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BUI: Thrown Out With The Bathwater?

Summary BUI is a closed end fund seeking total appreciation through capital gains and income, investing in utility and global infrastructure equities. BUI currently yields over 8% as its discount to NAV is near record highs. BUI is an atypical closed end mutual fund that has been discarded with the rest of the CEFS over the last 12 months. The BlackRock Utility & Infrastructure (NYSE: BUI ) closed end fund is an investment that I could of only wish for… on paper. BUI is an investment in one of my favorite asset classes (utilities and infrastructure), utilizing one of my favorite investment strategies (covered call writing), in one of my favorite investment fund structures (closed end fund). Unfortunately, since inception, it has been at best a mediocre investment, in particular over the last 12 months. Is the fund a bad fund? Or has the baby been thrown out with the bathwater? The Basics The BlackRock Utility & Infrastructure fund is a closed end mutual fund seeking income and capital appreciation by investing in equities of companies engaged in the utilities and infrastructure business. It carries a 1.1% expense ratio and invests in a portfolio of utility stocks that can be found in many other utility ETFs and mutual funds. What separates this fund from the competitors is the portfolio managers’ strategy of using/writing call options on the individual stocks in order to generate current income. In theory, this should reduce the overall volatility of the portfolio while providing current income. Currently it is paying a distribution rate of 8.57%. In rising markets, these types of portfolios tend to underperform the market as the upside is capped with the written call options. Let’s see how the portfolio has done. The Numbers Closed End Funds are a unique type of an investment that require extra care and attention. Unlike a traditional open end mutual fund that trades once a day, a closed end mutual fund trades like a stock and can be bought and sold throughout the day. Unlike traditional mutual funds which are priced once a day at the net asset value, closed end mutual funds trade a market prices, that may or may not be indicative of the true net asset value. For these reasons closed end mutual funds are typically more volatile compared to traditional funds, not because of the underlying performance, but rather on the reactions or over reactions in the market price. To understand this, you must also keep in mind that closed end funds, unlike their open ended siblings raise money once, and then they list on a public exchange and trade like a stock. If you as the investor want to invest money in the mutual fund strategy, you are buying someone else’s shares. The fund managers have that finite portfolio to work with and that is it, no new shares are created when you decide to invest your money. What this ends up translating into is most closed end funds trading at discounts below the actual value of the funds. That is why it is important to note the difference between the Market Price and the underlying Net Asset Value (NAV). In times of trouble, the market price may be significantly below the actual NAV, and may be a good opportunity to invest and buy assets on sale. Over the last 12 months, Closed End Funds have been hit quite hard with investors pulling out money. Typically, a closed end fund investor is looking for current income. The recent concerns about the health of the high yield markets as well as the interest rate hikes has caused fear and money flowing out of such investments. Unfortunately most people look at closed end funds as an asset class rather than as an investment vehicle with underlying investments. Has BUI been lumped in with other closed end funds? Let’s take a look. (click to enlarge) (Source: CEF Connect) As you can see, YTD BUI’s market price is down approximately 11%, however the underlying NAV is down only 6.99%. In essence, the investors were willing to accept less for the fund that what it was actually worth. In 2012 and 2013 you have had the same results. 2012 in particular resulted in a situation where the funds market price was down 3.51% for the year, yet the underlying net asset value was up 8.69%. 2014 showed what happens when people are chasing yield and were willing to pay more for the fund than what it earned where the market up was up 24.95%, yet the underlying NAV was up only 16.05%. An astute closed end fund investor looks for these opportunities to buy or to cash in their gains. On an annualized basis we have the following. (click to enlarge) (Source: CEF Connect) Since the fund launched in 2011, the total return including distributions averaged out to 3.43%. The fund has lost value, however it distributed a significant amount of dividends and income from the options. On a net asset value basis, the fund has performed respectably, earning an annualized 7.69%. Included are the performance numbers for the Closed End Fund Utilities category. What you can see is as expected, the fund has underperformed versus the peers, however during bad times, such as over the last year, BUI which uses no leverage and only generated income by writing call options was able to lower the volatility versus the peers as seen in the net asset value. Furthermore, while investors did notice this, you can still make the argument that this fund was hurt by the overall “dirty water” being thrown out as the market price did not hold up as well as the net asset value. The one place where this is evident is in the visualized chart of historical discounts and premiums to net asset value. (click to enlarge) (Source: CEF Connect) As of the time of writing, the fund is trading a discount of 13.24% to underlying net asset value. This has been historically a bigger discount than average, last seen late 2013 during the Fed’s Taper Tantrum. Conclusions and Final Thoughts Going through this analysis, it becomes more and more clear that unfortunately for this fund, it is lumped in with other closed end funds. Unlike other funds that employ leverage and invest in risky assets, BlackRock’s Utility & Infrastructure fund uses no leverage, buys globally listed equities, generates income with covered call options and has reasonable management fees. Unfortunately even though the underlying portfolio is seemingly performing as intended, the majority of investors are willing to overlook that and treat this as any other closed end fund. For a long term income investor looking for utility and infrastructure exposure, this fund at the current prices may be worthy of a look, at the very least put on your watch list.

