The Derivative - Is there Alpha in boring old Muni-Bonds, with Riverbend Capital

Episode Date: October 3, 2024

In this episode of the Derivative podcast, our host Jeff Malec sits down with Tim McGregor and Tom Hession from Riverbend Capital Advisors to dive deep into the world of municipal bonds. The discussion covers the unique inefficiencies and complexities of the $4 trillion muni bond market, which features over 75,000 different issuers across the country. Tim and Tom explain how this fragmented landscape creates opportunities for active management and value capture, even in a low-risk asset class. Throughout, we explore the importance of customized portfolio construction, credit analysis, and structure optimization to generate tax-advantaged income for individual investors. We also touch on the impact of federal policy, interest rates, and political dynamics on the muni market. With over 50 years of combined experience in municipal bonds, the Riverbend team provides valuable insights for anyone looking to understand this often-overlooked corner of the fixed income universe. Listen in, as we venture into uncharted waters with Muni bonds! SEND IT! Chapters: 01:33-14:25= Navigating the Fragmented and Inefficient Muni Bond Market 14:26-29:15= Complexities in structure, credit & policy 29:16-36:28= Muni Bonds in a changing market: Opportunities & Challenges 36:29-52:37= Election/Fed cuts? The importance of tailoring your clients portfolio 52:38-01:01:00= Experiences with Muni Bonds, covid-sell offs and tax advantages Follow along with Riverbend Capital on Twitter @Riverbend_Cap, Tom & Tim on LinkedIn, and check out their website Riverbendcapitaladvisors.com for more information! Don't forget to subscribe to ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Derivative⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, follow us on Twitter at ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠@rcmAlts⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ and our host Jeff at ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠@AttainCap2⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, or ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠LinkedIn⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ , and ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Facebook⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, and ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠sign-up for our blog digest⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠www.rcmalternatives.com/disclaimer⁠

Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Hello there. You know, sometimes I just want to do a pod because I don't know anything about the subject. That's the case this week. The only thing I knew about Muni bonds was that there used to be a Chicago Board of Trade Muni bond futures contract that was notoriously low volume and low liquidity.

Nobody really wanted to trade it. The best thing about that contract was you could do a mob spread, which was the nickname for Munis, M, over bonds, M-O-B. Anyway, a few local guys here in Chicago actually trade these things, munis that is, not mobs, tens of thousands of them, and think there's some alpha there. So we're digging in with Tom Heschen and Tim McGregor of Riverbend Capital Advisors to learn more.

Send it. This episode is brought to you by RCM's Outsource Trading Desk, where we have absolutely nothing to do with muni bonds. But hey, they could help you hedge them, help you trade some bond options around them, maybe get an interest rate swap or two for you right there on RCM's 24-6 Outsource Trade Desk operation. Check it out at rcmalts.com slash 24. And now, back to the show. All right. We are here with Tim and Tom.

Tom and Tim. Hey, guys. How are you? Great. Good to be here. Good. And from Tim's view, I can tell he's somewhere in downtown chicago with the background there where you guys are close to us right like somewhere franklin or something the red worker whacker all right we know and you guys are doing very little to dispel the stuffy Munibond image with the suit and button down shirt, right?

Us commodity guys are just in the golf shirt and mailing it in from a casual standpoint. Is that perception of the Munibond World Fair? Everyone suited up? I would say that's a little more Tim-specific coming from 30 years at Northern Trust. It's not all muting.

Didn't Northern try and go no suits for like a year, a couple months, and it epically failed and they made them all come back? They tried. I protested, so i got my way but yeah i've been accused a little bit of old school but you know you protested to bring the suits back i was in favor of bringing them back absolutely yeah i love it um what's what's your view just

makes you work a little harder makes you better oh yeah a little bit old school you know dress the part for me you get up at the crack of dawn, you get the suit on, you get on the train, you get to work. It's a good process. Awesome. You guys are doing muni bonds. I know next to nothing about muni bonds except that I get a tax break on them. Let's start there at the 30,000-foot view. What else is there for me to know about muni bonds besides that I get the tax break?

I'll tackle it. It's a fascinating market. I'll start with that. I believe it's probably the most inefficient investment market there is, maybe with the exception of real estate. And there's two deep-rooted reasons for that, with the first being the fact that there's 75,000 different municipal bond issuers, which is a staggering number. When I started,

it was 45,000. I would have thought that they'd figure out how to consolidate state and local governments, but it's actually gone the other way. So 75,000 different issuers in the municipal bond market. So that's one inefficiency. And then you couple that with the participants in the muni market, which are very different in terms of where and when they want to participate, what type of credits they want to buy, what type of maturity structure they want. So from a smaller retail investor to a high net worth investor, to an insurance company, to a bank, to a hedge fund, to a global investor. So that's what makes the market really fascinating to me is the volume of different issuers and the

very different participants that are in our market on any given day. And if you do your hard work and monitor the market on a daily basis, there's a lot of value you can pick up by capturing some of the undervalued opportunities and taking advantage of overvalued situations as well by maybe selling into some demand that might be too high. So putting all those things together, we strongly believe it's a market that you can add value in without pushing the envelope on credit risk. So in general, we like to tell clients if they have risk in their asset allocation, they can usually get paid for it better in a different asset class than municipal bonds.

