In this engaging episode of the NAAIM Confidential Podcast, host Asher Rogovy sits down for an enlightening conversation with Westport, CT investment manager Brandon Pacilio, a new member of The National Association of Active Investment Managers, and the founder and president of the boutique wealth management firm Alpine Hill Advisors.
Discover exclusive investment insights and effective strategies to navigate the complexities of today’s financial markets. Asher and Brandon delve into a range of intriguing topics, from current market trends to innovative investment approaches.
Transcript (edited for clarity and brevity):
Asher Rogovy
Brandon, you’re a new member of NAAIM! First of all, welcome to the organization and thanks for joining us. Maybe you can give us an introduction about yourself and your firm.
Brandon Pacilio
Yeah, absolutely! Thank you, Asher. I’m excited to be speaking today. I want to thank you personally for bringing me into the organization; I think it’s a great organization. I love active investment management, specifically in the fixed income markets. My background includes working at a fixed income broker-dealer for four years creating corporate and municipal bonds—I’ve got great experience there—and spent a year at Bridgewater Associates in client service. I’ve been on the RIA side ever since. I run my registered investment adviser in Westport, Connecticut called Alpine Hill Advisors. Our liquid investment strategy includes buying individual stocks as we see fit and ETFs, but our core focus is on fixed income looking at corporate and municipal bonds, where we build unique bond portfolios for clients depending on their particular needs.
Asher Rogovy
Fantastic! I know our members are focused on the equity side, and we’re eager to learn how active investing works with bonds and what kind of strategies are available. Do you look at individual bonds?
Brandon Pacilio
Absolutely! It’s funny because with equities, it’s an extremely liquid market; everyone has that conception about bonds being an over-the-counter product—it’s a little bit esoteric. Maybe there’s not much liquidity; actuality in today’s bond markets is pretty efficient. I say “pretty efficient” because they’re not perfectly efficient, and that provides alpha for your clients. Right? Corporate bonds across the board have different economic meanings and market makers where you can source liquidity for bonds—go to different custodians—and see their bond offerings; we have relationships with bond dealers, so there’s really a robust market for firms like us to find and execute bond strategies for different clients.
There are really two main components when clients use fixed income: one is to give a synthetic paycheck when they’re reaching retirement or in retirement—that’s unique bonds where we can build customized laddered portfolios so we know exactly which bonds are maturing and when coupon payments are coming due and give clients that income projection, which is unique compared to buying a bond fund where you’re buying a bond fund that doesn’t have the same characteristics as individual bonds.
Bonds have permanence by definition meaning you know clearly the money is coming versus a bond fund where yes, you get a monthly income stream from it but there’s forced selling like we saw in March 2020 where the value of the bond fund dropped precipitously—you might not recoup that value while individual bonds might paper losses still know at maturity you’re going to get your money back.
So we believe that fixed income serves two purposes: one for the synthetic paycheck through bond ladders for retirement and also looking at bonds from a total return perspective—right? We believe in bond markets there are really good opportunities for risk-adjusted returns if you do your homework and understand credit meaning the individual corporation or municipality you’re making a bet on—that is GNA payback—you could take advantage of that.
Asher Rogovy
That’s fantastic! So what kinds of trades do you find using individual bonds as opposed to investing in funds?
Brandon Pacilio
I think it’s a good question because funds are going to be benchmarking specific indices. In those funds, they’re going to have to buy a lot of stuff that they don’t necessarily want in their clients’ portfolios. You could manage portfolios based on specific yield bogeys—talk about clients—right? If someone wants five to six percent, they can go get five to six percent.
And the mention of specific trade benefits from higher interest rates allows you to take less risk from a credit rating perspective. I’ve been getting five to six percent returns just years ago—right? Years ago buying single A or double B rated corporate bonds only yielding three-and-a-half to four percent; well today we’re buying triple B rated bonds at six to six-and-a-half percent.
That’s really a great thing for our clients because they see higher interest rates—it’s a great time to be buying bonds. To answer your direct question about key characteristics that we look at: it’s going to be corporate credit ratings, coupon rates, yields, and also getting very specific industry perspectives—right? Say someone only wants to buy tech-based bonds or wants to look at energy bonds because maybe they see opportunity there.