The Time To Hedge Is Now! December 2015 Update

Summary Overview of strategy series and why I hedge. Short summary of how the strategy has worked so far. Some new positions I want to consider. Discussion of risk involved in this hedge strategy. Back to Do Not Rely On Gold Strategy Overview If you are new to this series, you will likely find it useful to refer back to the original articles, all of which are listed with links in this instablog . It may be more difficult to follow the logic without reading Parts I, II and IV. In Part I of this series, I provided an overview of a strategy to protect an equity portfolio from heavy losses in a market crash. In Part II, I provided more explanation of how the strategy works and gave the first two candidate companies to choose from as part of a diversified basket using put option contracts. I also provided an explanation of the candidate selection process and an example of how it can help grow both capital and income over the long term. Part III provided a basic tutorial on options. Part IV explained my process for selecting options and Part V explained why I prefer to not use ETFs for hedging. Parts VI through IX primarily provide additional candidates for use in the strategy. Part X explains my rules that guide my exit strategy. All of the articles in this series include varying views that I consider to be worthy of contemplation regarding possible triggers that could lead to another sizeable market correction. I want to make it very clear that I am NOT predicting a market crash. I merely like to take some of the pain out of the downside to make it easier to stick to my investing plan: select superior companies that have sustainable advantages, consistently rising dividends and excellent long-term growth prospects. Then I like to hold onto those investments unless the fundamental reasons for which I bought them in the first place changes. Investing long term works! If you are interested in a more detailed explanation of my investment philosophy, please consider reading ” How I Created My Own Portfolio Over a Lifetime .” Why I Hedge If the market (and your portfolio) drops by 50 percent, you will need to double your assets from the new lower level just to get back to even. I prefer to avoid such pain, both financial and emotional. If the market drops by 50 percent and I only lose 20 percent (but keep collecting my dividends all the while), I only need a gain of 25 percent to get back to even. That is much easier to accomplish than doubling a portfolio and takes less time. Trust me, I have done it both ways, and losing less puts me way ahead of the crowd when the dust settles. I view insurance, like hedging, as a necessary evil to avoid significant financial setbacks. From my point of view, those who do not hedge are trying to time the market, in my humble opinion. They intend to sell when the market turns but always buy the dips. While buying the dips is a sound strategy, it does not work well when the “dip” evolves into a full-blown bear market. At that point, the eternal bull finds himself catching the proverbial rain of falling knives as his/her portfolio tanks. Then panic sets in and the typical investor sells when they should be getting ready to buy. A short summary of how the strategy has worked so far I have been hedged since April 2014. In 2014, our only significant candidate win was Terex (NYSE: TEX ) which provided gains of over 600 percent to help offset some of my cost. I missed taking some profits in October of 2014 that could have put me in the black for the year, but by doing so, I would have left my portfolio too exposed, so I let most of those positions expire worthless. It is insurance, after all. The results for 2015 have been stellar! I like it when the market gives me a gain in early December because the likelihood of a year-end (Santa Claus) rally is very high and will usually give me an opportunity to redeploy the profits before the rest of my positions expire. I could have taken more gains but decided to leave some on the table in case the rally did not materialize to keep my portfolio mostly protected. I explained all my moves in the last article of the series linked at the top. My biggest winners in 2015 were Men’s Wearhouse (NYSE: MW ) with gains of over 2,700 percent, Micron Technologies (NASDAQ: MU ) with gains of up to 1,012 percent, Sotheby’s (NYSE: BID ) with gains of up to 1,500 percent, Seagate Technologies (NASDAQ: STX ) gaining over 570 percent, and Williams-Sonoma (NYSE: WSM ) with a gain of 527 percent. The gains realized on sold positions now puts me in a position of needing to add some hedges going into 2016, but with plenty of available cash. I will only deploy enough of those gains to protect my portfolio through the end of June 2016 and hold onto the rest to be deployed into new positions to provide a hedge through January 2017. Some new positions I want to consider Do not forget that I usually buy multiple positions in each candidate that I use and you should, too, unless you get in at a particularly good premium and strike. I add positions as I find I can do better than what I already own in order to improve