Paul Giannamore:
I’ve never seen a wealth manager at Pest World before. And here you are.
Nick Bartolo:
I am. I feel a bit out of place, but happy to be here. Everybody’s been actually really welcoming to me and giving me a lot of time, so I’m grateful.
Paul Giannamore:
So this is not far from you. You’re in LA so you came to Hawaii. It’s a lot closer than Boston. Well actually, is it closer than Boston? No, it’s about the same, right?
Nick Bartolo:
About the same.
Paul Giannamore:
About the same.
Nick Bartolo:
The East Coast to Hawaii is about the same.
Paul Giannamore:
So what have you learned here?
Nick Bartolo:
Well, despite hearing on your podcast about termite trapping, I finally found out what a Sentricon System is. So I saw that on the floor. But I think one thing that I’ve taken away in talking to people, or one impression that has been left on me is just the entrepreneurial journey of a lot of these pest control owners. And that would entail whether they started the business from scratch, whether it was passed down from their parents, working hand in hand with them. But really hearing those cool stories about building something, growing it, the challenges encapsulating that, which has been really interesting. And also I think I’m continually impressed and somewhat surprised sometimes with folks’ lack of desire to pay tax, which I’m with them on that because no one should pay more tax than they have to. So it’s been interesting to kind of push on that topic with some of the PCO.
Paul Giannamore:
It’s always a huge question. These guys always want to talk about how do I mitigate my taxes? But unfortunately there’s not a tremendous amount. I mean, you could renounce your citizenship, you could move to a jurisdiction like Puerto Rico for example, but outside of that, there’s not a lot of things you can do, or are there?
Nick Bartolo:
Everything’s on the margin, right? I do think when it comes to that sort of mid-career pest control owner that might have 3, 4 million of revenue, potentially relatively young, there’s a lot of tax deferral strategies that you can execute now in order to create tax-free gains. It might not feel like tax savings if you’re contributing to a Roth IRA for you and your wife and potentially your kids. But if you do that over 20, 25 years and earn a 7% return, all of a sudden you have a half a million dollars of tax-free gains just thinking about you and your wife. Also, we’ve talked a bit about it before, but attributing genuine business tasks to your family members, whether that’s your wife or your children, through maybe putting them in the advertisements or having them do general clerical tasks, clean the office, take out the trash, those things add up, and all of a sudden you’ve saved $10,000 on your taxes in a year, which I think everybody would be open-minded to do, even though a bigger pest control owner that might not seem that material.
So there’s those when you think about that mid-career person. But then there’s other things where you have a lot of owners that are charitably inclined, whether that’s through their church or other means, and they might not understand that if you have an investment portfolio that has large embedded capital gains within it, if the charity is set up properly, you can actually donate the appreciated securities. So you avoid that capital gain tax, yet you get to deduct the full amount against your income in that year. That’s one that’s very straightforward and simple that can save you tens of thousands of dollars. You have a $200,000 embedded gain on your Berkshire Hathaway position and you want to donate that instead of paying 30,000 or $60,000 on taxes or whatnot. Little things like that I think can add up.
Paul Giannamore:
What other things are you hearing from folks here?
Nick Bartolo:
I think inflation’s a big topic, and I think that interest rates are also a big topic. And these two things, as you know, go hand in hand. I get a little concerned though, because not only pest control owners, but my own client partners are talking about interest rates and how they’re waiting to take a certain action once interest rates come down, whether that’s buy a building for their business, whether it’s buy a house personally, whether it’s finance their business in a new operations or a new branch location, for instance. My view is that I think we’ve actually experienced a renormalization of interest rates and that the past 14 years are actually the abnormality in that they’ve been very distorted by the Fed and suppressed by the Fed. And if you take a chart of the 30-year bond, the 10-year bond, mortgage rates, the 30-year mortgage rate, you’ll actually find that where we are now relative to past 50, 60, 70 years-
Paul Giannamore:
Is on the low side.