Asher Rogovy
And we haven’t even talked yet about looking at the tax perspective that I’d love to continue this conversation on!
Asher Rogovy
Absolutely! You know there’s a lot of tax-free municipal bond funds in popular areas like Manhattan or California or something like that—I’m sure that would work wonders for clients in those areas without having a dedicated bond fund.
Brandon Pacilio
Well that’s exactly right! Look at these larger fixed income managers—they have to manage massive amounts of people that scale institutional investors—they might look at certain states but not buy those certain states because there might not be enough issuance for scalability in their portfolios.
Let’s say you’re a North Carolina resident; we can curate a North Carolina portfolio for you whereas larger fixed income managers might say “look, we can’t offer a North Carolina portfolio.” They won’t be able to produce that portfolio in large quantities.
We’ll look specifically at the secondary market; people look at the primary market but there’s not enough issuance there—so they might say “I’m sorry I can’t buy North Carolina bonds.”
What’s important to note is instead of getting into either municipal bond corporate bond strategy—we’re able to say “look in your portfolio let’s look at things on a tax basis.” We’re looking at bonds weekly or daily; we’re doing those calculations—we see tax returns sometimes may be more advantageous to buy single A rated municipal bonds yielding three-and-a-half percent than after pre-tax basis—that’s equivalent to six-and-a-half percent rated corporate bonds if you’re in the top tax bracket.
We can specifically cater portfolios to meet each client’s needs on a tax basis without saying “no need to go corporate bond or go municipal bond or bond fund.” I think that’s one of the unique advantages.
Another point is with your bond fund—that might be one position you might manage—we’re able to consistently do bond swaps—so we could bank taxable losses then just go rotate into a new bond that has the same par value; par value is coupon payments based on income streams doesn’t change; all we did was bank capital loss.
I think that’s one of the things we’ve been doing over the past couple of years when you’ve had blowout interest rates—maybe paper losses in portfolios—we’ve actually been able to say “let’s bank those losses and rotate into new bonds with higher income streams.” And that’s been something that our clients have loved.
Asher Rogovy
Fantastic! Correct; I never even thought about that in the bond market!
That’s great! Portfolio individual bonds allow for more adjustments compared to funds.
Brandon Pacilio
Yes, absolutely! I think with bond markets that’s why when I started talking about it being pretty efficient—everything prices off the treasury curve—all risks adjusted from that credit spread said it is an efficient market—that front double B-rated bond is going wider credit spread relative to triple B-rated bond—but then really you get your homework done and find different discrepancies which provide that incremental return for clients and it takes time—it takes diligence—that’s where you start getting outperformance at an individual bond level—you might not get that with a bond fund because they don’t have that flexibility as frequently—they’re going to swap bonds sometimes too depending on cash coming into cash coming out of funds.
You looked at March 2020—a fantastic time for buying bonds when cash was on the sidelines; rates blew out as credit markets froze—everything was completely mispriced! What happened was people were getting out of bond funds—sellers where time should have been buyers of bonds—and we were able to take exposure off the equity table rotate into bonds and just capture additional yield—a lifetime opportunity for bond investors!
Asher Rogovy
Fantastic! It’s not just about security selection; you’re also talking about timing along the yield curve.
Brandon Pacilio
Yes! It’s security selection; there are numerous factors involved sometimes too with even looking at individual corporations—you could use example companies like Ford who have billions in outstanding bonds—and find individual discrepancies within their capital structure too—to get incremental yield.
There are choices everywhere in the bond markets right? If you want to be super conservative you could buy single A rated bonds or if you want to take additional risk go into high yield market.
Asher Rogovy
There are so many different factors involved!
Brandon Pacilio
It really goes back to the client right? You go into a bond fund—the portfolio manager at that bond fund is never going to know you as a client—they’re not going to know “oh maybe right?” They won’t know if you’ll like what company they buy—but us—we’re able to get exactly what the client needs—for example—clients say “I want income” so we buy right now high coupon bonds; maybe I’ll give up some purchasing power because higher coupon bonds might be a little bit expensive just want them to know every month or quarter they’re getting higher income streams from coupons.
