Imagine this: You walk into a grocery store and buy a bag of apples priced at $1.50 – no sales tax. You hand the cashier two $1 bills. He hands you $0.40 in change and wishes you a nice day.

“Wait,” you say. “Don’t you owe me another dime?

“Oh, no,” he replies cheerfully. “I always keep a little extra for myself. I hope you don’t mind.”

As wrong as this may sound for the produce aisle, similar practices go on every day in muni and corporate bond markets, where they’re called markups and markdowns. Essentially, these are the commissions a bond broker/dealer takes out of your account for executing your trades. You incur a markup cost when you buy a bond and a markdown cost when you sell.

That last one is especially confusing, since a “markdown” usually means you’re getting a discount. Here, it means less money is heading into your pocket. And unless you have access to a (costly) Bloomberg terminal or similar resource, plus the details of your own trade, it’s usually an expense you never knew you incurred. Even with Bloomberg, here’s a peek at what a typical bond screen there looks like. Not so simple to decipher.

Given the relatively opaque nature of bond pricing, here’s how a typical transaction might work: Say you receive a nice, clean trade statement informing you that your bond broker just purchased a muni bond for your portfolio for $10,200 and sold one out of your portfolio for $9,800. Seems clear enough.

But here’s what may really have happened: The market rate of the bond you bought for $10,200 was actually only $10,000; the broker charged you a $200 markup and kept the difference. The bond you sold actually fetched you a market rate of $10,000, but the broker charged you a $200 markdown. For both trades, you paid the broker a relatively steep 2% fee.

We’re not suggesting bond brokers should work for free. One way they earn their keep is by charging you to transact your trades. That’s fair. But we’re less enthused about the relative lack of transparency on the amounts being charged.

This is especially concerning, since individual, retail traders are far more likely to incur higher transaction costs than large, institutional investors can command (such as a mutual fund company managing a fixed income fund). As described in this Vanguard report, “[I]n the municipal bond market, the bid-ask spread for a “retail” trade (less than $100,000 per bond) is typically higher than that for an institutional trade—sometimes substantially so.”

In the stock market, transaction fees are clearly disclosed on every trade confirmation. Plus, current stock prices are widely available to look up online, using any number of free services. It’s easy to see if the prices at which you bought or sold were vastly different from the “rack rate.” If transaction fees get out of line, you should be able to catch that too.

Compared to the stock market, the going price for bonds is much harder to find (again, usually requiring a costly Bloomberg subscription or similar service). And transaction costs are often hidden away within the totals on your trade confirmations. This makes it more difficult to tell whether or not you’ve received a fair deal.

Fortunately, over time, we’ve seen improvements in bond market pricing data and transaction cost disclosures. Last May, new regulations went into effect, requiring brokers to disclose markups and markdowns on bonds they sell to retail investors (that’s you) within the same trading day in which they bought them. The disclosures are reported to you after the trade has occurred.

That’s a start. But why not always require markup/markdown disclosures, for all types of bond trades? While we’re at it, why not require markup/markdown fees be disclosed in advance, in case you would like to do your due diligence on costs before you’ve already incurred them?

These are good questions. We hope, over time, they will be answered with continued clarifying action, until bond trades are at least as transparent and competitively priced as we see in the stock markets.

What do you get when you combine an evidence-based process with visionary team spirit and brilliant leadership? A World Series Commissioner’s Trophy, for starters. The “rags to riches” tale of the Houston Astros 2017 World Series victory is now available for your reading pleasure, thanks to Sports Illustrated senior writer Ben Reiter.

We love the recent approach to managing the Astros because it mirrors our approach to investing in two major ways:

• First, it is backed by data. The Astros management seeks to fully understand the factors that drive wins, quantify them, and weight heavily toward them.
• Second, like with investing, achieving your long-term goals may sometimes require short-term sacrifices. If you have the right philosophy and the right process, you can trust that the odds will work in your favor long-term.

Something of a visionary himself, Reiter actually predicted the team’s 2017 victory on the cover of the magazine’s June 30, 2014 edition. Was that luck or forecasting talent? You be the judge, when you read Reiter’s entertaining account in “Astroball: The New Way to Win It All.”

Reminiscent of Michael Lewis’ Moneyball tale of the Oakland A’s, the Astros applied similar evidence-based strategies to improve their game. They leveraged what the Oakland A’s Billy Beane began and took it a step further, incorporating (with help from the “Nerd Cave”) scores for more unconventional qualities, such as personality and grit. These elements and more are touched on in this review: “[R]oster-creation, all by itself, did not bring home the championship. Building an exceptional team is one thing, but making it work as a team is another.”

We’ve said it before; we’ll say it again: We couldn’t be prouder of our exceptional home-town team. Go Astros!

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Bonus read: For more of baseball’s rich historical lore, I also enjoyed this recent PBS documentary on legendary hitter Ted Williams, in all his quirky glory (narrated by St. Louis’s own Jon Hamm). This related New York Times piece tells the backstory of how some of the film’s best footage was almost lost for good.

In our ongoing effort to clarify and simplify, we keep the financial jargon to a minimum. But even where we may succeed, you’re likely to encounter references elsewhere that can turn valuable information into mumbo-jumbo. Consider us your interpreter. Today, we’ll explore correlation, and why it matters to investing.

A Quick Take: Correlation Helps People Invest More Efficiently

Expressed as a number between –1.0 and +1.0, correlation quantifies whether, and by how much two holdings have behaved differently or alike in various markets. If we can identify holdings with weak or no expected correlation among one another, we can combine these diverse “pieces” (individual investments) into a greater “whole” (an investment portfolio), to help investors better weather the market’s many moods.

Correlation, Defined

As suggested above, correlation is more than just a quality; it’s also a quantity – a measurement – offering two important insights along a spectrum of possibilities between –1.0 and +1.0:

1. Correlation can be positive or negative, which tells us whether two correlated subjects are behaving similar to or opposite of one another.
2. Correlation can be strong or weak (or high/low), which tells us how powerful the similar or opposite behavior has been.

Correlation, Applied

Most investors are aware of the benefits of diversification, or owning many, as well as many different kinds of holdings. A well-diversified portfolio helps you invest more efficiently and effectively over time. Diversification also offers a smoother ride, which helps you better stay on course toward your personal financial goals.

But in a world of nearly infinite possibilities, how do we:

• Compare existing funds – If one fund is expected to perform a certain way according to its averages, and another fund is supposed to perform differently according to its own averages, how do you know if they’re really performing differently as expected?
• Compare new factors – What about when a researcher claims they’ve found a new factor, or source of expected returns? As this University of Chicago paper explains, “factors are being discovered almost as quickly as they can be packaged and sold to the waiting public.” How do we determine which are actually worth considering out of the hundreds proposed?
• Compare one portfolio to another – Even perfectly good factors don’t always fit well together. You want factors that are not only strong on their own, but that are expected to create the strongest possible total portfolio once they’re combined.

Correlation is the answer to these and other portfolio analysis challenges. By quantifying and comparing the behaviors and relationships found among various funds, factors and portfolios, we can better determine which combinations are expected to produce optimal outcomes over time.

Correlation, Concluded  

Heeding correlation data is a lot like having a full line-up on your favorite sports team. If each player on the roster adds a distinct, useful and well-played talent to the mix, odds are, your team will go far. Similarly, your investment portfolio is best built from a global “team” of distinct factors, or sources of returns. A winning approach combines quality components that exhibit weak or no correlation among or between them across varied, long-term market conditions.

Let us know if we can use our experience and expertise to help you build a more diversified and less correlated portfolio.