Author Archives: Scalper1

Finding That Elusive 90-Cent Dollar

Photo credit: photosteve101 If I offered to pay you a crisp $1 bill for the 90 cents you have jingling in your pocket… well, you’d probably think I was either crazy or a scamster. Or maybe both. But if, after inspecting the dollar bill, you determined the deal to be legit, you’d jump on it in a heartbeat. In fact, you might even run to the bank and take out your entire life savings in dimes in the hopes that I’d give you a dollar for every 90 cents you could throw together. Why wouldn’t you? It’s free money. I’m not going to give you a dollar for 90 cents… so, sorry if I got your hopes up there. But I will point out several pockets of the market today where these kinds of deals (or better) are on offer. But first, we need a little background. “Book value” or “net asset value (NAV)” is the value of a company’s assets once all debts are settled. Think of it as the liquidation value of the company. Now, for most companies, book value is a pretty meaningless number. If you’re a service or information company like a Microsoft (NASDAQ: MSFT ) or Google (NASDAQ: GOOG ) (NASDAQ: GOOGL ), the value of your business is in intellectual capital and in the collective brainpower of your workforce. And that’s something that is a little hard to put on a balance sheet. Likewise, the accounting book values of old industrial companies with a lot of property, plant and equipment – think General Motors (NYSE: GM ) or Ford (NYSE: F ) – are also pretty useless as the numbers on the books reflect historical costs rather than current market or replacement value. And this is further distorted by accounting depreciation. But while NAV is more or less worthless for most mainstream companies, it’s extremely useful in a few pockets of the market, such as mortgage REITs and closed-end funds. In each of these cases, the book value of the companies is based on the real market value of the securities they own, minus any debt used to finance them. What you see really is what you get. And this is where it gets fun. At current prices, many mortgage REITs are worth more dead than alive. Mortgage REITs have an interesting business model: They borrow a ton of money at cheap, short-term rates and invest it in mortgage securities offering a higher yield. When the spread between short-term rates and long-term rates is wide, mortgage REITs leverage up aggressively and make a ton of money. When the spread narrows, they tend to reduce leverage and bide their time. Mortgage REITs usually trade at healthy premiums to book value, which makes sense. The whole is worth more than the sum of the parts, and you’re paying for management expertise, instant diversification and the REIT’s access to cheap and abundant credit – three things you’re going to have a hard time getting on your own. Well, today, it’s not uncommon to see these trading for just 80%-90% of book value, implying that you could hypothetically buy up the entire company, sell it off for spare parts, and walk away with 10%-20% in capital gains… all while collecting dividends. Closed-end bond funds are another quirky corner of the market where it’s easy to find some nice bargains these days. Closed-end funds are very different from what you’d think of as a “normal” mutual fund. In a regular, open-ended mutual fund, the size of the fund changes as new investors buy shares and old investors leave. Shares are priced every afternoon based on the closing prices of the stocks or bonds in the portfolio. So, you can never have a situation where the price of the fund deviates from its net asset value. Closed-end funds are a different animal. They have IPOs like stocks and have a fixed number of shares that trade on the New York Stock Exchange. And these shares are priced throughout the day, just like any stock. So, you can get quirky situations where a dollar’s worth of quality bonds are selling for $1.05, $0.90 or whatever price the fickle Mr. Market wants to assign that day. And right now, we’re seeing discounts as high as 10%-20% in some funds. Today, as an asset class, closed-end bond funds are trading at the deepest discounts since the pits of the 2008 crisis and aftermath. In an otherwise expensive market, we have the opportunity to profit in three ways: Earning a very solid current yield of anywhere from 6% to 9%. Enjoying capital gains as the values of the bonds in the portfolio appreciate. Enjoying additional capital gains as the current deep discounts to NAV start to shrink to something more reasonable. Given how expensive the broad market is right now, these closed-end funds really present us with a nice alternative. This article first appeared on Sizemore Insights as Finding that Elusive 90-Cent Dollar Disclaimer: This article is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results. Original Post

