There are a myriad of financial talking heads crowding the airwaves with baseless predictions. How do we find the few worth heeding? We look for intellectual curiosity – a thirst for understanding what is right and true, regardless of where it may lead. Inside of Hill Investment Group, we savor the voices who stand out in this way. We point you, our tribe who are committed to Take the Long View®, to AQR Capital Management’s new podcast channel “The Curious Investor.” We are especially impressed by its third episode, “Active versus Passive,” featuring a conversation between Vanguard founder John “Jack” Bogle and AQR managing and founding principal Cliff Asness. As the father of the world’s first publicly available index fund, Bogle personifies passive investing like nobody else can. In contrast, Asness has structured AQR on the premise that he and his team can add value to investors’ portfolios by identifying opportunities to apply evidence-based methodology. He’s our modern “active” aficionado, as we’ve described in earlier posts. You’d think the podcast would be a vigorous debate between these two legends. Instead, it exemplifies the considerable common ground and respect they share. Bogle explains:

“We do things very differently from an investment standpoint – to which I would say: So what? … [W]hat I’ve always admired about Cliff is his intellectual soundness. … I’ve always admired that in anybody. And it doesn’t matter whether their intellectual ideas align with my own or not.”

See what I mean? Especially when it comes to the science of investing, nobody has everything figured out. Even if we did, markets evolve over time, generating new insights, possibilities and questions – new subjects to debate. That’s one of the reasons I love what we do. PS: Here’s the iTunes Podcast channel link, if you’d like to “App it.”

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.

“Recency” is one of the most insidious behavioral biases that can impact an investor’s ability to Take the Long View® with their investments. The name alone suggests it’s the opposite of what we’re about here at Hill Investment Group.

Those ruled by recency will disregard decades of data, and instead allow only the latest, relatively random data points to skew their view. A prime example occurs whenever purveyors of traditional active investing revisit a perennially misleading script that goes something like this: “If too many investors invest in index funds (i.e., if the market is left to run on auto-pilot), there will be nobody left to set proper pricing. Investors should revert to an active investment strategy, before it’s too late.”

Again, the argument is nothing new; if index funds were the only investment available, markets would indeed stop functioning. But with every new season, the traditional active camp seems to come up with a fresh batch of stats that supposedly signal that the end of index investing is nigh.

Recently, the focus has been on index investing inflows – or, more accurately, their reduced volume. So far this year, the deluge of dollars mostly heading out of active investing and into index/passive funds has decreased to a more orderly flow compared to 2017.

Is index investing on the wane? In this related piece, we share a quibble we do have with index investing, and why we typically favor a similar, but more direct approach for capturing scientific sources of expected return. But before anyone concludes it’s time to get more active at timing and selecting specific stock picks, here are three, recency-dispelling reads we suggest:

“Index Funds Are Going to Be Just Fine,” Barry Ritholtz, ThinkAdvisor

Our favorite excerpt: “Why must we complicate what is otherwise a simple explanation? Investors have become a little more financially literate; indexing is maturing as an investment style. Those who are hoping for a major reversal of a trend that has been 40 years in the making are very likely to be disappointed.”

“Indexing Fuss Unwarranted,” Larry Swedroe, ETF.com

Our favorite excerpt: “While it’s certainly possible that, at some point, passive investing could reach such a dominant share that price discovery would be limited, clearly, we are nowhere near that level, and almost certainly won’t be there for a very long time.”

“The growth of index investing has not made the markets less efficient,” The Economist

Our favorite excerpt: “Perhaps the growth of indexing has robbed the world of outstanding stockpickers. But it seems more likely that it has put a lot of bad managers out of business … And it is not as if the buying and selling of stocks by informed investors with opinions has ceased. The turnover of stocks has actually increased over time. Active investors are more active than ever.”