Nick Bartolo:
It could be on the low side, average at best. And so I don’t think that’s well understood, and I think it’s one of those things when you’ve been in this suppressed interest rate environment for such a long period of time, it takes a while to adjust. And that’s not to say that interest rates won’t come down or couldn’t come down in a recession as nominal GDP comes down, but we’re not going to see, in my opinion anyway, 1.5% 10-year bond and a 2.5% 30-year mortgage like we did during COVID.
Paul Giannamore:
I mean, look, the only way in my mind that we see that in the future or the near future at least, is if the government really finds itself in such a desperate position that they need to buy up and down the duration of government securities. That’s the only way they start engaging in overt yield curve control. And then we have a lot of other issues, right? Now we have a currency issue, not a sovereign debt issue.
Nick Bartolo:
Big time. Big time. It’s a perfect point. And another topic that I’ve been thinking about and talking to folks about, and you’ve mentioned in the past is the 1940s style financial repression. I actually think it’s a better analogy than the ’70s in thinking about the current environment.
Paul Giannamore:
Probably.
Nick Bartolo:
And especially now as new wars have broken out since I know the last time you and I have spoken, what’s going on in the Middle East. So we have high fiscal deficits, which was similar in the 1940s due to World War II, although those were at least temporary now, the fiscal deficits are really embedded in the system. And then we have high debt to GDP, same thing that happened in the 1940s, and you had episodic cyclical inflation in the 1940s as well, which arguably we’re going to have that. And I certainly think we’re going to have higher structural inflation versus what we’ve seen over the past 15, 20 years or whatnot in this disinflationary environment. And so again, in the 1940s, what happened? What you said, yield curve control.
Paul Giannamore:
1946, the government gunned it and burned it up.
Nick Bartolo:
And then in the ’40s you had the short end of the interest rate curve at 3/8 of a percent. And the tenure, they fixed it too. And so if that were to happen, my question I always ask people is, “What do you own that will do well in that environment?” Is it stocks? Stocks or companies with pricing power, they could do well in that environment as the discounting mechanism is lower, but we know the dollar’s going to go down. And so assets priced in dollars, real assets priced in dollars like gold and commodities, those are going to do well. And I just sadly don’t think many people own those assets. You could also say that foreign stocks in jurisdictions or countries that stay out of any potential global conflict could do well.
India is an example potentially of that is yes, they’re buying Russian crude, but they’re staying relatively neutral in some ways in the global battle lines that unfortunately seem to be being drawn at the current juncture. With most folks owning 60 40 or heavy US stock portfolio with not necessarily a commensurate valuation discount in that portfolio, it leaves me a bit concerned that portfolios are prepared for this type of environment.
Paul Giannamore:
What are you doing now for your own clients from a capital allocation perspective amongst a variety of different assets?
Nick Bartolo:
Look, I have my framework, this core four framework where I want to ensure that my clients have some exposure to all of the economic environments as defined by the rate of change in economic growth and the rate of change in inflation versus expectations. Within that framework, you have a stagflationary environment where economic growth is likely to be weaker, but inflation is likely to be higher. This environment that we’re discussing, whether the analogy is the ’40s, whether it’s the ’70s, the assets that perform well in that environment are the ones that are inflating, which would be commodities and gold, real assets, and also Treasury Inflation-Protected Securities or TIPS bonds as issued by the US government. Right now, you have a pretty intriguing situation in TIPS in that the real yield across the curve is about 2.5%, which is actually historically high. So you’re getting a 2.5% real return. So if inflation ends up being 4, you’re getting 6.5. If it’s 5, you’re getting 7.5, which you do have that protection from something that’s much higher than that.
Paul Giannamore:
Why would an investor consider putting money in TIPS rather than buying on the short end of the curve and T-bills?
Nick Bartolo:
Look, TIPS I would argue in the short term, are even safer than just short treasury bills. They both have the optionality in order to sell and deploy that, but yet if you did have some sort of spike in inflation, you’re getting that with TIPS. And also embedded in TIPS are the inflation expectations that exist in the nominal yield in a short-term treasury, like a three-month T-bill where, as you know, you can get 5.5, 5.6%, but again, that’s only one piece of what the full asset allocation would be. My clients do own US stocks. It’s their largest individual holding because I can talk about these potential outcomes in the world and what assets would do well, but again, it’s just a probability distribution of what could happen and could be wrong.