What do you got to add, Tom? I mean, I obviously agree with all that. And, you know, I've always felt like, you know, the muni market has a lot of beneficial attributes and, you know, but it is very fragmented and you know there are there's good and bad um aspects to that you know um i think that it's it's uh a difficult market to kind of dabble in from time to time you know it's a market where if you're participating you know you need to be engaged on a on a regular basis um you know so for example for advisors that we work with to try to you know just occasionally jump in and and buy some bonds um you know there's there it's not very transparent at times as far as pricing.

And, you know, there's a lot of different structures. You know, there's a million and a half or so QSIPs in the muni market. And the vast majority of those don't trade on a given day. So, you know, it can- You have those all housed. Like I could pull up any of those 1.5 million on Bloomberg. Yeah, I mean, you figure every city, state, town, university, hospital, water authority, you name it,

probably does a bond issue or more every year. And every one of those may have 20 30 different maturities with different coupons and structures and call features so you know that's how we get to the 75,000 issuers right how many cities are there in the US I don't even know more than less than 75,000 so then you add in there so if I'm a you guys live up near north shore right let's use glencoe as an example i'm a the glencoe township what is it a township or a village of the village of glencoe will i do a separate village of glencoe and then a water

district of glencoe yes park district um you know there's a place like glencoe? Yes, park district. You know, there's a place like Glencoe, which is where I live. Yeah, I mean, at any given year, there may be a couple of different bond issues for school improvements or, you know, water, park district. And, you know, each one of those issues, it may only be a, you know, about 10 million in total, but, you know, each one of those issues, it may only be, you know, about $10 million in total. But, you know, there's probably going to be maturities ranging from one year out to 20 or 30 years. And, you know, every one of those is going to have its own QSIP. And they'll have different, they'll come at different yields. They'll have different structure different coupon maybe

different call features each within that one issuer so what so why do they do different all the different stuff inside right you think they'd just be like all right i need to raise 10 million bucks i'm going to bring it out at x percent for x years well because they're going to pay the bonds off over time from revenue that comes in from property tax or other taxes. So if they need to, let's just say they needed to build a school and it was going to cost $10 million, they don't have the $10 million sitting in a checking account, but they need to pay for that construction in the near term. But then that's going to be financed over the next 20 or 30 years. So as property tax is collected year by year, it goes to pay the debt service and to pay off the bonds staggered over a longer period of time but if it was an individual right i would just take out a 30-year mortgage likely maybe a 15-year whatever but right i'd take out one

or the other not both are you saying they do both they put different durations all in the same borrow uh well i mean i think in a way it's similar. Like they're paying back that $10 million in one year. They're going to pay part of that principal, but they're also going to be paying interest in year two. You know, they're going to pay off. They're like tranche them all based on when they're paying it back. Right. And on the other side of that, you know, that fragmentation creates opportunity, I think, in a lot of cases because, you know, the different structures and call features can be, you know,

viewed or valued differently by different market participants. And sometimes there are anomalies in municipal bond pricing, and those can be taken advantage of. The municipal bond market doesn't have a ticker with prices like equities or a screen with uh yields and price like treasuries you know it's an over-the-counter market and a bond that's worth something to one participant might be worth something very different to another and um given the fact that a lot of them don't trade on a given day. You know, it could be treacherous at times, but it could also create a lot of opportunity at times. And if you're a regular participant and you can recognize those situations,

you can take advantage of them on behalf of your clients. Now, I'm old enough to remember there were Munibond bond futures here in Chicago. Why didn't that work? What was the problem with those guys? Just not a deep enough market on the old mob trade that you're referring to, Jeff. That was made up of 50 only term bonds, which...

Out of 1.5 million. Yeah, so pretty quickly... 50, pretty quickly some bigger firms realized they could kind of monopolize the underlying collateral on those contracts so it didn't last very long so you essentially could own everything in the futures contract which just not enough depth in the marketplace. And is there a reliable index though that gives you price across those 1.5 million or no, it's too diverse? That's kind of the real proof statement of just how inefficient the market is. There isn't an investable index in the muni space. They're basically just computer models. So there's indices out there, but it's not like an S&P 500 that you can go buy.

That's just an index that does measure the market properly, but it's not something that's investable. There's products that try to replicate the index, but there's no pure version of like an S&P 500 index in the muni market. And that leads to why you guys are even in business, right? So I can't just go out and buy. So what are my options? I could go buy an ETF that does munis. I could go interact with the village of Glencoe directly or not so much? No, it's really not.

