Riverbend Capital Advisors Founder Tom Hession is adept at identifying problem spots within investors' muni bond portfolios — what he refers to as “smoking guns.” In fact, advisors frequently ask him to review prospective clients’ portfolios in search of hindrances and opportunities to better align muni bond selections with clients’ goals.
In this blog post, Tom provides examples of some of the smoking guns Riverbend Capital has uncovered during portfolio reviews and offers recommendations for how to avoid them. He also explains how Riverbend approaches these reviews with clients’ best interest as the primary focus.
What kind of impact is Riverbend able to have by reviewing a portfolio that’s under the purview of another asset manager?
For an advisor working to win a prospective client’s business, our “forensic analysis” of how that client’s current asset manager has allocated to muni bonds can expose shortcomings and position the advisor to recommend opportunities for enhancement. It can reveal whether the manager is taking an active or passive approach to investing and how effective that approach is in delivering on the client’s unique investment objectives. The goal is to identify and solve potential problems in a portfolio. It’s part of the specialized expertise we provide to advisors and something their clients see as a point of differentiation.
"The goal is to identify and solve potential problems in a portfolio. It’s part of the specialized expertise we provide to advisors and something their clients see as a point of differentiation."
What smoking gun surprises investors the most?
In some situations, it’s execution. Many investors are under the impression that their advisor doesn’t charge a fee for their muni bond portfolio. The reality is that the fee is often built into the bond price in the form of a price markup and it’s generally not distinguishable to the typical investor.
At Riverbend, when we are considering buying a bond for a client’s portfolio, we make a concerted effort to achieve the best possible execution on every trade.
What other issues have you come across during your analysis of portfolios?
Owning bonds from states that are disadvantageous. For example, being a taxpayer in a high-tax state like CA, NJ, NY incentivizes the investor to own bonds in that state, as they are exempt from state income taxes. Therefore, taxpayers in those states should seek to include a significant proportion of in-state bonds in their portfolio. Due to the in-state demand this creates, these bonds tend to trade at a tighter spread.
An investor in a state with no income tax, like Florida or Texas, would be best served with a general market / non-state-specific portfolio. They have no particular reason to own bonds in their home state. And, in particular, they would likely be better off not owning bonds from a high-tax state given that they’d be sacrificing yield unnecessarily. We’ve encountered many portfolios that are misaligned in both ways.
For advisors who are generalists and not familiar with the nuances of the muni market, the state-by-state tax benefits and consequences may not be top of mind. As a muni bond specialist firm, we’re very acquainted with these considerations and well positioned to structure client portfolios appropriately.
What are the signs and risks of passively managed portfolios?
One indication is having a disproportionate share of bonds in an investor’s portfolio set to mature in the near future. It’s likely that the portfolio hasn’t been rebalanced with a longer-term client investment horizon and objectives in mind. In this scenario a client could be vulnerable to reinvestment risk. They may have become accustomed to a certain level of income and now face the prospect of reinvesting in bonds that offer less income and a lower yield.
Periodic rebalancing can prevent this, but so can structuring a portfolio by investing in muni bonds with staggered maturities and call dates. This type of proactive management — anticipating and preparing for risks rather than reacting to them — is what we do at Riverbend.
Unnoticed credit deterioration is another sign of passive management. Without consistent portfolio reviews, credit rating downgrades may be overlooked and become problematic.
What are some of the missed opportunities you’ve uncovered during your portfolio analyses?
Recently, we’ve been finding opportunities where investors could have harvested tax losses but didn’t. In 2022, as interest rates climbed, muni bonds experienced losses for the first time in years. Through tax-loss harvesting, investors with capital losses on munis often can offset tax liabilities from capital gains in other asset classes. We’re always on the lookout for tax-loss harvesting opportunities that investors may be able to realize. The benefits of harvesting tax losses can be significant.
"We’re always on the lookout for tax-loss harvesting opportunities that investors may be able to realize. The benefits of harvesting tax losses can be significant."
Why do these smoking guns often go undetected by investors?
Lack of transparency and the fragmented market landscape make it difficult for investors to navigate the muni bond market. As a result, many rely on big box managers, which may employ a passive approach to portfolio management with limited focus on investors’ specific situations or goals.
Without municipal bond expertise and ongoing oversight, it’s easy to see how many of these smoking guns would remain undetected by individual investors. Riverbend is a fiduciary with expertise to help individual investors and family offices and their advisors navigate the complexities of this market.
