March 10, 2016
Why Tech Tools Still Need Skilled Technicians
By Susan Munson, Director of Client Services and Business Development
A common theme around the CFI lunch table of late is related to the impact of technology on municipal bond trading. The investment industry is collectively striving to do more with less. Streamlining, scaling, and competing by slashing fees. Obviously, people are more expensive. They cannot be depreciated. And while companies like to claim that people are their greatest asset, they reluctantly confess that they would really like to have fewer of them.
We appreciate the challenge. People can be expensive, or they can be one’s most cost effective investment. Which is why, contrary to many in the investment industry, we are adding to the team to allow us to realize superior results using both technology and people. The critical questions are these: What technological tools are needed? And what is the skill level of the craftsman in charge of implementation?
Why is achieving this balance so important to municipal bond investors? Because the municipal bond market by nature is far more diverse than other financial markets. Skip is fond of saying that muni bonds are “like stars in the sky and on a clear night, one can buy forever!” Still, even we were surprised last month after digging into the numbers. In 2015, 10 times more municipal issues came to market than corporate issues on less than one third of the volume, which of course leads to the diversity. [Please see the February 2016 newsletter.] You can see why we are able to take advantage by discovering compelling, undervalued pieces of all shapes and sizes for the benefit of CFI clients. To illustrate the benefit of searching for value in both the rated and non-rated arenas, we thought it would be useful and interesting to walk through the investment cycle of a typical non-rated bond:
1. To Rate or Not to Rate? Very simplistically, issuers may decide it is more cost effective and/or expedient to sell a bond without paying for a credit rating. Sometimes this occurs because the issuer’s underwriter has identified sufficient interest from institutional and/or quasi-institutional buyers already familiar with their credit profile. Other times, a new project has an insufficient track record, making it difficult to demonstrate an ability to repay bondholders. This results in bonds needing to be sold at a higher interest rate to attract buyers.
2. Buyer Sees Potential: In lieu of relying completely on credit rating agencies, some investors are happy to do their own homework to assess if the potential risks are commensurate with the potential reward.
3. Bought and Held: The bond may be purchased and “tucked away” in a portfolio as part of a buy and hold strategy, with no further attention paid by either a credit analyst or portfolio manager.
4. Project Evolves: Over the years, the credit profile is likely to strengthen or weaken depending on the success of the project. While ongoing research is warranted, without an immediate need for the analysis it is often overlooked or put on the back burner.
5. Bond Owner Needs Cash: For a variety of reasons, a bond owner may choose to sell the bond. It may be that the owner dies or no longer needs the tax exemption. Or, it may simply be that the bond owner needs to raise cash for unrelated purposes.
6. Time to Sell: Ideally, the bond owner, working through trusted agent(s), seeks multiple bids for the bond through a wide range of channels in the bond market’s “over-the-counter” system in an effort to receive the best price at execution. (This is not always the case, unfortunately, as many investors instead sell directly to the broker dealer where they safe keep their bonds. A topic to be addressed in future articles.)
7. “Robo-Bidders” Pass: The trend towards “matrix” trading (aka “Robo-bidders”) increases the chance that systems will “pass” (aka decline to bid) on the bond since it does not fit into a pre-defined set of criteria.
8. Human Credit Analyst Approves: Once the system passes, professionals are needed to step in to assess the credit worthiness, determine a suitable price for the bond, and put in a bid to buy.
Professionals willing to do the work add value by purchasing bonds at attractive levels. This is where commitment, collaboration between credit and trading, and systematic execution reap the rewards. Individuals unable to determine value will have a difficult time taking advantage of opportunities and could easily pay way too much for bonds.
Expending the time and energy necessary to hand select and hand price bonds is not for everyone. It is labor intensive, difficult to scale and requires unique skill sets and judgment. However, we continue to believe the investments of time and talent are essential to preserve wealth. If you agree and would like to discuss further, we would love to hear from you.
The contents herein are for informational purposes only, and under no circumstances are they to be construed as a recommendation of a solicitation. The information and opinions herein are subject to change without notice and CFI does not undertake to advise the reader of changes in opinion or information.
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Charles Fish Investments, Inc. (CFI) founded in 1984, is a Registered Investment Advisor with the Securities and Exchange Commission under the Investment Act of 1940 and notice filed with the California Department of Business Oversight. The firm, which is wholly-owned by its employees, is not affiliated with any broker/dealer. CFI's revenues are derived exclusively from the fees received for the investment advisory and/or management services provided.
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