And so if for some reason we did enter more of a Goldilocks environment, US stocks are going to do well. And there are still a lot of excellent businesses in the S&P 500, for instance, or in the value indices as they have more exposure to commodity producers that could do well in these other environments. That’s how I’m thinking about it. But again, tactically, I’m less positive on US equities right now, just given the valuation and the deteriorating environment.
Paul Giannamore:
There’s definitely a gap there.
Nick Bartolo:
What are you thinking?
Paul Giannamore:
I guess from my own portfolio, as you already know, we’ve talked about this. I’m extremely heavy in short-term sovereign, the very short end of the curve. I’ve built up a significant gold position and I’ve dabbled in things like in recent months, I’ve built long oil and ancillary oil industries, like XOP type positions. I still remain short Tesla, and then I’ve got short positions on and a variety of different REITs, basically rate sensitive type. But I am not a good person to talk to about that because I’m more of an active manager. I am active on a day-to-day basis. I’m not a trader per se, but I’m very active in allocating capital amongst different asset classes.
Nick Bartolo:
Interesting. The other area where I’ve been making incremental investments is just in fixed income in general, and not just short-term paper and not just government paper and not just TIPS, but actually more credit-oriented investments.
Paul Giannamore:
Like in private credit type stuff?
Nick Bartolo:
I haven’t done private credit. I’ve done a bit of public high yield just because the credit quality in public high yield is as good as it’s ever been. And relative to private credit, it’s far better. So while the spreads between government bonds and high yield bonds isn’t necessarily high relative to historical standards, the absolute return or the absolute yield is quite good at around 9%, which if you think or if you know that equities have done about 10 since the beginning of time or for the past 100 years, then if you can get nine in high yield bonds, public bonds with greater credit quality and in a more advantaged position in the capital structure, then I think that warrants some capital, particularly if you have tax deferred accounts because they’re not as…
Stocks are more tax advantaged because they can grow without paying that recurring income each year. So if you can own credit and an IRA, 401(k), et cetera, then you’re sort of, in some ways, as long as the credit analysis is good of the manager you’re selecting, in some ways you’re locking in something close to 9% over a full cycle. I think most people would take.
Paul Giannamore:
Yep. For me, a lot of capital goes into box spreads on the S&P, just because Puerto Rico, we don’t have capital gains.
Nick Bartolo:
Beautiful.
Paul Giannamore:
Instead of being in a T-bill, I can get roughly the same return as a six-month T-bill. We’re running a box spread and it’s a capital asset as opposed to interest rate.
Nick Bartolo:
Another smart reason to be in Puerto Rico.
Paul Giannamore:
A lot of great reasons to be there. So let me ask you, when you deal with your clients, well actually let me rephrase this question. How often does a client actually speak with his wealth manager?
Nick Bartolo:
Based on some of the folks that I’ve talked to this week at Pest World once a year, if they reach out to them and bother them about it. Every client is different. Typically, I think there’s some wealth managers out there, wealth advisors out there that want to meet quarterly and put that on the calendar and they want to justify their value by doing it quarterly. That philosophy, that activity justifies value. I don’t necessarily ascribe to that. I have a sort of open communication policy where if something’s going on material or if there’s some sort of emotion that is coming up for that particular client about the markets or the environment, please reach out to me. That’s how I handle it. But always have annual meetings to just have a full review of performance, the environment and how we’re positioned for that. But depending on the client partner of mine, we will also depend on how involved I am with just their overall financial life.
If it’s a higher net worth client who has complicated trust and estate is going through a transaction, if they need help with a referral for an attorney, a CPA, those types of things, it ends up having a more complex financial life. We just end up speaking more. And some client partners, they might have those resources already at their disposal when they come to me, but oftentimes they don’t. And so I try to be helpful on that dimension. When I’m thinking about this renormalization of interest rates as you know interest rates are the cost of money and the price of time.
Paul Giannamore:
Price of time.
Nick Bartolo:
Essentially, right?
Paul Giannamore:
Yes.
Nick Bartolo:
Like Edward Chancellor’s book.
