In this episode of the Derivative podcast, our host Jeff Malec sits down with Tim McGregor and Tom Hession from Riverbend Capital Advisors(@Riverbend_Cap) 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!
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Check out the complete Transcript from this week’s podcast below:
Is there Alpha in boring old Muni-Bonds, with Riverbend Capital
Jeff Malec 00:06
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, few local guys here in Chicago actually trade these things munis, that is not mobs, 10s of 1000s of them, and think there’s some alpha there. So we’re digging in with Tom hessian and Tim McGregor of Riverbend Capital Advisors to learn more. Send it This episode is brought to you by RCMs, outsourced trading desk, where we have absolutely nothing to do with mini bonds. But hey, could 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 RCMs, 24 6, outsource trade desk operation. Check it out at RCM, alts.com/ 24 and now back to the show.
All right, we are here with Tim and Tom. Tom and Tim. Hey guys, how are you
01:42
great? Good to be here,
Jeff Malec 01:43
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 Wacker, all right, we know. And you guys are doing very little to dispel the stuffy muni bond image with the suit and button down shirt, right? We’re us commodity guys are just in the golf shirt and mailing it in from a casual standpoint, is that is that perception of the muni bond World Fair, everyone suited up.
Tom Hession 02:24
I would say that’s a little more Tim specific, coming from 30 years at Northern Trust. It’s not, it’s not all Muni.
Jeff Malec 02:33
They went. Didn’t northern try and go no suits for like, a year, couple months, and it epically failed, and they made them all come back.
Tim McGregor 02:43
They tried. I protested, so I got my way. But, yeah, I’ve been accused a little bit of old school.
Jeff Malec 02:48
But, you know, you protested to bring the suits back.
Tim McGregor 02:51
I was in favor of bringing them back. Absolutely. Yeah,
Jeff Malec 02:54
I love it. Um, what’s, what’s your view? Just makes you work a little harder, makes you better.
Tim McGregor 03:01
Oh yeah, a little bit old school, you know, dress the part me, you get up at the crack of dawn, you get the suit on, you get on the drain, you get to work, you know. So it’s a good process,
Jeff Malec 03:12
awesome. So you guys are doing muni bonds. I know next to nothing about muni bonds, except that I get a tax break on them. So 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
Tim McGregor 03:31
tackle it. It’s a fascinating market. I’ll start with Matt. I believe it’s probably the most inefficient investment market there is, maybe with the exception of real estate. And there’s two deep root 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 it 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 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 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. 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 in a different asset class than municipal bonds. What
Jeff Malec 05:09
do you got to add? Tom,
Tom Hession 05:10
I mean, 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, there’s good and bad aspects to that, you know, I think that it’s, it’s 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, you know. So, for example, for advisors that we work with to try to, you know, just occasionally jump in and buy some bonds. You know, there’s there, it’s not very transparent at times as far as pricing and and, you know, there’s a lot of different structures. You know, there’s a mill, a million and a half or so Qs in the muni market, and the vast majority of those don’t trade on a given day. So, you know, it can
Jeff Malec 06:24
those all housed like I could pull up any of those 1.5 million on Bloomberg.
Tom Hession 06:30
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 2030, different maturities with different coupons and structures and call features. So, you know, there’s
Jeff Malec 06:53
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 glenco as an example. I’m a 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,
Tom Hession 07:23
yes, Park District. You know, there’s a place like Glencoe, which is where I live in any given year. There may be a couple of different bond issues for school improvements. Or, you know, water park district. And you know, the each one of those issues, it may only be a, 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 Q sip, and they’ll have different they’ll come at different yields. They’ll have different structure, different coupon, maybe different call features
Jeff Malec 08:07
within that one issuer. 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.
Tom Hession 08:20
Well, because they’re going to pay the bonds off over time from revenue that comes in from property tax, or, you know, other taxes. So you know, they don’t 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, you know, but they need to pay for that construction in the near term. But then, you know, that’s going to be financed over the next 20 or 30 years. So as property tax is collected year by year, you know, it goes to pay the debt service and to pay off the bonds you know, staggered over a longer period of
Jeff Malec 09:05
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.
