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Good Luck Getting Profits In $4 Trillion Municipal Bond Market

Stocks in this article: SCHW

NEW YORK ( TheStreet) -- Buying a municipal bond is a trip back in time.

It's hard to get solid bid and ask information. The cost of buying or selling is high. The market is not very liquid. But if you focus on bonds in your own state, you can get a tax-free profit as part of a $4 trillion market whose prospects in the near term are good.

The most recent SEC report on the $4 trillion market is dated August, 2012.

Experts often predict disaster for municipal bonds, as in this recent Janney Research report, but with bond issuance at half its 10-year moving average and investors hungry for yield, those who've bought and held are sitting on fat capital gains for 2014.

Still, this is a market where financial disclosures are notoriously bad. Since the bonds rarely trade, price discovery is hard and there are lots of horror stories told around the investment campfire.

Detroit's bankruptcy is a favorite theme and municipal bond bears, even though default rates in 2013 across the industry came to 0.107%, compared with a corporate bond default rate of 2.1% 

Thanks to the lack of liquidity most municipal bonds go straight into the portfolios of local investors looking for tax-free income, and stay there. Barely 1% of municipal bonds actually trade on the secondary market. You'll get more comparable sales data listing your house.

Brokers do offer bonds for sale.

Charles Schwab (SCHW), where I trade, currently has a collection of Atlanta bonds with 4% and 4.5% coupons, expiring in 2025 and rated A-, priced at about $105, for a yield of 3.88%. Put $1 million in retirement money into these puppies and a Buckhead matron can get almost $39,000 in tax-free income for the next 10 years. She might need a 6% pre-tax return to equal that.

Most buyers don't buy bonds that way, but Ron Valinoti wants to help them do that. He is the operating manager for Municipal Bond Information Service, a consortium of 11 brokerages pooling their information to try and make trading more liquid.

The result is a file offered every half-hour through the brokerages, in .cos or .xml format, but that's still not a lot of data, because there may be just 125,000 "market observations" in the average day, he said.

MBIS hopes to build the business by offering the data to asset managers who need to know the value of their portfolios -- but there's a chicken-and-egg problem. The market needs more trading to get better data, and trading is thin because there is so little data.

The best pricing data on municipals comes from, owned by Mitre Media of Alberta, Canada. Mitre is headed by former Investopedia Research head Tom Hendrickson, 30. 

Absent more data, retail investors are encouraged to buy bond funds. These not only offer returns of just 4% per year, but a national fund doesn't offer the full tax advantage, and a state fund like this one for Georgia, where I live, may charge a 1%/year management fee, meaning over one-fourth of your net return goes to the broker.

Paying a management firm 2% of your initial investment to build you a portfolio of bonds starts to make great financial sense in this kind of market. Assuming, that is, you can trust the management firm. And no one that I found is measuring that.

So you have a great asset class that you can make some tax-free money on, but the cost of getting in is high. There are ways to cut those costs, and that may be the biggest opportunity in the market.

>>Read More:

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At the time of publication the author owned shares in SCHW. 

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff

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