Very, very small private placement market like that. So there's ETFs, there's municipal mutual funds. But we strongly believe investors should have their own account, an SMA, a separately managed account that they can customize around their views on interest rate risk duration they might want to overweight certain states for tax purposes they really want to control their tax strategy so if interest rates spike up unexpectedly some of the bonds might have losses in them so you could do some tax loss harvesting so in the mutual fund space you lose control that tax awareness so in the sma you really control your taxes which is a big priority and technology's improved so sma is going to be managed for individuals now at a smaller level than before and what's the

back end of that look like though so if i'm an individual in an SMA, I have to buy it through the, so the issuer is gonna go to a Goldman Sachs or someone similar or a Northern Trust and then deal with the advisor who's gonna buy them for the client? Yeah, or you come to a river bend and we will set up an SMA and we'll take advantage of the marketplace.

Like Tom was saying, we'll have a credit team internally make sure we buy you know good strong credits proper maturity selection is important as well you know you could have a portfolio that's totally laddered like even maturity is one to ten years or you could have a portfolio that has more maybe short bonds and a few longer bonds which we call a barbell strategy so it's important in the muni market for whatever interest rate risk whatever maturity average your client wants to have you can get that a lot of different ways and what's important is those ways all will generate a different income flow so we want to make sure we're maximizing tax-free income versus whatever maturity target the client may want to have.

You mentioned the different states. Tom, we had lunch the other day. We were talking. I'm like, well, one, why do you guys work out of Chicago? Is that the worst municipality there is in terms of muni bonds? So it's a little, you might get people be like, I don't trust these guys if they're selling munis out of Chicago. But you mentioned at lunch, you won't touch Chicago, right? So talk to us a little bit. And I think that dives into your, where there's different opportunities, right? Like not all states, not all cities, not all water districts are created the same. Right. Yeah. I mean, I guess in terms of,

you know, the client base that we work with and what the primary objectives generally are in a portfolio that we're managing, you know, the portfolio, a municipal bond portfolio is usually there to, you know, offset risk. It's capital preservation. It's to try to balance risks that the investor may be taking in another asset class or an operating business or, you know, other investments. So as far as, you know, what we do here at Riverbend,

it's really not like we're trying to get into high yield, non-rated, esoteric structures or credits. It's high quality bonds and we're trying to add some alpha, some incremental yield through structure and taking advantage of some of the inefficiencies that are out there uh you know generally avoiding credits that are you know chicago a place like chicago where you know it's in the it's in the news on a regular basis you know seems to be an ongoing um you know budgetary struggle and um you know some of the the demographic and you know revenue trends um you know with uh population loss and so forth you know kind of work against it i think for the most part you know the clients that we have don't want to see obviously they don't want to see defaults or downgrades but they also don't want to see you know the stories about the credits

you own in the news every day for the uh the the challenges and the and the deficiencies that they're dealing with you know the unfunded pension situation in Chicago and in Illinois are pretty grim. Not to say that there aren't a lot of strong issuers in the state. There are, but there are certain high-profile ones that we've steered clear of over the years, and Chicago happens to be one of them. It sounds like you're saying don't put risk inside your low risk bucket of your portfolio right like there's no reason to add risk to this low risk muni part of the portfolio but i've got enough risk elsewhere yeah i think you can you can obtain uh you know additional yield and additional

uh alpha through through structure and like said, taking advantage of some of the market anomalies that occur. Yeah. We're unique communities. So let's talk through those, if you could. Like, how do you get alpha out of the structure? Aren't generally all the structures the same or no? You're saying someone might be so desperate or so doesn't know what they're doing that they set up a structure bad for them

that good for the investor? So where do you get the alpha out of the structure? There's incredible ability to negotiate structure in the muni market. So certain issuers as an example will have, they might really overvalue a call option. So you might structure a 12-year bond with a three-year call option because that issuer, it's not really a view on the economy for them, but they might want to have the right in two or three years to do

an indenture refinancing or call in their debt. And mathematically, they might overpay 50, 75 basis points for that call option. So, sure, we'll do a premium bond in 12 years that gets the yield level of a 12-year bond, but the risk profile more of that call, we call those cushion bonds. And a lot of that is based on that particular issuer demand just to have that flexibility. And historically, there are definitely muni issuers that overpay for that flexibility to do a refinancing. Love it. And then what was your other you said structure alpha and my brain blanked on the second one. There's also just an incredible amount of day to day price discovery. You know, if you're looking at a couple hundred bond deals a week and they're being underwritten by 20 or 25 different underwriters on a weekly basis, depending on that underwriter's risk tolerance, let's say they know they have X amount to underwrite next week.

Well, then, you know, for sure this week their bonds are going to get sold. They don't have the balance sheet to carry unsold deals. So if they have a lot of supply in their future calendar, most likely their deals currently are going to be priced to sell, meaning a nice discount to marketplace. So good old-fashioned price discovery and a rigorous security selection process is the starting point as well. And does that track with rates, obviously, with Fed expectations? Like what's driving that of like, we got to price this to sell or we're fine waiting to, what drives those dynamics? Yeah, there's definitely macro factors that affect the muni market. But even more importantly, there's specific muni centric factors and supply is a big one.