Going back into conversation earlier—clients say “hey give me total return” so maybe I’ll buy low coupon bonds; they might be a little bit juicier right now as rates start coming back—it’s knowing your client—it’s being able to customize things—I think that’s one of unique benefits of owning individual bonds.
Asher Rogovy
Very cool. So what’s your outlook today? Any favorite maturities or sectors or credit ratings you’re finding value in?
Brandon Pacilio
Yes! If you don’t mind—I would like to share a chart just to give a snapshot of what the current interest rate curve looks like…
(Visuals shared)
The green line gives an indication of interest rates today; everyone should be aware it’s an inverted yield curve which indicates higher rates at front end interest rate curve—and what you should be careful about is loading up on short-term bonds—because one key principle in bond investing is reinvestment risk—it means when your bond matures what will the interest rate environment look like?
If you go into short-term bonds—let’s say Federal Reserve—I’m not saying they’ll lower rates back down to zero—but if your bond matures in two years—you’ll be investing in an interest rate environment with low rates and won’t be able to get returns—so where I like to focus is really on the seven-10 year range right? Believe me—you can get good yields.
Maybe you don’t get that five-to-five-and-a-half percent—you’re locking in seven-to-ten years—but four quarter ten-year treasuries plus add credit spread—that’s probably five-to-five-and-a-half or six-six percent—we don’t think it makes sense really extending duration maturity profile portfolio over twenty or thirty years—you see here it’s only twenty-to-thirty basis points—the curve doesn’t make sense if you walk maturity range twenty-to-thirty years knowing you’re getting twenty-five-to-thirty additional basis points especially since long-end curves tend to be most volatile part of curve specifically!
Asher Rogovy
That sounds counterintuitive—the long end is most volatile right?
Brandon Pacilio
Yes! The Federal Reserve can’t control interest rates on long end because there are different supply-demand and inflation expectations—there are tons of variables factored into long end interest rate curves—that’s where you’re going whipsaw so generally speaking thinking about normal interest rate curves—it’s upward sloping—you extend your maturity as an investor—you should be compensated for taking additional risk because of all those variables back end of interest rate curve.
Asher Rogovy
Yeah, thanks—that’s a great outlook! Doesn’t seem like much difference like I said seven-and-twenty years knows could happen—seven years there are probably going opportunities for reinvestment too—kind of peak curve right?
Brandon Pacilio
Well it is good! So specifically liking this curve seven-to-ten years—I can’t be naive about fact front end of interest rate curve giving you great yield right? So take barbell approach where you’re going buy some seven-to-ten year bonds knowing you’re locking yields over next seven-to-ten years five-and-a-half-to-six percent saying okay look I’m also going take advantage of these short-term yields.
If I mature next year and we’re still high interest rates higher great—not least I know I have those six-to-nine bonds still giving higher yields!
In front end interest rate curves starting driving this way—you’re giving kind uh multiple options.
Brandon Pacilio
Exactly right! You’re giving optionality trying mitigate reinvestment risk because what happens just let’s say interest rates drop—okay? Had your entire portfolio mature next year—and across curve ten-year treasury rates two percent means investment grade bonds might be three-and-a-half or four percent—that’s fine—it’s just better take more balanced approach knowing today there are great yields getting five-and-a-half-six percent investment grade bonds especially considering past few years when we’ve been yield-starved bond markets.
I think one caveat note—everything read right—is there are trillions of dollars parked in money market funds—it’s fantastic right? People say it’s super safe—it’s super short—we’re getting great yields but do anything else—that’s fair—but all of sudden if interest rates move quickly—and when they start getting low again—they might go down pretty fast velocity will rapid so don’t want get left holding that trade “oh I’m sitting in money market getting great yield” but then suddenly rates fall out below—I can’t buy those yields you’re getting today at five-and-a-half, six percent!
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No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. All investments include a risk of loss that clients should be prepared to bear. The principal risks of Alpine Hill Advisors strategies are disclosed in the publicly available Form ADV Part 2A.