Is now the time to re-think fixed income vehicles for your clients?

Concerns about municipal bond credit quality arising from the recession and the historically poor condition of state and municipal finances are driving an increasing number of advisors to look at alternatives to traditional bond mutual funds for their clients. Small states are suffering the worst from the federal spending cutbacks, since larger states have larger budgets and can weather such cuts more effectively.

Possible rating agency downgrades in the bonds of vulnerable states recently spurred a decision by the Coral Gables, Fla., wealth management firm of Evensky, Brown & Katz to switch their clients from municipal bond funds to separately managed accounts from Nuveen, Thornburg and Neuberger Berman. We caught up with Harold Evensky and asked about his firm's decision-making process, as well as his thoughts on the advantages of working with separate account bond managers.

Says Evensky, "We're not concerned necessarily that if we buy a AA bond that it's going to go broke, but we can see downgrades. We're in bonds to help clients preserve principal and sleep well at night, not to have to explain to them, 'Oh, don't worry, the price dropped because it was downgraded, but you're going to be okay.'"

Evensky says that today's bond market is extraordinarily complex, so they monitor credit quality on a daily basis. "Our policy traditionally has been to buy high quality and forget it, but we no longer think that's necessarily wise." Evensky states that using separate account managers has been prohibitively expensive in the past, but the technological developments of the past few years now enable the firm to "cut out the middleman" and offer separate accounts at reduced fees. He says that even 1% is too much to manage a municipal bond portfolio, "but now we can access high-quality managers in the range of 35 basis points. They can buy cheaper than we can, add some value through active credit management, and more than cover their costs."

FA: Are the managers charging less?

Evensky: The "brains" have probably always gotten around 35 bps, while all the bells and whistles added by the middlemen tacked on up to another 115 bps. Our frustration was that we were paying so much, and so little was going to the intellectual capital.

FA: So you're able to deal directly with the manager thru the SMA?

Evensky: Right. We can open an account and give them limited discretionary authority. We do our own due diligence now, so we don't need the fancy reports and their due diligence. We just want the brains.

FA: Are you telling us that you're cutting out the extra fees by coming out of mutual funds or by going to SMAs?

Evensky: Both. In our larger accounts, we used to purchase our own bonds. We'd design our own maturity ladders and had our own quality and other criteria, but once we bought in, we held. Now, we can get active management using some of the same managers we used at the mutual funds, only we deal with them directly, and we get them cheaper than we could by buying their fund.

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