And so is seasonality. So if there's a lot of supply coming to market, municipals might cheapen in price even if, say, the treasury market is not because they have a lot of supply to get through the system. On the flip side, you can get in the summer months, as an example, June, July, August, which are very heavy months in terms of client redemptions from maturities and call features and coupon payments where there's a lot of reinvestment demand. And some summers, simply there's not much deals because you don't get bond authorities, underwriters, FAs together in the summertime to get a bond deal done. So you can have all this reinvestment demand and little issuance where municipals can appreciate in price,

even if the overall market is doing nothing. So there's definitely some municipal specific events and factors out there. The inefficiency makes me think of the promise of blockchain. Blockchain was supposed to fix all this. Like a municipality could go on the blockchain and get their deal price and have it be put out there to the world and you wouldn't have to go through issuers and all this stuff uh i'm assuming that's not happening not yet the blockchain version of the muni market would be you know every state having its own bond bank and they would just issue through that bond bank but it's going the other direction because right now you have

1200 plus school districts in illinois and i'm not giving up my seat on the school board and neither is tom on his and jeff neither are you on yours so there's no consolidation of state local governments happening anytime soon 1200 school districts just in illinois yeah so that's what really drives the inefficiency so there's no reason to have 1200 that's what really drives the inefficiency. So there's no reason to have 1200. That's what you're saying. But Tim and Tom and Jeff don't want to give up their board seats. So nobody's incented to be like, hey, we should put our 10 school districts together. We could get better terms going to the muni market. So that's really the crux of it. That's what's driving it all. What drives a lot of it, a little bit of a good old-fashioned turf war yeah people want to do their own financing and take matters into their own hands

and that's never ended poorly heavy sarcasm the other thing that jumped in my head was the like these right here in chicago we're doing a new stadium maybe maybe not is that government funded is it privately funded have you guys ever gotten into those type of deals are those muni deals like when these stadiums get half private half public yeah there will be you know municipal bonds issued in a lot of those cases. And we've generally shied away from those type of credits. In some cases, it may be like a sales tax revenue and it's not so reliant on usage of the facility,

like small convention centers and things like that, we've completely avoided. There may be a handful of stadium-related bonds out there that we've participated in, but when it's a sales tax revenue source and not gate gate revenue from right right not we the bondholders want half of the taylor swift uh concert revenue yeah that would be better proceeds so what are the different types like what's the most attractive what's generally considered like these are the safest and easiest munis in terms of uh payment schedules or their revenue that they're paying it with? They're essential service revenue bonds like, you know, water and sewer considered to be, you know, probably one of the most pristine sectors in the muni market because, you know if even if all else goes wrong most people are still going to pay their water bill you know like that's uh predictable you know they have

flexibility to change rates if if needed over time and uh and you know general obligations um backed by you know property tax that um uh you know that, assuming that the municipality is in a credit worthy position, like we probably wouldn't participate in Chicago GOs, but many other cities and most states around the country. If it's higher education, we've really only participated in deals where it's a large institution, large endowment. Like a Stanford or something? Like Stanford's not going out of business yeah stanford or a lot of the state schools you know what purdue ohio state places

like that um you know we what we've avoided historically have been like a small maybe more obscure liberal arts schools you know where you know enrollment is declining and um you know the endowments aren't particularly strong um you know when it comes to health care larger systems that you know have a network and a strong market position not like one-off hospitals in a rural area or or nursing homes um and you know as i i mentioned briefly before we've we've tended to shy away from you know project specific issues like um recycling centers or or golf courses things like that so you're making it clear to me like there's no way an individual could do this right i can't know about the politics in some town in ohio and then the um revenue sources from some other town in california right so how you guys are a small

team how do you guys handle like have all you have to know across all these different pieces of the puzzle? It's not as simple as they're just, these guys are, it's not just school districts. As you just said, there's recycling plants, all these different pieces to the puzzle. How can you keep all those pieces straight without having like a thousand person firm? Well, it definitely helps to have a 25 plus years experience of both Tom and I in there. And there has been some nice technology improvements in terms of financial statement analysis around credits

and things like that. And as Tom mentioned, the market's huge, but you can get it down to the credits you really wanna focus on in a manageable way. So the dedicated essential service revs, bonds that have taxing power, bonds where the bondholder gets paid first, you know, where that revenue stream comes to you, the bondholder first, doesn't have to go through an appropriation mechanism where you don't want to run into a situation really where a city,

county, township, state, you know, is paying your bonds with discretionary funds at the bottom of the budget, which if the economy slows and those discretionary funds get tight, their ability and willingness to every year make an appropriation to pay for this project or that project could become more challenged, where if the revenue from the water, sewer, public public power transportation bond is going right to you first you know that's not a concern for you so avoiding those project-specific appropriation type credits um takes a lot of the the numerous small deals kind of off the table and what what are some of the muni bond horror stories, if you will, right?