Paul Giannamore:
Good book.
Nick Bartolo:
And so when you think about this renormalization, I always wonder have asset markets, whether that’s public equities, whether it’s real estate, commercial houses and transactions, so private equity transactions, pest controlled transactions, have these asset markets or transaction markets reflected the new renormalization of interest rates? And if you look at the equity risk premium of equities, if the multiple on the S&P 500’s 19, 20 times give or take, we’re looking at a 5, 5.5%-
Paul Giannamore:
It’s roughly yielding. I just had this discussion, I fought with the Mexican on it last night.
Nick Bartolo:
Did you?
Paul Giannamore:
Exactly right. The S&P is effectively trade net 20 times, which implies a 5% yield and it’s far more risky than being in government paper.
Nick Bartolo:
Right, exactly. And then you have to think as that goes down the chain for transactions, has that reality, if folks think it’s actually structural, which I don’t think they do, but is that filtering into private equity transactions and what they’re paying for pest control companies or other home services companies? That’s your area.
Paul Giannamore:
No, and I think this has not worked its way through the system yet. I think that there are… So as to your point, the last 15 years has been a distortion. But we’ve got a massive proportion of folks that work in the financial industry that have only worked in the last 15 years. And I think about the Max, I think about Franco, he’s in his mid-thirties. He’s not worked in an environment other than this, and the only environment he’s worked in is seen asset prices go like this and yields go like this. And so I think it appears to me that it’s probably something that’s going to happen very slowly and then all at once. And there’s certainly going to be areas in the greater economy and when you look at things like commercial real estate and when the pressure really starts hitting that stuff will chain react throughout the economy.
And so again, I think we’re on the front end of this still, and I think we’re starting to see, if you read the earnings reports from BlackRock, for example, we’re starting to see sophisticated asset managers looking around saying, “Well, why do I need to have so much in these crazy structured products and equities when I can be in traditional credit and fixed income and take a whole heck of a lot less risk and get the same return?” And so I think we’re starting to see more sophisticated players making those allocation decisions. We’re certainly not seeing the general… The general investing public is still living in the meme stock era and doubling down on Tesla. But I think that’ll change here in the very near term. And then of course, obviously the recent conflict in the United States or it actually is in the United States basically with Biden run around, but the recent conflict in the Middle East I think is going to be extremely complicated because my gut reaction, I don’t view this as something that’s going to be particularly short-lived.
Nick Bartolo:
Neither do I.
Paul Giannamore:
I think we are seeing now in live, I think we’re seeing the global chessboard pieces moving around at a very rapid clip. And so I think that this is ultimately going to be a more further inflationary situation due to this.
Nick Bartolo:
Absolutely. Either a cold or hot war is inflationary and historically has been inflationary. And so this recency bias, if you will, that people are suffering from, and I don’t blame them because we’re talking about a 14-year period, that’s a long period, people’s entire careers as you point out. I did a recent analysis on the housing market and thinking about rent versus buy, and I didn’t do it on the broad housing market because we all know housing is local anyway, or typically is local, with the exception of the global financial crisis when lending got out of control. But one thing that I looked at 10, 15 years ago before the financial crisis, and one thing I looked at recently was just a simple rent versus buy analysis in a high-priced area in California. I looked at it in this house, it wasn’t for me, it was for a potential client.
And they asked, “What do you think of the housing market?” And I said, “Well, let’s do a little rent versus buy analysis.” And the house in question was a $6.5 million house and Zillow, this reputable source online, but they have good data. Zillow thought this house could rent for $16,000, $6.5 million house. I calculated the property tax and that was already 8,000 a month. So then you have 8,000 left for your mortgage principal payment and interest. Once you calculated those, you’re up to over 40,000 a month. When I do a type of analysis like that, clearly the new interest rate reality is not being reflected in that housing price or that rent or a combination of it. I just think it’s one sort of micro example of how this renormalization has impact or could impact asset prices going forward. I’m not calling for a housing bust or anything like that, but it’s just these are the decisions that people are making on the ground that ultimately impact asset prices.
Paul Giannamore:
And like you said earlier in the conversation, folks are waiting for interest rates to go down. I hear this all the time. “I’m just going to wait for interest rates to go down.” Well, you might be waiting a long time.