my overall hedge. Sometimes I may buy only half or a third of the position I intend to own in the first purchase. As we get deeper into this bull market (if it still is a bull), I try to stay closer to fully hedged as much as possible. I will be hedging most of my portfolio again over the next month or so since most of my remaining positions are set to expire in mid-January of 2016. I cannot emphasize this enough: buy put options on strong rally days! Here is the list of what I would buy next and the premiums at which I would make the purchases. I may get in if the premium gets down close to my buy price and you will need to make such decisions for yourself. This is a different format from what I have used prior to this month. I will be placing good until cancelled orders at or just below my target premiums to get the positions I want when available without my having to watch daily. I list the candidates in the order of my preference. I will explain how many contracts per $100,000 of portfolio value will be needed and list the expiration months below the table. Symbol Current Price Target Price Strike Price Ask Prem Buy At Prem Poss. % Gain Tot. Est. $ Hedge % Cost of Portfolio RCL $99.92 $22 $75 $1.85 $1.80 2,844 $5,120 0.180% GT $32.79 $8 $28 $1.25 $1.25 1,500 $3,750 0.250% ADSK $61.85 $24 $50 $2.03 $1.80 1,344 $4,840 0.360% SIX $54.63 $20 $45 $1.30 $1.20 1,983 $4,760 0.240% LB $96.82 $30 $85 $2.65 $2.50 2,100 $5,250 0.250% LVLT $54.40 $20 $48 $2.20 $1.90 1,374 $2,610 0.190% TPX $71.64 $20 $60 $2.85 $2.50 1,500 $3,750 0.250% UAL $59.78 $18 $50 $2.29 $2.00 1,500 $3,000 0.200% MAS $28.44 $10 $25 $1.25 $0.85 1,665 $4,245 0.255% ETFC $29.71 $7 $27 $1.87 $1.25 1,500 $3,750 0.250% I will need only one June 2016 RCL put option contract to provide the coverage indicated in the above table. Remember that this is one of eight positions, each designed to hedge one-eighth of a $100,000 portfolio against a 30 percent drop in the S&P 500 Index. I will need eight positions from the table above to protect each $100,000 of equity portfolio value. To protect a $500,000 portfolio, I would need to multiply the number of contracts in each of my five positions by five to be fully protected. Below is a list of the expiration month (all expire in 2016) and number contracts needed for each position I use. Royal Caribbean Cruises Ltd. (NYSE: RCL ) June One Goodyear Tire (NASDAQ: GT ) July Two Autodesk (NASDAQ: ADSK ) July Two Six Flags (NYSE: SIX ) June Two L Brands (NYSE: LB ) May One Level 3 Communications (NYSE: LVLT ) June One Tempur Sealy (NYSE: TPX ) June One United Continental (NYSE: UAL ) June One Masco (NYSE: MAS ) July Three E – Trade Financial (NASDAQ: ETFC ) June Two If I use only the first eight positions listed above, I would protect each $100,000 of equity portfolio value against a drop of approximately $33,080 for a cost of $1,920 (plus commissions). What this means is that if the market falls by 30 percent, my hedge positions should more than offset the losses to my portfolio. This coverage only provides about six months of additional protection, but I have more than double that from my gains taken this year. Hopefully, there will more gains available to further offset future losses come summer and I will roll my positions again (and again, if necessary) until we finally have a recession. Both MAS and ETFC “Buy at Premiums” listed above are below the range of the current bid and ask premiums. That was the case with all of the premiums I used in the last article and most of those have been achieved already. Patience often pays off in lower costs. All of the other premiums listed are within the current range and should be available either immediately or with a small additional rally. I do not intend to chase these premiums and will try to get lower premiums when available. I expect that the current rally could extend into year-end giving me a better entry point on some of these candidates and possibly some others that just do not work at this level. I will provide another update if that opportunity occurs. But I am not ready to take that possibility to the bank, so I will place some orders Monday morning. I do not try to hedge the bond portion of my portfolio with equity options. For those who would like to hedge against a rout in high-yield bonds, I use options on JNK and may add HYG as a candidate for that purpose. If that seems interesting, please consider my recent article on the subject. Discussion of risk involved in this hedge strategy If an investor decides to employ this hedge strategy, each individual needs to do some additional due diligence to identify which candidates they wish to use and which contracts are best suited for their respective risk tolerance. I do not always choose the option contract with the highest possible gain or the lowest cost. I should also point out that in many cases I will own several different contracts with different strikes on one company. I do so because as the strike rises, the hedge kicks in sooner, but I buy a mix to keep the overall cost down. To accomplish this, I generally add new positions at the new strikes over time, especially when the stock is near