Tom Hession 09:22
Well, I mean, I think, in a way, it’s the similar, it’s similar, like, they’re, they’re paying back that 10 million in one year. They’re going to pay part of the principal, but they’re also going to be paying interest in year two. You know, they’re going
Jeff Malec 09:38
to pay off, like tranche them all based on when they’re paying a bit right.
Tom Hession 09:44
And on the other side of that, you know that fragmentation creates opportunity, I think in a lot of cases, because, you know, the the different structures and call features can be, you know, viewed or. You differently by different market participants. And you know, sometimes there are, you know, anomalies in municipal bond pricing. And you know, those can be taken advantage of. You know, it’s not the municipal bond market doesn’t have a ticker, you know, with prices like equities, or a screen with 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 given the fact that a lot of them don’t trade on a given day. You know that it could be treacherous at times, but it could also create a lot of opportunity at times. And if you’re if you’re a regular participant, and you know you can recognize those situations, you can take advantage of them on behalf of your clients.
Jeff Malec 11:01
Now I’m old enough to remember there were muni bond futures here in Chicago. Why didn’t that work? What was the problem with those
Tim McGregor 11:13
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
Jeff Malec 11:21
at every 1.5 million, yeah.
Tim McGregor 11:25
So pretty quickly, 5050, so, pretty quickly, some bigger firms realized we 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.
Jeff Malec 11:44
And is there a reliable index, though, that gives you price across those 1.5 million or No, it’s too diverse. That’s
Tim McGregor 11:51
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 p5 100 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 there’s products that try to replicate the index, but there’s no pure version of like an S p5 100 index in the meeting market.
Jeff Malec 12:15
And that leads to why you guys are even are in business, right? So I can’t just go out and buy right? 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.
Tim McGregor 12:29
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 an interest rate, risk duration. They might want to overweight certain states for tax purposes. They really want to control their tax strategies, 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 SMAs can be managed for individuals now at a smaller level than before.
Jeff Malec 13:19
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 going to go to a Goldman Sachs, or someone similar, or no trust, and go and then deal with the advisor who’s going to buy them for the
Tim McGregor 13:38
client. Yeah. Or you come to a Riverbend and then we will set up an SMA, and we’ll take it. 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 10 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 a 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.
Jeff Malec 14:34
You mentioned the different states. Tom, we had lunch today. We were talking, I’m like, why? Well, one Why do you guys work out of Chicago? Is that the worst municipal municipality there is in terms of muni bonds, it’s a little deep. 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 you. Uh, where there’s different opportunities, right? Like, not all states, not all cities, not all water districts are created the same,
Tom Hession 15:08
right? Yeah. I mean, I guess in terms of, you know, the client base that we work with, and what the 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, like, we’re trying to get into high yield, non rated esoteric structures or credits. It’s, you know, high quality bonds. And you know, we’re trying to add some alpha, some incremental yield through structure. And, you know, the taking advantage of some of the inefficiencies that are out there, 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 seems to be an ongoing budgetary struggle, and some of the demographic and revenue trends with population loss and so forth, kind of work against it. I think for the most part. You know, the clients that we have don’t want to see, obviously, don’t want to see defaults or downgrades, but they also don’t want to see you know stories about the credits you own in the news every day for the challenges 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, you know, strong issuers in the state there are, but you know, there are certain high profile ones that we’ve steered clear of over the years, and Chicago happens to be one of them.
Jeff Malec 17:19
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, right? Got enough risk elsewhere?
Tom Hession 17:33
Yeah, I think you can. You can obtain, you know, additional yield and additional Alpha through through structure, and, like I said, taking advantage of some of the market anomal anomalies that occur, you know, yeah, unique communities.
Jeff Malec 17:53
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 yeah, where do you get the alphahead of the structure?
Tim McGregor 18:15
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 5075, 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 with the risk profile more of that call, we call those cushion bonds, and a lot of that is based on that particular issue or demand, just to have that flexibility. And historically, there are definitely Muni issuers that overpay for that flexibility to do a refinancing.