Like these things do default from time to time, I'm sure. Time to time. It's a very low risk. You know, munis default very, very small portion of the time in aggregate. Most defaults are in kind of a, if a corporate, corporations have the ability to issue some municipal bonds, if they use the proceeds for things like pollution control corporate bonds in general default 15 20 times more than municipal bonds so it's not surprising that corporate related municipal bonds lead the default charts every year so you'll see those

you'll see a small project specific housing deal so like states have housing bonds which are very safe credits because they're bundled. You have a lot of mortgages, but there might be also a project specific housing development, which is obviously a lot more risky than a full state program. So the small project specifics, the corporate related things, those are where your risk really lies. So let's, we put the cart before the horse, but you mentioned the 25 plus years of experience. So give us a quick little rundown of that experience if you could. Well, for me, I started at the Board of Trade, so I had interest in the markets right away, and I found my way to the muni market shortly after that. What really attracted me was the good old-fashioned saying that hard work pays off.

If you do your work in the muni market, you can add value on a day-to-day basis. Some days the market doesn't do anything. It's one of those situations where you can't pinpoint, I want my hard work to pay off today or next week or next month. But if you stay after it and you monitor the market and are diligent about it with a disciplined manner, you'll provide value because the market will present opportunities and you need to be there to take advantage of them when they arise. So that's what's intrigued me about the market and it hasn't gone away. It's a technology has helped credit management in particular in the municipal space, but the overall fragmentation that Tom talks about and the sheer volume of issuers and price discovery,

that's still very much goes on on a day-to-day basis. Go ahead, Tom. Then I'll, I had one question popped in my head, but go ahead. But where were those? Were they all at Northern that we mentioned? Or were you a few different places? Yeah. Northern the entire time, and then took a little fortunate to have a break at 55 and 30 years at Northern, and fortunate to have some valuable family time, and then ran into Tom about a year ago and found a great home here at Riverbend. Love it. So, Tom, tell us about Riverbend and your background.

So my background is just past the 30-year mark in Muni's. First half of my career was at Merrill Lynch where I worked on the institutional side of the business. So, you know, I had my clients there were insurance companies and banks and funds and so forth. And, you know, my experience with the Muni desk at Merrill. I was in the Muni desk, yeah. And, you know, my experience there and my observation was that, you know, the muni market is a two-tiered market in a lot of ways, with institutional clients getting much better execution and more active management and much better access to, you know, everything that's offered out there by a variety of broker

dealers and individuals tending to get price markups with the market not being very transparent. transparent, it's possible to take advantage of that. And getting passive strategies, passive approach, bond ladders, just kind of like a static portfolio and maybe just what was in the firm's inventory as what they had access to. And thinking through that over time, I thought there might be an opportunity to bring a little bit more of an institutional approach to individual and you know family office type investors so I left Merrill started out on my own and you know eventually kind of gravitated towards working with investment advisors initially, where we function as like a sub-advisor in that capacity. Riverbend will be engaged by an advisor to manage bonds on behalf of their clients. And we have individual accounts as well,

individual and family office. But we've focused a little bit more up until recently on the investment advisor space. And now with Tim joining us and the added capacity and the expertise that he brings to the table, we're in an active effort to start working more with individuals and family offices. said we we you know connected a while back you know a year or so ago uh and you know we've we found that we agreed philosophically on our approach to the market and our approach to working with clients and it was a good fit and um now we're we're moving forward is is your size give you an advantage do you think are there deals you can do that the biggest players in the space can't do?

I don't think there's any doubt about it. You know, I think that the tactical size of Riverbend and where we want to be is really a positive in the municipal space. So there's an incredible amount of deals that we've talked about, but a lot of those deals are smaller in size. So, for example, about 75% of all municipal bond deals are $50 million or smaller. That makes up 20% of the market, but 75% of the deal volume. In terms of dollar value, it's only 25%, but volume, 75%. Right. it's only 25 but volume 75 right so that's important because if you're trying to turn the titanic at one of the bigger firms those deals aren't going to be big enough to really

be on your radar so um we can take advantage of those and it's not at all saying those smaller issuers are weaker credits and many times they're stronger credits it's a it's a park district that wants to borrow 25 million bonds instead of 400 million. So the credit quality is strong. They just don't need to borrow as much. They also might have a little more creativity and flexibility on negotiating those things we talked about, Jeff, around coupons and call features. So super exciting part to me at Riverbend is it's opened up a new world of deal size that you can have at your arsenal to add value so it's really been really exciting and are the the big guys can't get into those smaller deals it's just not worth their time to to analyze them or they have