Best And Worst Of January: Nontraditional Bond Funds

Nontraditional bond mutual funds and ETFs had a tough month in January, losing 1.13% on average. This extended the category’s one-year losses through January 31 to -2.57%, consisting of -2.76% alpha and a -0.47 beta, relative to the Barclays US Aggregate Bond Total Return USD Index. Mutual funds and ETFs in the category averaged a -0.66 Sharpe ratio for the year ending January 31, with volatility of 3.53%. The nontraditional bond fund category is a mixed bag of long/short credit funds, non-traditional income funds and unconstrained bond funds. In total, there are 150 funds (only 63 have a track record of 3 years or more) in the category and $129.3 billion of assets. Below is a look at the top and bottom performers for January. Top Performers in January The three best-performing nontraditional bond funds in January were: Navigator Tactical Fixed Income Fund A (MUTF: NTBAX ) BTS Tactical Fixed Income Fund A (MUTF: BTFAX ) Counterpoint Tactical Income Fund A (MUTF: CPATX ) NTBAX was the top-performing nontraditional bond fund in January, posting gains of 2.38%. This was enough to push the fund’s one-year returns through January 31 into the black, at +0.34%. These returns consisted of 0.49% alpha and a 0.76 beta, yielding a Sharpe ratio of 0.09 with standard deviation (volatility) of 3.90%. BTFAX ranked second for the month, with gains of 2.00%. Its one-year returns, however, remained in the red at -0.16%, with -0.02% alpha and a 0.65 beta. BFTAX’s one-year Sharpe ratio stood at -0.04 through January 31, with annualized volatility of 4.15%. Finally, CPATX was the month’s third-best performing nontraditional bond fund in January, with gains of 1.31%. Its 12-month returns through January 31 stood at +2.10%, with 2.09% of alpha and a low 0.15 beta. CPTAX’s Sharpe ratio of 0.60 was by far the best of any fund reviewed this month, and its 3.41% volatility was the lowest. Bottom Performers in January The three worst-performing nontraditional bond funds in January were: Driehaus Select Credit Fund (MUTF: DRSLX ) Putnam Diversified Income Trust A (MUTF: PDINX ) Altegris Fixed Income Long Short Fund A (MUTF: FXDAX ) FXDAX was January’s worst-performing nontraditional bond fund, with its shares falling 5.17% for the month. Through January 31, FXDAX’s one-year returns stood at -9.82%, consisting of -10.50% alpha and a -1.59 beta. This gave the fund a one-year Sharpe ratio of -1.60, with annualized volatility of 6.33%. PDINX, the month’s second-worst performer at -4.83%, also had bad-looking one-year numbers. Its losses of 5.47% were made up of -5.86% alpha and a -2.05 beta, yielding a -0.76 Sharpe ratio and 7.15% volatility. Although it outperformed FXDAX and PDINX in January, DRSLX looked worst of all over the year ending January 31. In those 12 months, the fund lost 11.18%, with -11.97% alpha and a -1.55 beta. Its one-year Sharpe ratio stood at -1.70, and its annual volatility was 6.85%. Even over three- and five-year terms, DRSLX was down an annualized 4.58% and 1.66%, respectively. Past performance does not necessarily predict future results. Jason Seagraves contributed to this article. Note: The MPT benchmark used for the above calculations was the Barclays US Aggregate Bond Total Return USD Index.

Why Stock Market Declines Are Good

James Bullard, the St Louis Fed President, gave an interview today discussing how the stock correction has been good because it has helped to prevent a bubble. He’s inferring that lower prices are bad in the short term and good in the long term. And he’s totally right. I’ll show you why. What happens when the stock market booms is that future returns get pulled into the present. Stock bubbles are dangerous because they pull so much of that future return into the present that they create an abnormal amount of temporal balance sheet instability. I’ve referred to this pricing change as a “price compression” in my book and elsewhere. It’s a fairly simple concept and can help us understand what happens to prices in the short term relative to the long term. In essence, when prices boom in the short term, we pull future returns into the present which often reduces future returns. For instance, imagine a zero coupon bond like a Treasury Bill yielding, for fun, 3%.¹ This Bill will sell at $97.09 and will mature at par plus your 3% in 1 year. Now, imagine that interest rates shoot higher to 6% right after you buy this Bill. The price of your Bill will fall to $94.34 for a 2.83% loss. But that’s just a short-term unrealized loss and not necessarily a realized loss. After all, if you hold the Bill for 1 year you will still get your $100 plus 3% in interest. So, what’s happening here? The price of the Bill has compressed as the market environment changed. Had you purchased another Bill immediately after the price decline you would have earned 5.99% on the second Bill. If you’d doubled down on the first Bill you would have earned an average return of 4.49% on both Bills thereby increasing your average return. The price decline was bad in the short term, but it was good in the long term! In other words, as prices compress positively (think bull market) in the short term they tend to pull future returns into the present thereby lowering future returns, whereas, when prices compress negatively (think, bear market), they push future returns higher. Stocks, while not perfectly analogous to bonds, are essentially coupon paying financial instruments. For instance, rolling mutli-year dividend payments from corporate America have been remarkably stable throughout history.² Now, the problem with the stock market is that the stock market has a very long and relatively imprecise duration³, but by my calculations it’s about 25 years at present. Of course, most people don’t have that kind of patience. But with a bit of clever analysis it’s not hard to build an asset allocation model that reduces that duration by mixing fixed income instruments with stocks making all of this much more precise. And in doing so, you’re essentially capturing that price compression concept in a very intelligent manner by realizing a few things: Price declines are bad in the short term, but good in the long term. Buying dips isn’t just for market timers. It’s for the savvy asset allocator who realizes that price declines will tend to boost future returns. The trick is making sure the duration of your asset allocation matches your overall investment time horizon! The problem with most of today’s stock market asset allocators is that they spend too much time judging a 25 year instrument inside of a short-term time horizon thereby resulting in faulty analysis, excessive activity and all sorts of behavioral biases that reduce future returns. ¹ – I know, I shouldn’t technically call a T-Bill a zero coupon bond, but that’s essentially what it is. And yes, 3% yielding T-Bills were the golden days! ² – See Robert Shiller in ” Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends? ” ³ – I like to think of Corporate America as one aggregate living entity. It doesn’t die. It just evolves over time and shifts a growing pool of profits from one legal entity to another to another (usually changing names or getting gobbled up over time) all adding up to higher profits in the aggregate, in the long run.