Jeff Malec 19:09
Love it. And then what was your other you said structure alpha, and my brain blanked on the second one, the
Tim McGregor 19:16
there’s also just an incredible amount of day to day price discovery. You know, if there’s you’re looking at a couple 100 bond deals a week, and they’re being underwritten by 20 or 25 different underwriters on a weekly basis, depending on that underwriters 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 is the starting point as well. Yeah,
Jeff Malec 20:00
and does that track with rates, obviously, with fed expectations, like, what’s what’s driving that? Of like, we got to price this to sell, or we’re fine, waiting to what drives those dynamics? Yeah,
Tim McGregor 20:13
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, 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
Jeff Malec 21:12
inefficiency, it makes me think of right the promise of blockchain, that 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. I’m assuming that’s not happening,
Tim McGregor 21:32
not yet. The blockchain version of the media market would be, you know, every state having its own bond bank, and they would just issue through that bond bank, but it 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 and local governments happening anytime
Jeff Malec 21:58
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 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 that’s really the crux of it. That’s what’s driving it all.
Tim McGregor 22:21
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.
Jeff Malec 22:32
And that’s never ended, poorly. Sarcastic. 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?
Tom Hession 22:58
Yeah, there will be municipal bonds issued in a lot of those cases. And, you know, we’ve, we’ve generally shied away from those type of credits, you know, in some cases, you know, they may be like a sales tax revenue. And you know, it’s not. It’s so reliant on, you know, usage of the facility, you know, like small convention centers and things like that we’ve completely avoided. There may be, you know, a handful of stadium related bonds out there that we’ve participated in, but you know, when it’s when it’s a sales tax revenue source, and not like gate revenue
Jeff Malec 23:45
from, right from not so bondholders want half of the Taylor Swift concert.
Tom Hession 23:52
Yeah, proceeds.
Jeff Malec 23:54
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 payment schedules or their revenue that they’re paying it with.
Tom Hession 24:09
They’re, 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, even if, even if all else goes wrong, most people are still going to pay their water bill. You know, like, that’s predictable. You know, they have flexibility to change rates if, if needed over time and and, you know, general obligations backed by, you know, property tax that you know that like assuming that the municipality is in a in a credit worthy position, like, you know, we probably wouldn’t participate in. Chicago GEOS, but you know, many other cities and most states around the country, you know, if it’s higher education, you know, we’ve really only participated in in deals where, you know, it’s a large institution, large endowment, you know,
Jeff Malec 25:23
like a Stanford, or something like a Stanford’s not going out of business, yeah, Stanford,
Tom Hession 25:28
or a lot of the state schools, you know what, Purdue, Ohio State, places like that, you know, we, what we’ve avoided historically have been like Small, maybe more obscure, liberal arts schools where enrollment is declining and the endowments aren’t particularly strong. When it comes to healthcare, larger systems that have a network and a strong market position, not like one off hospitals in a rural area or or nursing homes. And you know, as I mentioned briefly before, we’ve tended to shy away from, you know, project specific issues like recycling centers or or golf courses, things like that.
Jeff Malec 26:23
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 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, right? So it’s not as simple as they’re just these guys are, right? It’s not just school districts, as you just said. There’s recycling plants, all these different pieces to the puzzle. How do How can you keep all those pieces straight without having like, 1000 person firm.
Tim McGregor 27:03
Well, it definitely helps to have a 25 plus years experience, 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, you can get it down to the credits you really want to focus on in a 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 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 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 takes a lot of the numerous small deals kind of off the table.
Jeff Malec 28:20
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
Tim McGregor 28:29
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 1520, 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 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.
Jeff Malec 29:26
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.