we can only do 100 million slugs at a time or something they probably have some boundaries around looking at smaller deal size and you know if you're trying to turn a firm that has 50 billion to 125 billion in aum you know a deal that small simply is not going to move the needle for you so, many of those deals we feel are overlooked and we're not going to miss them. So let's talk for a minute. We've got an election coming up. We've got Fed rate cuts coming up. I assume both those are a pretty big deal in your guys' world, if not everyone's world. But what's that all mean? is that the whole game for you the

the rates and and the policy right is it possible that muni bond policy could be changed by the wrong president who wants to wade into politics yeah well we feel the tax exemption is safe in either scenario but clearly tax policy affects the beauty market you know if tax rates were to go up that tax-free nature of municipal bonds would be more attractive um if they tinker with some of the salt limits and caps that can also you know affect municipal bonds from a tax advantage standpoint. So tax policy is important. It's hard to believe with the amount of money this country owes and ongoing deficits that

taxes are coming down anytime soon. So municipal bonds, maybe best case they stay the same, but more than likely they probably go up at some point on the individual side and on the corporate side so corporations don't forget can own on any given year maybe 25 of the muni bond market as well they have not been big participants when their rates were cut but if those corporate tax rates go back up at all they could be another new participant in the muni market as well. So keeping a very close eye on tax policy. There's some smaller programs too out there that could

increase the issuance of municipal bonds. So we want to keep an eye on those. So yeah, clearly the election and the expiring tax cuts at the end of 25 are two key matters. And we watch that. So the whole game, if I'm a family office, I've got $2 billion whatever in hedge funds that's throwing off this income that I'm getting charged the long-term

capital gain or even carried interest when I sell it. I call it 20%. If for some reason taxes go to 30, 40, 50, 60, whatever that math is like i'd be i just want to get this net out of munis would be better at some marginal tax rate than whatever return i'm getting out of the hedge funds that's the math there yeah even if if your individual tax rate or corporate rate goes up a little bit the break-even yield on munis can really jump so even if it reverts back

to 39.6 from 37 the break-even yield on a four percent muni goes up almost 27 basis points so some small tax changes can have really big effects especially on the break-even type yields that you need to compensate wouldn't that push the pricing up and the yields down there where you get less yield if all that demand comes in? Yeah, if taxes were to skyrocket, no doubt the demand for municipal bonds would be very strong. Yeah, which would go below, which gets to our second one there, what the Fed's going to do, right? So where are they currently? Below, at, above T-bill rates? What's a general benchmark?

So, yeah. I'll let Tom go in a second, but the one thing, municipal valuations really look different depending on where you are on the yield curve. So, short municipal bonds might be average price to maybe even a little bit expensive and 15-year municipal bonds are incredibly cheap you know so that's the other thing like the market rarely moves in unison where all munis are rich or all munis are cheap uh there's always pockets where valuations are quite different is that curve usually inverted like that or does it depend usually yeah usually separate curve than treasuries. And, you know, like we went through a period here where, you know, with treasuries, treasury curve inverted munis were as well. And, you know, it made sense to own short to barbell, basically, to own, you know, short-term maturities and then you know out longer where the

incremental additional yield you know from one maturity one year to the next to the next was more significant so you know we went through a period where we were doing a lot of barbell portfolios because you know owning short-term burns bonds you really weren't sacrificing yield. You're getting great yield. And then, you know, locking in some of that longer-term and very high and attractive taxable equivalent yield where, you know, we were up to the, you know, almost in and around 7% taxable equivalent on, you know, longer duration bonds for something very high quality. You know, it's equity like returns that you could just lock in on like double A plain

vanilla munis for 10 or 15 years. So that's just an example of the market conditions changed. You know, it had been a long time since we would have, you know, recommended a barbell approach. But, you know, that was the right thing to do when, you know, the muni curve was inverted. And, you know, but generally the muni curve has, you curve has stayed steep historically. Got it. So what's our thoughts on what happens next with the Fed? And what that does for you guys? In typical bond market fashion, today the bond market seems to be well ahead of Fed

expectations. So the bond market today has close to 150 basis points of cuts priced in by the end of the year and just over 250 basis points of cuts by this time next year. So as soon as they get hint of an ease cycle, they tend to overshoot a little bit, which they've done again. So if I was just a treasury investor, I'd be cautious at some of these treasury levels. But on the muni side, things are a little bit different because we've had what's going to be an all time record year of issuance.

So a lot of that has just been because of wanting to get into the market ahead of election and any uncertainty. A lot of it has been trying to address the country's seemingly endless infrastructure needs. So that muni supply has kept muni valuations a lot more attractive and still plenty of great opportunities in the community market today, where the treasury market itself seems to be kind of well ahead of what the federal did. What's that record issuance look like? What number is that? The all-time record is $480 billion. We're at about probably 375 today, so it'll be a tight one right to the wire, but most likely if we don't beat the record, we'll be in the top three of all time issuance. And what's it look like historically?

