and the leading vendors in the surrounding #fintech space. He can be reached at craig@ezragroupllc.com