Tim McGregor 29:37
Well, for me, I started the Board of Trade, so I had interest in the market right away, and I found my way to the muni market shortly after that. And 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. And I. 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 still very much goes on on a day to day basis, I uh,
Jeff Malec 30:43
go ahead. Tom, then I had one question popped in my head, but go ahead and wait. But where were those 20 were they all at Northern that we mentioned? Or were you few different? Yeah,
Tim McGregor 30:51
Northern, 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, but a year ago and found a great home here at Riverbend. Love
Jeff Malec 31:09
it So Tom, what tell us about Riverbend and your
Tom Hession 31:14
background? So my background is just past the 30 year mark in Muniz. 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 my
Jeff Malec 31:36
experience the muni desk at Merrill, I was in the muni desk, yeah,
Tom Hession 31:42
and, you know, I my experience there, and my observation was that, you know, the meaning 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, you know, tending to get price markups. You know, with the market not being with Mark market not being very transparent, you know, it’s, it’s possible to, you know, take advantage of that. And, you know, getting passive strategies, passive approach, bond ladder, is 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. You know, I thought there might be an opportunity to bring a little bit more of an institutional approach to individual and and, you know, family office type investors. So I left Merrill started out on my own. And, you know, eventually, kind of gravitated towards, towards working with investment advisors, initially, where, you know, 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 you know, we’ve, we’ve focused a little bit more, up until recently, on the investment advisor space, and now, you know, with Tim joining us, and, you know, the added capacity and the expertise that he brings to the table, you know, we’re, we’re in a an active effort to start working more with with individuals and family offices, but the Philosophy, like Tim said, we, we, you know, connected a while back, you know, a year or so ago, 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 now we’re, we’re moving forward.
Jeff Malec 34:20
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
Tim McGregor 34:29
don’t think there’s any doubt about it. You know, I think that the tactical size of river bend 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,
Jeff Malec 34:57
deal dollar value. It’s only 25% but volume 75
Tim McGregor 35:02
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 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 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.
Jeff Malec 35:52
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 a we can only do 100 million slugs at a time or something. They probably
Tim McGregor 36:03
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, many of those deals we feel are overlooked and we’re not going to miss
Jeff Malec 36:31
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 pretty big deal in your guys’ world, if not everyone’s world, but Right? What? What’s that all mean? Is that the whole game for you, the rates 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,
Tim McGregor 37:02
we feel the tax exemption is safe in either scenario, but clearly, tax policy affects the muni market. You know, if tax rates were to go up, that tax free nature of municipal bonds would be more attractive if they tinker with some of the salt limits and caps that can also 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 them, you need 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 the end of 25 are are two key matters, and we watch
Jeff Malec 38:23
so the whole game. If I’ve got, 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, I call it 20% if, for some reason, taxes go to 3040, 5060, right? 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.
Tim McGregor 38:56
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 six from 37 the break even yield on a 4% 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.
Jeff Malec 39:19
Wouldn’t that push the pricing up and the yields down? That way you get less yield if all that demand comes in, yeah, if
Tim McGregor 39:27
taxes were to skyrocket, no doubt the demand for municipal bonds would be very strong,
Jeff Malec 39:32
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 range, what’s a general benchmark?
Tim McGregor 39:47
So, yeah, go ahead. 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. Originally 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. There’s always pockets where valuations are quite different.
Jeff Malec 40:15
Is that curve usually inverted like that? Or is it depend
Tim McGregor 40:22
usually, yeah, usually curve the treasuries.
Tom Hession 40:25
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 some 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’re doing a lot of barbell portfolios, because, you know, owning short term bonds, you really weren’t sacrificing yield. You’re getting great yield. And then, you know, locking in some of that longer term, 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, that’s equity, like return. So you could just lock in on, like, double A plain vanilla Munis for, for, you know, 10 or 15 years. So, you know that that’s just an example of, you know, the market, 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, was inverted and, you know, but generally, the muni curves is, you know, stayed steep, historic,
Jeff Malec 42:07
the so what? What’s our thoughts on, what happens next with the Fed? Know, what that does for you guys? For Yeah,
Tim McGregor 42:18
you know, in typical bond market fashion. You know, today, the bond market seems to be well ahead of Fed expectations. So 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 a e 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, you know, a lot more attractive, and still plenty of great opportunities in the media market today, where Treasury market itself seems to be kind of well ahead of what the federal
Jeff Malec 43:30
What’s that record issuance look like? What numbers that
Tim McGregor 43:35
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.
