It takes a complete nut, or someone with a terrific record, to tell a client, "We do not measure performance. We don't manage for performance. We manage risk, and learn to accept superior performance."
Meet Edward J. Reinoso, CEO and founding partner of money management firm Castleton Partners. Over the past two years, clients of Castleton have earned decent returns -- from 6% to nearly 14% -- while the rest of the world suffered wrenching losses in almost every investment category.
The secret? Active management of municipal bonds -- one of the dullest markets around. The message to everyday retail investors? Investing at least some of your portfolio in relatively safe munis may help preserve your wealth.
Reinoso has spent most of his 40-year career dealing in bonds -- at Lehman, Bear Stearns (now part of JPMorgan Chase
In 1986, he opened his eponymous firm to specialize in originating and distributing municipal securities. The firm co-managed offerings totaling more than $65 billion over its lifetime, and the profitability of the business gradually shrunk. In the late 1990s, Reinoso took a sober look at his company's prospects and recognized that his returns would increase if he liquidated the firm and invested the proceeds in high-grade municipal bonds.
He did just that, and started managing muni portfolios for friends and family. More recently, he teamed up with John Tamagni, a 30-plus-year partner at Lazard
Together, these two have focused on investing their clients' money, which now totals around $250 million, in fixed-income investments -- mainly munis.
They recognize that this is their moment; they may never have a better opportunity to welcome investors in from the cold world of equities.
And it has been quite cold of late
Most investors have had a miserable experience holding stocks over the past two years. On top of that, they may be facing rising taxes, which make tax-exempt income from municipal bonds even more attractive. Not only does President Obama's proposed budget include increased income tax rates for high earners, but it also sets the 15% tax rate on dividends instituted by President Bush to expire in 2010.
At the same time, munis are selling at compelling levels relative to Treasuries. Historically, muni yields have averaged 88% to 94% of the yield of Treasuries. Today, the yield on 10-year munis is 3.48%, according to Bloomberg, compared with 2.73% for 10-year Treasuries. The comparable figures for 30-year bonds are 4.91% and 3.62%, respectively. It would seem the flight to safety has handed investors a gift.
Reinoso and his partners intend to take full advantage of this window by sifting through alternatives, looking at agency bonds and also taxable municipals -- a sector rarely mentioned.
"Taxable munis aren't as liquid as the tax-free alternatives," Reinoso says. "But, as a result the market is inefficient. Also, a lot of the money we run is in retirement accounts, where liquidity is not as crucial."
"We don't expect to hold most of these securities to maturity; the market changes. For example, two years ago the yield curve was essentially flat. We saw no reason to extend out in terms of maturities. At that time we were buying two- or three-year pre-refunded bonds that were cheaper than alternatives rated double-A."
"Now," he says, "it's a different story. These pre-refunded bonds are escrowed with Treasuries. Now we're extending out in terms of maturities, and picking up not only higher yield for longer terms, but also because of wider spreads."
For sure, the relative strength of municipal bonds over the past two years has attracted some interest. A number of exchange-traded funds have sprouted up, such as iShares S&P National Municipal Bond
Notwithstanding its growing popularity, the sector may confront challenges, including the widely publicized budget problems facing states and municipalities.
The ETFs above are easy options for investors, although Reinoso and partners would argue that the worsening municipal revenue outlook argues for hands-on experienced management. They focus mainly on top-rated securities, which are less likely to experience liquidity or credit issues, and prefer general obligation and essential services bonds, such as those backed by water or sewage authorities. Reinoso also likes education bonds, such as those raising money for state university dormitory authorities.
Foolish final thoughts
Reinoso acknowledges that there is considerable uncertainty in today's outlook. As the United States ratchets up spending to fight the recession, the prospect of rising inflation and higher interest rates dances across the horizon.
He's not alarmed, partly because he and Tamagni have seen a similar cycle before and are prepared to deal with it. In particular, he is not concerned that a bounce-back in equities will undermine his quest for clients: "You can't compare the second-safest fixed income sector with equities. It's like comparing a Formula One race car with a Mercedes sedan. One is for speed and excitement, and the other is for safety and comfort."
In fact, he is now composing a letter to clients that will say this about a potential slowing in gains, "We don't care. We're interested in protecting your assets, and earning income." He says that for people who have accumulated wealth, the only mistake is in losing it. Reinoso's advice: "Stay rich."
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