Nick Bartolo:
You might. And the short end might go down in recession with the Fed lowering rates and the long end might not go down, or it certainly is not going to go down, in my opinion as much as it has in the past.
Paul Giannamore:
I tend to agree with that. I mean, that will be the bond markets revenge against the Fed on the long end of the curve is what it’ll be. And it’ll likely we’ll find ourself in a position in 2024 where the Fed will start to push the short end of the curve down. And we’ll see how this goes.
Nick Bartolo:
And unfortunately, they’ll have the potential opportunity to use global conflict as a reason to do it.
Paul Giannamore:
Right. There’s always a good scapegoat out there.
Nick Bartolo:
There is, no, I can see the headlines already saying that like, “Global conflict and war caused the recession.”
Paul Giannamore:
“Hamas caused the price of your lettuce to go up.” This is definitely going to be a New York Times headlines at some point.
Nick Bartolo:
When the cake was most likely already baked, given how aggressive the Fed has been and the fact that fiscal stimulus at some point is going to run out unless they perpetually increase deficits, which they have done up to this point.
Paul Giannamore:
So Nick, you’ve done a lot of research on the pest control industry. I know that you’ve talked to a lot of former buzz guests. You’ve met with a ton of people out here this week. I guess you’re heading out here tomorrow.
Nick Bartolo:
I am.
Paul Giannamore:
And so you’re really beginning to specialize in this industry, and I guess what is it about pest control that’s kind of brought you into the mold?
Nick Bartolo:
I think that the first thing is that the people and the attitude of the people really resonates with me just based on how I was raised.
Paul Giannamore:
You were raised a redneck?
Nick Bartolo:
Well, I mean Las Vegas in the 1970s.
Paul Giannamore:
That’s right. You’re a Las Vegas guy. That’s right.
Nick Bartolo:
That’s fairly similar. My dad actually, after being a high school teacher, operated a route-based business. It wasn’t pest control, but it was a Vegas route based business that owned video poker machines. It got them in locations. And then as we talked about before, I do have friends that operate landscaping and pest control businesses back home in Las Vegas. So the people have really resonated with me. And to your point, the former buzz guests have been very generous with their time. I’ve tried to come into it with a very humble approach to learn about the industry that way I can design my services to add as much value as possible in a specific fashion to the industry and to the pest control owners.
And then, I mean, clearly I’m a capitalist and in this to make a profit, and it definitely helps that folks in this industry do quite well, generate nice cash flow margins, and end up selling their businesses. And so I think I can help them on all of those dimensions. Hopefully I’ll be adding value well in advance or well in excess of anything that my business is able to garner.
Paul Giannamore:
Sounds like you can definitely help them get good reservations at restaurants in Las Vegas as well as LA.
Nick Bartolo:
Potentially. I could potentially do that or find somebody that can.
Paul Giannamore:
So Nick, when I think about folks in this industry, it’s people that are experiencing liquidity events because that’s of course where I live. And so when you work with somebody, let’s say I’m a client of yours, got a pest control business, and I’m selling it next year and I’m going to make 25 million bucks, I might have nothing now. Maybe you’ve got a million dollars of my money in an account that you’re managing, and next year I’m going to call you up and say, “Here’s 25 million.” What sort of discussions might you and I be having in a situation like that?
Nick Bartolo:
The first discussion is to really understand your life and what your uses of the cashflow are going to be from those investments and from there-
Paul Giannamore:
Coke, hookers, that kind of stuff. Everyone’s different.
Nick Bartolo:
Everybody has their cash usage, if you will, and so we want to make sure that we can create returns in order to ensure that those needs get met, but really it’s understanding that lifestyle so we can then design an investment program to ensure that the cashflow is going to be-
Paul Giannamore:
I’m going to have 25 million bucks, how much do I spend right now per year, or how much do I project my lifestyle will run me forward?
