Municipal Bond Swaps
Evan C. Rourke, CFA Portfolio Manager M. D. Sass Tax Advantaged Bond Strategies, LLC
For individual investors, executing bond swaps can be a valuable tool for managing their portfolio. Swaps can be done to reduce an investor’s tax liability or to alter the characteristics of the investor’s portfolio. Swaps can be used to increase income, to reduce credit risk, to increase liquidity, or to diversify a portfolio. Swaps can be done to restructure a portfolio to meet a revised strategic plan or to adjust to changing circumstances. In this chapter, we describe bond swaps.
DESCRIPTION OF A BOND SWAP
Simply put, a bond swap involves the selling of one bond and the simultaneous purchase of another. The addition of the new bond and subtraction of the old bond should adjust the portfolio to better conform to investment objectives. Swaps are done to adjust coupon, maturity, credit rating, yield, or portfolio diversity.
Investors should remember that transactions have costs and frequent trading can reduce portfolio performance. Investors should include cost considerations before deciding to execute bond swaps. Some broker-dealers charge lower commissions for swaps than for outright purchase and sales. Transaction fees may be lower for municipal bonds held in fee-based accounts.
The most common form of bond swap involving municipal bond is the tax swap. The objective of tax swapping is to minimize an investor’s overall tax liability. Investors ...