Has it been steady climb always going upwards? Has it been back and forth, back and forth? No, it's been in a tight range over the years, which is interesting because as the country has grown, infrastructure and municipal financing hasn't really accelerated that much. So it has room to accelerate, which is a good news. Right, if you put that next to federal borrowing, is it like, it's crazy. You'll need two completely different charts to look at those things. But I mean, even the pace of the growth, right? The federal just keeps growing, growing, growing.

Yeah, munis have been pretty flat between that, usually between like 350 and 450, you know, a couple of outlier higher years. But yeah, municipal financing has not taken off. And you know, there's clearly still a ton of infrastructure needs. And to the extent they're improved or fixed with munis, there room for more muni bonds which tom and i talk about and that's encouraging because we'd like to see more supply and keep those yields a little bit generous for investors it almost tells me that tax rates aren't high enough right if if you can do all that other federal buying everything and the munis haven't rallied it's like well, well, the people are figuring out how to skirt the taxes

or I guess the rest of their investments are just doing after-tax better where it's not of interest to them. Yeah. The size of the muni market has stayed around $4 trillion for a while. It really hasn't expanded or blown out like the supply of Treasury's outstanding. I mean, just an interesting observation. This year, as Tim had mentioned, I think issuance is up about 38% year over year to this point. So definitely tracking to be potentially the biggest year of all time. What's it look like in other countries? Is it a similar setup? I can't get a tax break by some munis in Canada or something, right? No.

So you guys are US only. No. No. So you guys are US only. Yes. So I don't know if I really got your answer there. So the Fed's going to cut, you think, less than the 150 that's priced in. Not that you're in the business of making predictions, but yeah, out of interest. My personal view is they'll go with 50 today, which might be a little bit out of consensus. But to get 250 in a year, you're going to need a pretty serious economic slowdown, which I don't see coming. And you're saying that is good for business.

Who cares? I think it would be good for business. I don't think the Fed will cut as much as the market wants you to believe. I think they want to get back to a more neutral range, but that's probably around 3.5%, not 2.5%. And then the supply of munis is going to remain high in our view. Some of it was election related, but some of it is also infrastructure related and money that has to be put to work, which is good for the economy. Obviously, these are good paying jobs when you're talking about infrastructure improvement and workers. So those things are positive in terms that they're going to keep yields at a level that, you know,

provide a nice after-tax income flow. Tom, anything to add there? Yeah, my personal opinion is 25 today and you know i and i like to think that there'll be a bit of a sell-off and in response to that if the market's disappointed um but you know we're not really we we've generally not been you know making duration bets or or a game where we think rates are going to go. It's been more like, let's take advantage of where the value is in the current market on behalf of our clients. Sometimes it may be shorter, intermediate, longer, different structures.

But with all that in mind, yeah, I mean, I think that the general trend obviously is going to be, you know, rates coming down probably over the next six to 12 months. And, you know, whenever there's a, if there's a pullback, a sell-off or expectations that aren't met and, you know, sentiment changes, you know, we're here trying to take advantage of those opportunities. It's not like the old Board of Trade days, Tim, right? On Fed Day, watching bond prices go crazy. So you might not even see any, right? You're not even seeing any price data

when the Fed cuts on the muni prices, right? You don't have an intraday feed, right? Maybe something trades and you get a report. Yeah, I mean, there's trades that go on throughout the day. So there's definitely some price, some price movement throughout the day that we're monitoring for sure. And we'd be posted on, you know, adjustments that dealers are making to their inventory um their offerings you know the market's selling off you know things are being cut two three four five basis points and you know uh and likewise if if things rally so you know in your we're constantly made aware of where

things are trading by the broker dealerdealer network that we have. And, you know, like I said, there's no ticker with bond prices, with muni prices flowing past throughout the day. the market and the brokers that we work with to know where things are moving or trending at any given moment. Do you think some of this record issuance new demand is people fearing Gamla will win and taxes will be raised? Is that the underlying feeling there? I think if, if a client or an investor is anticipating that, you know,

taxes are going to go higher than yeah. I mean, munis, the go-to asset class, it would, it only makes sense. You know, some of these things have been thrown out like a 44% top bracket. Okay, well, you know, who say oh i don't want anything to do with that state that red state or that blue state right i'm like hey we got this great structure this great yield everything looks good with this issue and we're going to put it in your account and they're like nope i don't want anything to do with texas or illinois or whatever um like based just on the division in the country and yeah yeah i mean for sure we we've had uh clients that have they may single out certain states for a variety of reasons but we definitely have had some that have said to avoid you know a state or a number of states because of their own, I guess, you know, political standpoint.