Nick Bartolo:
That’s an initial step in the analysis just to ensure that we can execute some cashflow planning and forecast that out to make sure that the investment program is going to be in alignment with the cash that you’re actually going to need to live. But to take even a step back from there, in that situation, when you have a pest control owner that’s worked 20, 30 years to build up this pest control business and this cashflow stream, and then they get this windfall, the first thing we want to make sure is that, we’re going to figure out how to keep this person rich. And the first way to do that is to start slowly and put the money in short term T-bills, generate that 5.5% return, and then opportunistically and systematically deploy the capital over time. And when we think about deploying that cash into stocks, there’s multiple ways that you can do that. Again, it’s not going to be the whole portfolio, but there are very tax efficient ways around tax loss harvesting or direct indexing-
Paul Giannamore:
Let’s talk about both of those.
Nick Bartolo:
…in order to do that.
Paul Giannamore:
What is direct indexing?
Nick Bartolo:
Direct indexing has really been an innovation that’s been enabled by technology. And usually when those things are mentioned in financial areas, it’s like a red flag. “We have this great financial engineering technology.” But direct indexing has been enabled by no cost trading commissions and also just fractionalization of security trading, that sort of thing. What it is essentially instead of owning the ETF, which is an index fund, you own the underlying components of the ETF, so the individual stocks, and then based on the movements of those prices, the computer algorithm can buy and sell, or really sell the ones that are going down temporarily and then replace it with other components of the index all the while tracking the index within a fairly close band.
And it creates a much more tax efficient vehicle to where on an after-tax basis, direct indexing has shown over long periods of time to outperform regular index investing by 1 to 2% per year. And that’s particularly important when you have new capital that’s being invested. That’s a pretty substantial advantage. It doesn’t sound like a lot on the surface, but it is. And that compounds over time. That’s one tactic we use to be more tax efficient on new capital.
Paul Giannamore:
What’s tax loss harvesting?
Nick Bartolo:
Good question. That’s a good question. So tax loss harvesting is essentially, if you were to buy the S%P 500 index fund today at 100, let’s just say to make up numbers, it goes down to 90. And then you could sell that security, that ETF at 90, and you capture that $10 per share loss, that loss… Well, back up. So then you would redeploy that $90 into another S&P index fund that’s issued by a different provider. Let’s say you own BlackRocks first and now you’re going to buy Vanguards. So then now you have that embedded $10 loss that you can use to offset future gains. So it makes your portfolio more tax efficient and defers potential gains out into the future.
Paul Giannamore:
So what you’re saying is if it goes from 100 to 90 and you don’t sell it and then it goes back up to 100, you’re saying you haven’t reset your basis, therefore you’re not able to roll that credit forward, so to speak? Is that what you’re saying?
Nick Bartolo:
That’s right. And so ultimately, if it’s an equity based security, you’re going to pay that tax if you end up selling it because as you point out, your basis is now lower. But there has been a really interesting opportunity in fixed income over the past couple years, given the last two years. Last year in particular was the worst year for fixed income really in the last a hundred years. And so if you actually owned a portfolio of, let’s say, muni bonds, where that portfolio, you had a $2 million portfolio, let’s say, and muni bonds are down around 15% or so over that period, so that’s a $300,000 loss. You can sell that entire portfolio, buy a new portfolio of muni bonds, but you’re buying individual bonds at par, so you’re never going to have a future capital gain on that portfolio yet you can recognize that $300,000 loss today, which is permanent for the future to offset gains. So bonds, it’s more advantageous even than stocks to execute tax loss harvesting.
Paul Giannamore:
Interesting.
Nick Bartolo:
Which is, it’s an esoteric topic, but every percent, every 2%, I’ll take it on behalf of my client partners.
Paul Giannamore:
And I’m glad it’s guys like you looking at this because I wouldn’t have no patience for that.
Nick Bartolo:
Deals are more fun.
Paul Giannamore:
A hundred percent, way more fun. Well, Nick, I appreciate you coming out to Pest World and visiting all of us. It’s been great to spend some time with you and look forward to spending more time with you in the industry.
Nick Bartolo:
Absolutely. I appreciate you having me on, and it’s been great to spend time with everybody.
Paul Giannamore:
Sounds good.
Nick Bartolo:
All right.
Paul Giannamore:
Cheers, brother.