February 26, 2025
Dear Investors and Friends,
In last month’s letter, we explored asset allocation within fixed income and cash management, detailing how different bond categories fit within a broader portfolio strategy. This month, we continue our discussion of What Bonds to Buy, turning our focus to security selection, the foundation of generating superior fixed-income returns relative to a specific benchmark.
RCM’s Security Selection Philosophy
Most market participants follow a simple framework: “What do I like, and at what price can I buy it?” At RCM, we turn this framework upside down. Instead of starting with what we like, we ask: “What is for sale at a great price, and am I willing to own it?”
This distinction is more than philosophical—it has massive implications for our clients. By focusing only on the most attractively priced securities available, we ensure that we are always buying the bonds with the highest expected returns while maintaining strict credit, liquidity, and risk criteria.
RCM’s Security Selection Process
To execute this approach effectively, one must have a robust and disciplined prospecting process. At RCM, our methodology follows five key steps:
- Endeavoring to pull in most of the bonds offered in the market—we cast a wide net, reviewing all available securities across sectors.
- Sorting these from highest yield to lowest yield—prioritizing the most attractive securities.
- Eliminating bonds that don’t fit our clients’ investment criteria—focusing only on securities that align with specific portfolio objectives.
- Removing securities that fit our criteria but fail fundamental analysis—ensuring credit quality and risk remain acceptable.
- Buying from highest yield to lowest yield—allocating capital efficiently to maximize return per unit of risk.
This structured and repeatable process enables us to capitalize on inefficiencies that exist even in the most liquid and developed fixed-income markets.
Inefficiencies in the Fixed-Income Market
Contrary to popular belief, bond markets can be highly inefficient, even in ultra-liquid sectors such as U.S. Treasuries. When we zoom in on specific market segments, these inefficiencies become even more pronounced.
To illustrate, let’s take a deep look at what is arguably the most efficient market in the world – the front end of the US Treasury market. Rather than forming a smooth yield curve, we see a highly scattered, noisy market—demonstrating substantial pricing inefficiencies.
Each dot represents an actual offer yield of a security issued by the US Treasury that matures in less than 200 days. Notice the relative dispersion of the yields – the highest are yielding slightly above 4.30% and the lowest a little above 4.15%. I don’t know about you, but when I am looking for a safe place to park my cash, I prefer getting paid more, not less, all things being equal.
These inefficiencies exist across all fixed-income sectors and can become much more pronounced. Below is a chart showing the distribution of yields in a segment of the municipal bond market on February 25.
The chart shows the distribution of offer yields on muni bonds rated AA or better that mature between 9 and 10 years. For instance, as illustrated on the chart, 73% of this market segment has a yield of 5.0% or below. When buying bonds from this bucket, because we are a boutique, we have the luxury of focusing on the 3% of bonds offered with yields greater than 6.0%. This process of buying bonds of acceptable credit quality at the “pointy” end of the market nearly ensures that RCM clients will beat their benchmark over the medium to longer term.
Why Large Asset Managers Struggle to Exploit Market Inefficiencies
While inefficiencies can be abundant, especially in times of volatility, most large asset managers cannot capitalize on them. Why?
- They are the market. Large firms manage such vast sums that their trades move prices against them, preventing nimbleness.
- They often lack the systems, processes, and technology to optimize pricing. Many firms still rely on manual bond selection rather than data-driven, quantitative approaches.
- Their traders lack the expertise or incentives to optimize execution. Execution quality can vary widely, leading to suboptimal pricing.
- Regulatory and compliance constraints. Large firms must distribute securities fairly among thousands of clients, preventing them from prioritizing the best opportunities.
How RCM Capitalizes on Market Inefficiencies
At RCM, we are not the market. We are a boutique firm with the flexibility, expertise, and execution capabilities to identify and act on mispricings. This requires:
- Deep market knowledge – Understanding where and why mispricings occur.
- Ongoing monitoring – Tracking real-time bond offerings and secondary market activity.
- Extensive trading capabilities – Ensuring the best pricing and execution for clients.
Larger firms, by contrast, are often siloed, constrained, and lack execution flexibility, making it nearly impossible for them to execute this strategy at scale.
Conclusion: The Value of Thoughtfulness in Security Selection
At RCM, security selection is not about taking more risk—it’s about taking the same risk at a higher yield. Our disciplined approach ensures that we always select the highest-yielding bond that meets our and our clients’ guidelines. This requires deep expertise, ongoing diligence, and superior execution.
By working closely with our clients, we provide transparency and insight into our process, ensuring that their fixed-income investments are optimized to generate the best possible returns. Security selection is a continuous, data-driven process, and we remain committed to navigating the complexities of the fixed-income market on behalf of those we serve.
We look forward to continuing to serve you.
Warm regards,
David and Mike
Disclaimer
Roosevelt Capital Management LLC is a registered investment adviser. The information presented is for educational purposes only and is not intended to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.
Past performance is not indicative of future performance. Principal value and investment return will fluctuate. No guarantees or assurances that the target returns will be achieved, or objectives will be met are implied. Future returns may differ significantly from past returns due to many different factors. Investments involve risk and the possibility of loss of principal.
While all the values used in this report were obtained from sources believed to be reliable, all calculations that underly numbers shown in this report believed to be accurate, and all assumptions made in this report believed to be reasonable, Roosevelt Capital Management LLC neither represents nor warrants the values, calculations or assumptions and encourages each prospective investor to conduct their own review of the audits, values, calculations and assumptions.