Transparency in investment management fees is uneven and confusing. This blog post touches on different ways that investors pay for their bonds and bond portfolio management.
Investors in bond mutual funds and ETFs are charged an annual expense ratio associated with owning that specific investment. While the expense ratio they pay will not show up in their monthly or quarterly brokerage statements, investors can learn what they are paying by looking up the expense ratio on the Internet. Fees for bond mutual funds and ETFs vary widely between .05% and .8% of assets under management, and typically depend on the type of bond fund and whether it is an index or actively managed fund.
For separately managed bond accounts (which are accounts where an outside manager is buying and selling individual bonds for an investor), the investor pays a management fee that is normally a percentage of assets under management, with no additional fees on the bonds. These types of accounts typically have an annual fee between .2% and .7%, and the fee will often depend on the account size. If a broker or financial advisor is managing the bond portfolio as part of a larger portfolio in a “wrap account”, the fee may be much higher (1.0-1.5%).
We occasionally hear from clients that they are not paying anything for the management of their bond portfolio. Brokers and advisors may not charge a separate fee for bond management, but they still get compensated through bond mark-ups/commissions. The mark-up/commission is the difference between what the brokerage firm paid for the bond and the price they sell it to the client. It is usually not disclosed to the client. The lack of mark-up transparency in the municipal bond market has been especially contentious. According to the Financial Industry Regulatory Authority, the rules for disclosure of mark-ups for both municipal and corporate bonds are as follows:
“If the firm acts as agent, meaning it acts on your behalf to buy or sell a bond, you may be charged a commission. In most bond transactions, the firm acts as principal. For example, it sells you a bond that the firm already owns. When a firm sells you a bond in a principal capacity, it may increase or mark up the price you pay over the price the firm paid to acquire the bond. The mark-up is the firm's compensation. Similarly, if you sell a bond, the firm, when acting as a principal, may offer you a price that includes a mark-down from the price that it believes it can sell the bond to another dealer or another buyer. You should understand that the firm very likely has charged you a fee for its transaction services.
If the firm acts as agent, the fee will be transparent to you. The firm must disclose the amount of the commission you were charged in the confirmation of the transaction. However, if the firm acts as principal, it is not required to disclose to you on the confirmation how much of the total price you paid to buy the security was the firm's mark-up; it is only required to disclose the price at which it sold the bond to you and the yield. Similarly, if you sell a security to a firm and it acts as principal, the firm is not required to tell you how much of a mark-down the firm incorporated in determining the price the firm would pay you. It is also possible to buy and sell bonds through an online or discount broker, which often charges a flat fee to buy or sell a bond.”
Being an informed bond investor is difficult, but help is on the way, at least for municipal bond investors. In November 2016, the SEC approved a proposal by the Municipal Securities Rulemaking Board (MSRB) to require brokers to disclose mark-ups and mark-downs to retail customers on “certain” principal transactions. These rules go into effect in May 2018. While the quality of the new rules will be better understood once they are implemented, this is a welcome move toward fee transparency.
In summary, we strongly encourage all investors to ask their financial advisor or broker what mark-ups, commissions, and fees are being charged on any purchase or sale of individual bonds, bond mutual funds, and ETF’s. Your broker or financial advisor usually has some discretion over these charges. It is important for clients to show they want complete transparency and will be monitoring the fees and expenses charged on their assets.
DISCLAIMER: This information is not intended to provide legal or accounting advice, or to address specific situations. Please consult with your legal or tax advisor to supplement and verify what you learn here. This is presented for informational or educational purposes only and does not constitute a recommendation to buy/sell any security investment or other product, nor is this an offer or a solicitation of an offer to buy/sell any security investment or other product. Any opinion or estimate constitutes that of the writer only, and is subject to change without notice. The above may contain information obtained from sources believed to be reliable. No guarantees are made about the accuracy or completeness of information provided. Past performance is no guarantee of future results.