Purchasing a bond requires research and goes beyond looking for a good return on your investment and return of your investment. It requires time and effort, to insure that the security that you are investing in is safe and secure. Monitoring news, gauging the demand for bonds, the health of municipalities and projects, will go a long way to achieving a healthy return. A great way to start the process is by making a checklist.
- Read the Official Statement and pricing information – check Municipal Securities Rulemaking Board’s EMMA Website
- Diversification (diversify your bond portfolio geographically and by type) Purchase different types of bonds, as an example, some that are revenue bonds, and others that are general obligation bonds. Also, look at GARVEE bonds, which are tax-exempt debt instrument financing mechanisms that are backed by annual Federal appropriations for Federal-aid transportation projects.
- Credit quality (is the bonds underlying rating without insurance enough for you, is it reasonable compared to similar bonds). Bonds with higher rating will offer a lower yield. Find a combination that works for you and will let you sleep at night. Shop for AAA or AA rated bonds.
- Repayment sources (will repayment funds remain intact for a long time – what sources does the municipality use to generate income – for example taxes or tolls).
- Issue size (is there enough liquidity to buy and sell this at any time). The size of the issue is how much money is borrowed in total for this security.
- Maturity distribution (will they be able to pay you before money runs out). This requires dynamic monitoring. You will have to keep on top of the municipality’s news events to follow their progress.
- Sales history (see how the bond has been trading and how liquid it is based on recent sales on sites like Emma or investinginbonds.com). This requires that you look at past transactions to determine how much was bought and sold. If you are looking to buy $200,000 worth of a bond, but the last 10 transactions where for approximately $25,000, history is telling you that the security might not have sufficient liquidity.
- Price (are you paying a price with a reasonable amount of markup). Markup is the spread that a dealer is charging you for the transaction. To minimize this amount, you will need to speak to a number of dealers to get a fair value, and buy at least $25,000 at a time. Look for a markup of less than 4%.
- Yield (munis should have less risk than corporate bonds). Check multiple issues to determine if the combination of rating and duration justifies to that yield.
- What type of bond are you looking to add to your portfolio? Revenue bond, general obligation, pre-refunded bond, essential services. Each has a benefit, but a diversified portfolio creates the best risk profile.
- Does the state or local government have a letter of credit with a bank? When does it expire, how likely is it to be renewed by the bank.
- Insurance or lack thereof, collateral or lack thereof. Pre-funded Muni Bonds are great if they are backed by Treasury bonds. Make sure they are escrowed with US Treasurys, not Fannie Maes, not Freddie Macs, not Guaranteed Investment Contracts–GICS. You can verify this by entering the bonds CUSIP number on MSRB.org
- The maturity, debt coverage number, inflation risk, reinvestment risk, default risk, downgrade risk, supply and demand should be considered.
- Use web site such as muninetguide to perform research, bonds.com to find data and transactions, and the Wall Street Journal or Bloomberg to monitor the news
- New municipal bond issues help get you the best deal and pay less markup.
Investors also need to determine if the bond is issued for private activity. This is a concept that will affect the tax treatment of the bond. Projects such as stadiums, airports, recycling facilities and some housing developments, are subject to AMT (alternative minimum tax). The alternative minimum tax is a high tax that hits at specific income levels. Check with your accountant to determine if you fall into AMT. Private-activity bonds usually offer higher yields than conventional munis to compensate for the risk that they could be taxable to some investors.
Bonds to avoid include tobacco bonds. With smoking rates falling, there is the likelihood that a future payment might be missed. Also, avoid Interest rate swaps, sub debt, and PIK bonds.
Additional Related Municipal Bond Educational Articles:
What are municipal bonds?
How to Research Municipal Bonds
The Risks of Owning Municipal Bonds
How to Buy And Sell Municipal Bonds
Municipal Bond Mutual funds – Municipal Bond Managed Accounts
What Are Closed-end Municipal Bond Funds?
What are Municipal Bond Exchange Traded Funds or ETFs
How to Make a Municipal Bond Ladder
How to Select Municipal Bonds
Municipal Bond Trading Example
How to Perform Active Municipal Bond Management
Municipal Bond Books and Educational Resources