its recent high. My goal is to commit approximately two percent (but up to three percent, if necessary) of my portfolio value to this hedge per year. If we need to roll positions before expiration there may be additional costs involved, so I try to hold down costs for each round that is necessary. My expectation is that this represents the last time we should need to roll positions before we see the benefit of this strategy work more fully. We have been fortunate enough this past year to have ample gains to cover our hedge costs for the next year. The previous year, we were able to reduce the cost to below one percent due to gains taken. Thus, over the full 20 months since I began writing this series, our total cost to hedge has turned out to be less than one percent. I want to discuss risk for a moment now. Obviously, if the market continues higher beyond January 2016, all of our old January expiration option contracts that we have open could expire worthless. I have never found insurance offered for free. We could lose all of our initial premiums paid plus commissions, except for those gains we have already collected. If I expected that to happen, I would not be using the strategy myself. But it is one of the potential outcomes and readers should be aware of it. I have already begun to initiate another round of put options for expiration beyond January 2016, using up to two percent of my portfolio (fully offset this year by realized gains) to hedge for another year. The longer the bulls maintain control of the market the more the insurance is likely to cost me. But I will not be worrying about the next crash. Peace of mind has a cost. I just like to keep it as low as possible. Because of the uncertainty in terms of how much longer this bull market can be sustained and the potential risk versus reward potential of hedging versus not hedging, it is my preference to risk a small percentage of my principal (perhaps as much as two percent per year) to insure against losing a much larger portion of my capital (30 to 50 percent). But this is a decision that each investor needs to make for themselves. I do not commit more than three percent of my portfolio value to an initial hedge strategy position and have never committed more than ten percent to such a strategy in total before a major market downturn has occurred. The ten percent rule may come into play when a bull market continues much longer than expected (like five years instead of 18 months). And when the bull continues for longer than is supported by the fundamentals, the bear that follows is usually deeper than it otherwise would have been. In other words, at this point, I would expect the next bear market to be more like the last two, especially if the market continues higher through all of 2016. Anything is possible but if I am right, protecting a portfolio becomes ever more important as the bull market continues. As always, I welcome comments and will try to address any concerns or questions either in the comments section or in a future article as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other’s experience and knowledge.

Junk Bonds: Time To Start Accumulating – Yield Over 21%

Summary Overselling mostly done in the junk bond space. I am buying for my retirement portfolio: CEFL – over 21% yield. Components of CEFL are trading at heavy discounts, and the security is on the rebound. CEFL: An opportunistic buy. Following my latest article on my high-yield “Model Retirement Portfolio” (6% Dividend Target) published Monday (December 14) on Seeking Alpha, recommending dividend investors to start buying the UBS ETRACS Wells Fargo Business Development Company ETN (NYSEARCA: BDCS ), the shares of the ETN have rallied around 3%. I believe there is much more upside to come, as the sector is still oversold with no real merit. If you have not started to buy, it is not too late. For those who have opted to buy the leveraged version, the UBS ETRACS 2X Leveraged Long Wells Fargo Business Development Company ETN (NYSEARCA: BDCL ), the shares closed over 6% up since Monday. I promised in my Monday article to give an update on the best time to start accumulating on junk bonds. Well, the time has come! I will provide guidance on the best approach. Update on the Junk market space The sector recently experienced heavy losses and a meltdown , leading to heavy redemptions by investors. This was sparked by rock-bottom levels of risk tolerance, persistent downside risk to commodity prices, and turmoil in emerging markets. However, recent comments from high profile investment banks have calmed down the markets: UBS (NYSE: UBS ) reported last Monday: Junk bonds sell off, oil drop worries are overdone. The Chief Investment Officer at Guggenheim Partners stated: There is a “buy” signal for junk bonds. A Goldman analyst stated that investors are being too pessimistic . BlackRock’s Senior Director stated on Monday that junk bonds won’t spark a new crisis. It will be contained. Tracking this sector, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) and the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ) both ended the week with returns (before dividends) of 