Jeff Malec 43:55
And what’s it look like, historically? Has it been come steady climb, always going upwards. Has it been back and forth? Back and forth? No, it’s
Tim McGregor 44:04
been in a tight, tight range over the years, which is a interesting, because as the country has grown, you know, infrastructure and municipal financing hasn’t really accelerated that much, so it has room to accelerate, which is a good
Jeff Malec 44:15
right? If you put that next to federal borrowing. Is it red? Like it’s crazy.
Tim McGregor 44:19
You’ll need two completely different charts to look at those things.
Jeff Malec 44:23
But I mean, even the pace of the growth, right? The Federal just keeps growing, growing, growing. Yeah,
Tim McGregor 44:28
Munis have been pretty flat between that usually between, like, 350, and 450 you know, a couple 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’s 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
Jeff Malec 44:53
almost tells me that tax rates aren’t high enough, right? If you can do all that other federal borrowing, everything. And the munies Haven’t rallied. It’s like, well, the people are figuring out how to, how to skirt the taxes or, or, I guess the rest of their investments are just doing after tax better where it’s not of interest
Tom Hession 45:14
to them. Yeah, yeah. This, you know, the size of the muni market has stayed around 4 trillion for a while it really hasn’t, you know, expand, expanded or blown out, like the supply of treasuries outstanding. I was 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.
Jeff Malec 45:49
What’s it look like in other countries, a similar setup, right? I can’t get a tax break by some Munis in Canada or something, right?
Tom Hession 46:01
No, no.
Jeff Malec 46:02
So you got your US only, 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, yeah, out of interest,
Tim McGregor 46:19
my personal view is they’ll go with 50 today, which might be a little bit out of consensus. But you know, to get 250 in a year, you’re going to need a pretty serious economic slowdown, which I don’t see coming.
Jeff Malec 46:31
And you’re saying that is good for business. Who cares? I
Tim McGregor 46:37
think it’d be good for business. I don’t think the federal cut as much as a as the market wants you to believe, I think they want to get back to a more neutral range, but that’s probably around, you know, three and a half percent, not two and a half percent, and then the supply needs 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
Jeff Malec 47:18
Tom. Anything to add there?
Tom Hession 47:22
Yeah, yeah. I, 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. But, you know, we’re not really, we, we’ve generally not been, you know, making duration bets or or, yeah, game where we think rates are going to go. And, you know, it’s been more like, let’s take advantage of of where the value is in the current market on behalf of our clients. Sometimes it may be shorter, intermediate, longer, different structures, but, 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, sediment changes. You know, we’re here trying to take advantage of those, those opportunities,
Jeff Malec 48:31
the it’s not like the old Board of Trade days. Tim, right on fed day watching bond prices go crazy, right? So you want, 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.
Tim McGregor 48:48
Yeah? I mean, there’s, there’s trades that go on throughout the day. So there’s definitely some price, some price movement throughout the day that we’re we’re monitoring for sure.
Tom Hession 48:59
Yeah, and we’d be posted on, you know, adjustments that dealers are making to their inventory, their offerings. You know, markets selling off. You know, things are being cut, 2345, basis points. And, you know, and likewise, if, if things rally so, you know, in your we’re we’re constantly made aware of where things are trading by the broker dealer network that we have. And, you know, it’s like I said, there’s no, there’s no ticker with bond prices, with mini prices flowing past throughout the day. But we get enough information from, you know the market, and the brokers that we work with to know, you know where, where things are moving or are trending any, any given moment.
Jeff Malec 49:50
Yeah. And then are you seeing, do you think some of this record issuance, new demand is people fearing gamala will win? And. Taxes will be raised. Is that the underlying feeling there?
Tom Hession 50:07
I mean, 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, right, 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, Muni tax free, Muni income becomes that much more valuable in that situation. So
Jeff Malec 50:39
I’m gonna try not to get too political here. But like, part of me is, do you get clients who say, Oh, I don’t want anything to do with that state, that red state or that blue state, right? Of 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. Like, based just on the believers division in the country. And, yeah, yeah.
