Opening Illiquid Markets

September 11, 2007

I agree, Jim: You gotta love this tit-for-tat battle in the muni bond market.

We are seeing real innovation and real competition, to the real benefit of investors. 

I love in particular the battle of expenses. 0.25% ... 0.20% ... do I hear 15 basis points? Ten? These funds are revitalizing an area of the market marked by illiquidity and relatively high expenses.

As Jim and Rudy point out, there are also real differences on the index side and on the creation redemption process. I find the birth of cash creation/redemptions in this space very interesting. It will be important to see if the transaction costs of implementing that cash really do impact shareholders, as Rudy thinks they might. I have to think that SSgA and others have studied this, but the devil is in the details ... and the real-time operation. Still, if the cash process works, it could be applied to other illiquid areas of the market.

(As a side note, I've had a number of people tell me that these funds could have a major impact on the muni markets themselves, introducing a new layer of liquidity and transparency.)

One point on my blog, Jim. You're right in a sense that returns decay is the same as return-to-the-mean. But there is one important difference: On the returns decay model, these strategies are launching at the peak of their sine curve ... or at least, near the peak.  Returning to the mean is a GOOD thing if you buy at the bottom, but if you're coming in at the top, it hurts.

I'm not saying that's what's happening with all these funds, but it's something worth considering.


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