1.66% and -0.18%, respectively, during the last 5 trading sessions. This is despite heavy losses for the week sustained in all the major indexes. So it looks like we are close to a bottom. Best way to enter the Junk Bond Space To be prudent, I am not investing directly into the junk market ETFs. I am investing with a much more balanced approach using the UBS ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA: CEFL ), a leveraged Exchange Traded Note issued by UBS with a stated yield of over 26%. What exactly is CEFL? CEFL is a fund of “closed-end funds” (basically a fund of funds) issued by UBS. It comes in the form of an exchange-traded note (ETN) linked to the monthly compounded 2x leveraged performance of the ISE High Income index. Its objective is to capture the top 30 closed-end funds as determined by a ranking scheme, allowing investors to take advantage of both event-driven news and long-term trends of the U.S. closed-end fund marketplace. The note is leveraged, so it pays approximately twice the yield of the related index, which comes with a stated yield of 21.78% ( UBS ). The dividend is paid monthly via a variable monthly coupon. CEFL’s top ten components (making up 45% of total holdings) are depicted in the following table, which includes the weight of the security and the discount to net asset value (NAV) and return of capital for 2015. (click to enlarge) Advantages of Investing in CEFL Now: CEFL is not a pure junk bond play. It is a very diversified product which includes, among others, preferred shares, mortgage backed securities, corporate bonds, junk bonds, emerging market bonds, foreign government bonds, investment grade corporate bonds, high yield corporate bonds, and even certain stocks. It offers one of the most diversified ways to invest in the high-yield bond space, as it is basically a “fund of funds”. The security has been selling off since the beginning of the year, both from worries of higher interest rates and from the junk bond crisis. The shares have lost, after dividends, over 17% of their value. Signs of life and rallying the past week: CEFL is up 5.8% during the last 5 trading sessions. This is despite the heavy losses sustained in all the indexes. The S&P (NYSEARCA: SPY ) was down about 1.2%, while the Dow Jones Index (NYSEARCA: DIA ) was down 1.4%. It is a good time to catch them on the way up. CEFL components are still trading at a heavy discount to net asset value. As seen on the table above, the average discount of its 10 top components is 13.1%. So this security is on fire sale. CEFL provides exposure to emerging markets through its bond portfolio. With certain analysts predicting that emerging markets will start recovering in 2016 and 2017, along with the prices of commodities, CEFL will benefit from such a recovery. Several investment bankers, including Goldman, Guggenheim, UBS, and BlackRock, have just started being optimistic. Now that the fears of high rate increase by the Fed have started to dissipate (only 0.25% hike and prudent approach to future hikes), I expect the security to do well in the short and medium term. Other Important Information on CEFL: Not all the stated 21.78% yield is actual dividend. Part of it is a return of capital as some of these funds had to return part of the investment to their shareholders in order to maintain yield. If we have a look at the table above, the average “return of capital” for the 10 largest holdings is 15.3% for the year 2015 (to-date). If we assume the same percentage for all the securities, that will give CEFL an effective yield of 18.4%. CEFL’s dividend is also variable. The security of CEFL is twice leveraged. So any price movement in the underlying securities will have a double effect. Expect volatility, but do not worry much, the fundamentals are good. It may be wise to spread small purchases during a period of one week. Try to average down during down days. Conservative Diversification Please note that I use conservative diversification to protect my “high dividend portfolio”. I have started buying CEFL but will only allocate around 3% of my total portfolio to the security, especially due to the leverage effect. I advise investors to also take a prudent approach. For this investment, I am happy to get a dividend of over 20%, which means in 5 years, I should have all my capital back and the rest is pure earnings generating additional income. Get alerts for “My Model High-Yield Retirement Portfolio” (6% Dividend Target) I am currently sharing future opportunistic additions to my “Model Retirement Portfolio” (6% Dividend Target), for which I often use ETFs and CEFs to protect my “egg nest” against volatility and against the risk of investing in a single security. Furthermore, my conservative strategy includes scrutinizing and generally avoiding excessively high dividend securities, which may lead to disproportionate risk taking and heavy losses. My target is to have a conservative and well-balanced high-yielding 6% dividend portfolio to generate long lasting income and protect against inflation. Please follow me if you are looking for dividend safety, diversification, and sound investment ideas.