Tom Hession 51:05
I mean, for sure, we, we’ve had clients that have they, 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, you know, working with Riverbend is we customize portfolios according to what the client preferences are and parameters. And if somebody wants to do that. We can structure the portfolio, you know, accordingly. So that’s
Jeff Malec 51:46
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, but that’s paying that bond
Tom Hession 52:05
Exactly. Yeah.
Tim McGregor 52:06
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 cost them extra yield. So that’s just one of the inefficiencies that out there, but because it’s got the word Illinois, they’re paying a higher cost for financing than if they were elsewhere.
Jeff Malec 52:26
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 Doug, it’s going to save us a billion dollars, like we don’t want Wisconsin on our signs. You 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?
Tom Hession 53:01
Me, I’ll throw one out. 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 a market reaction, the huge sell off. Munis 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, 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 For at that point. And you know, bond, bond yields. I mean, you know, if, 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 never seen anything like it. I remember actually going and meeting with some of 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, you know, a lot of existing portfolios in a real short time. And you know, you’d see something that was 140 basis points cheaper than than it was at the beginning of the week. Make and show a bid on it and get hit immediately. You know, it was kind of a free for all. It turned around way too fast. I think the next week, well,
Jeff Malec 55:09
you could see some logic in that right of like, something in Vegas backed by tourism revenue, or something like, right, that was yeah for sure, at risk. I wanted something more like, oh, that time Arnold Schwarzenegger was funding a ten million gym in the governor’s mansion or something. Nothing, nothing crazy like that.
Tom Hession 55:32
Tim may have one of those. I don’t
Tim McGregor 55:35
know. No, I was thinking about that. Jeff and my my big surprise is really the muni market itself is still operates the way that provides these opportunities we’ve talked about. You know, the fact is, 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 is that’s the big surprise to me, is that they exist, and the behavior of investors and the rationality of some of them for certain parts of the yield curve and sectors and states. And it’s a one big, giant surprise that keeps me invigorated and excited about the marketplace that it’s probably never going to change.
Jeff Malec 56:16
Yeah, it seems ripe for disruption, in my humble opinion, of, like, some technology solution, get it, get this all less efficient, but that would be bad for the investors. Keep it inefficient so we can find some edge.
Tim McGregor 56:30
Yeah, efficient markets. Demand, active, active, Relative Value Management for sure.
Tom Hession 56:37
And you know, just one quick thing is, you know, 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. You know, the individual investors a lot of times overreact, you know, they see some good performance, so they they pile into bond funds, you know, at the wrong time, or they when things are selling off, you know, they get jumpy about that, and they and they sell their holdings, and you know that it, it can distort the market in in ways
Jeff Malec 57:32
patient professional investors advantage, man, right, yeah, last bit there made Me think is that all boomers and older, right? Like is, do you have any idea in the like demographics, do Silicon Valley family offices have munis, right? Is it? Is that an old man’s game or a young man’s game? I guess I’m saying, in terms of the investor makeup,
Tom Hession 57:58
I think, I think there really isn’t a, you know, a stereotype like that. I mean, at least the profile of a typical client here. A lot of them are, you know, private equity investors, or, you know, have an operating business, or, you know they’re, they’re in a position where, you know they’re generating a lot of income, and you know they, they like the tax advantage of of munis, you know, it’s really not the old stereotype of, you know, a little old lady clipping coupons, right? You it’s something that’s used to offset risk and and, you know, create balance. And I think a lot of astute investors take advantage of that,
Tim McGregor 58:46
right? It’s more that’s why we want to take advantage of those market sell offs when they occur to 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, it is kind of a stable force of buyers. And then everybody else you know around the fringes
Jeff Malec 59:16
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 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
Tom Hession 59:34
uh, our website, Riverbend, Capital advisors.com, yes,
Jeff Malec 59:39
we’ll put that out there, so we’ll put that out there and put it in the show notes, but thanks for coming on, guys. We’ll see you soon. Around the loop here.
59:48
Makes your time appreciate it.
Jeff Malec 59:55
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.
This transcript was compiled automatically via Otter.AI and as such may include typos and errors the artificial intelligence did not pick up correctly.
