Trading costs substantially higher for mom and pop than institutions: MSRB

The cost of trading municipal bonds remains stubbornly higher for mom and pop investors than for institutional buyers buying large blocks despite pre-2020 progress in closing the gap.

“There’s an inverse relationship between trade size and the effective spread,” said Simon Wu, chief economist at the Municipal Securities Rulemaking Board, who presented a paper Tuesday outlining transaction costs at Brookings’ annual municipal finance conference.

In the equity market, the gap is reversed, Wu noted. “The odd lots tend to be cheap to trade,” he said. “But in the fixed-income markets it’s exactly the reverse, and not just for munis; it’s also for corporates.”

The smaller the lot, the higher the cost, although that’s shifted a bit since 2023.

Transaction costs as measured by effective spread, which Wu measured by bond price not yield, are 56 basis points for odd-lot customer trades and less than 18 basis points for block trades, the MSRB found.

While smaller trades have higher effective spreads than larger trades across all fixed income securities, the difference was more pronounced for municipal securities, where it was a 38 basis point spread, while corporate bonds had a 25bps spread and agency securities a 32bp difference, the paper found.

A rising number of the odd-lot buys are coming from separately managed accounts as SMAs continue to grow in the muni market. Household ownership of individual bonds, which includes SMAs, was the largest category of muni ownership at 44.6%, according to Federal Reserve data. Mutual funds owned 19.2%; ETFs 3.1%; and U.S. banks at 12.4%.

Drilling down into transaction costs is important because it can help dictate future policies that may help to bring down those costs, Wu said.

“The obvious question is whether any potential change in market structure may help further reduce transaction costs for odd-lot customer trades relative to other types of customer trades,” he said in the paper. “Further research would be needed to investigate this possibility.”

While the gap has remained “substantial” over the last few years, the long-term trend is encouraging, Wu said. Transparency initiatives and electronification of the muni market will help narrow spreads, he added.

Maturity may also have an impact on transaction costs, said Brad Wendt of Charles River Associates, who weighed in on the paper at the conference. The emphasis on trade size and effective spread, “I agree with that 100%,” Wendt said. “But we also need to look at maturity,” he said. “There’s far less risk with a one-year bond than with a 30-year bond,” he said. “As you go out the curve … the commission changes,” he said. “So that’s very important information we need.”

The paper, which compares the transaction costs of municipal bonds to other fixed-income securities, builds on earlier MSRB research that found the cost of trading municipal securities have climbed since early 2022 despite a long-term downward trend since 2009. The larger market backdrop of lower bond prices, rising interest rates, inflation, and volatility have stalled the long-term downward transaction cost trend.

Unlike the previous two interruptions to the long-term downward trend — the “Taper Tantrum” in 2013 and COVID pandemic in 2020 — the spike in costs starting in 2022 have not come back down quickly, Wu noted.

The paper found that the average effective spread for municipal securities traded between January 2023 and June 2024 was 53 basis points, as compared to 36bps for corporate bonds and 40bps for agency securities.