And one of the advantages of working with Riverbend is we customize portfolios according to what the client preferences are and and parameters. And if somebody wants to do that, we can structure the portfolio accordingly so um that's what makes a market that like creates opportunity if someone's like i don't want anything to do with right when you tell me lunch like people just say i don't want anything to do with illinois or chicago but the toll road seems to be doing just fine you could drive through here pay your tolls and never

step foot in illinois um but that's paying that bond off. Exactly. Yeah. And if that toll road was in Wisconsin or Indiana, they would be financing a lot cheaper. I mean, the fact that it says Illinois toll road costs them extra yield. So that's just one of the inefficiencies that out there. But because it's got the word Illinois in it, they're paying a higher cost for financing than if they were elsewhere maybe you should run for governor and say we're going to change the name of all the roads to wisconsin i don't think you get many votes actually like it's going to save us a billion dollars like we don't want wisconsin on our signs you're kidding so along those lines last question what are some of the weirdest issues that you've seen

out there in your 25 years like what's some of the craziest stuff or the coolest most unique any cool stories like that me i'll throw one out um i guess it was the first week of COVID. You know, when there was a lot of uncertainty about, you know, how it was spread and, you know, just the market reaction, the huge sell off. Muniz sold off about 140 basis points in three days it was just an enormous liquidity grab i think you know equity markets sold off too but uh but you know it really the impact on funds in particular was devastating because you know there were all sorts of fund redemptions and bond fund managers having to meet those redemptions had to, you know, liquidate bonds into a market that just had no liquidity at that point. And, you know, bond yields, I mean, you know, if muni yields go up 10 basis points on a given day, that's a huge move.

This was about 140 basis points in three days. And I had never seen anything like it. the advisors that we work with and saying, you know, I'm about 89% sure that this is just a liquidity issue that's going to pass pretty quickly and not anything fundamental. And I think this is a, probably an opportunity to take advantage of. And, you know, fortunately some of them did, and we, we added a lot of money into, and, of money into a lot of existing portfolios in a real short time. You'd see something that was 140 basis points cheaper than it was at the beginning of the week and show a bid on it and get hit immediately. It was kind of a free-for-all it turned around way too fast i think the next week well you could see some logic in that right of like

something in vegas backed by tourism revenue or something like right that was for sure at risk um i wanted something more like oh that time arnold Arnold Schwarzenegger was funding a $10 million gym in the governor's mansion or something. Nothing crazy like that? Tim may have one of those. I don't know. No, I was thinking about that, Jeff. And my big surprise is really the muni market itself still operates the way that provides these opportunities we've talked about. You know, the fact that there's now 75,000 issuers and the price discovery that goes

on every day and the surprises and opportunities you can get on a daily basis, that's the big surprise to me is that they exist and the behavior of investors and the irrationality of some of them for certain parts of the yield curve and sectors and states. It's the one big giant surprise that keeps me invigorated and excited about the marketplace that it's probably never going to change. It seems ripe for disruption in my humble opinion of like some technology solution, get this all less efficient, But that would be bad for the investors. Keep it inefficient so we can find some edge. Efficient markets demand active

relative value management, for sure. And just one other quick thing is, I don't think we mentioned the individual investor proportion of the market between you know just direct ownership sma and and bond funds is more than two-thirds of the market you know that's that's a much bigger proportion than any other you know fixed income so that contributes to a lot of the inefficiency. Individual investors a lot of times overreact. They see some good performance, so they pile into bond funds at the wrong time. Or when things are selling off, they get jumpy about that and they sell their holdings and it can distort the market

in ways. To a patient professional investor's advantage. Right. Last bit there made me think is that all boomers and older? Do you have any idea

in the demographics? Do you have any idea on the demographics? Do Silicon Valley family offices have munis? Is that an old man's game or a young man's game, I guess I'm saying, in terms of the investor makeup? I think there really isn't a stereotype like that. At least the profile of a typical client here, a lot of them are private equity investors or have an operating business or they're in a position where they're generating a lot of income and they like the tax advantage of munis. It's really not the old stereotype of a little old lady

clipping coupons. It's something that's used to offset risk and create balance. And I think a lot of astute investors, you know, they're taking advantage of that. Right. It's more. That's why we want to take advantage of those, you know, market sell-offs when they occur too, to Tom's point. There's a new generation of buyers out there, but to your point, Jeff, the baby boomers, you know, born 46 to 64. So what they're 60 to 78 years old right now, which is kind of prime demographic fixed income years. So yeah, that is kind of a stable force of buyers. And then everybody else, you know,

around the fringes. Love it. All right, guys, I think we'll leave it there. Any last thoughts? We're good to grow. Good to grow. I said, I misspoke, but I think you're good to grow i said i i misspoke but i think you're good to grow as well so we're good to go and grow i like it awesome well thank you guys for being here we'll put uh links to where can people find it give us the uh our website riverbendcapitaladvisors.com yes we'll put that out there so we'll put that out there and uh put it in the show notes but thanks for coming on guys we'll see you soon around the loop here sounds good make sure you're time appreciate it guys okay that's it for the pod thanks to tom thanks to tim thanks to rcm for sponsoring thanks jeff burger for producing we'll see you soon. Peace. You've been listening to The Derivative. Links from this episode will be in the episode

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