The belief that estates can realize significant estate tax savings from custom bond valuations is based largely on the inefficiencies of the fixed income markets and the use of standard bond valuations. There's some validity in that belief, but nowadays, the discrepancy between the prices that institutions and individuals receive for bonds should not be that great. Standard bond valuations shouldn't be that “off” from custom bond valuations and shouldn't produce significant estate tax savings.
During the past five years, giant strides have been made to create transparency and efficiency in the bond markets. The biggest step forward is that all corporate and municipal trades must be reported to their regulating authority in a timely fashion. For municipal bonds trading in the secondary market, trades are reported to the Municipal Securities Rulemaking Board (MSRB). For corporate bonds trading in the secondary market, trades are reported to the Financial Industry Regulatory Authority (FINRA). All trading information is available through the Internet and can be viewed at www.investinginbonds.com. This website is published by the Securities Industry and Financial Markets Association (SIFMA) in an effort to educate investors. The site is user-friendly and informative, showing all transactions in the municipal and corporate markets.
These efforts have made the fixed-income market more efficient. As transaction information now is available to all, the playing field between retail investors and institutional investors is leveling. Retail investors, armed with more knowledge, can receive better execution through lower mark-ups and mark-downs. Also, there are multiple brokerage houses specializing in fixed income that can negotiate on their behalf. The result is that the spreads are not as wide as they once were. For example, let's say the institutional market is $100 bid and $101 offer. A retail investor may be paid $98 for its retail-size position for a block of 25 million ($25,000 face value). A bond valuation based on the institutional price would calculate a fair market value (FMV) of $100, while a custom valuation would calculate an FMV of $98. But, with the help of a bond specialist or by accessing information available to the investor, a better execution price is possible.
Still, I disagree that if the retail investor was paid $98, a custom bond valuation should be $98. The dealer, in turn, sells the position to another investor at the offer side. In my opinion, the end user should be included as part of the transaction and the calculation of the FMV. The true value of the security is where it can be bought and sold — it's not based solely on the bid side of the market.
Standard bond valuations typically are used from pricing services and not based on transactions. Custom bond valuations performed by economic experts should take into consideration the security, or like security, if it is infrequently traded. But, if investors use the tools available to them, they can get better execution when selling (and buying) the securities.
Of course, investors also might generate estate tax savings by having a custom bond valuation — it just might be that the savings are not significant.
The opinions expressed herein are solely the author's and are not necessarily representative of Rehmann Financial. Investment advisory services are offered through Rehmann Financial, a Securities and Exchange Commission (SEC) Registered Investment Advisor.
Kristopher M. Burak is a fixed income and equity analyst in the Lansing, Mich., office of Rehmann Financial