Tag Archives: capital-gains

Monthly Paying Closed-End Fund NRO Offers 8% Return

Summary NRO pays $0.03 per month per share and currently returns 8%. NRO is currently selling at a 17% discount to NAV. The share price of NRO should grow as REITs gain favor again with investors. I wrote an article in June suggesting Neuberger Berman Real Estate Securities Income Fund (NYSEMKT: NRO ) was a good closed equity fund to place one’s money to get a 7% distribution on a monthly basis. At that time NRO was offering a 7% yield and was selling about 15% below NAV. The issue was selling for about $5.00 per share and was paying $0.03 per share a month. Since the company is now selling at about $4.54 per share (9/16/15), I thought I would take another look at this CEF again to see what is happening. NRO is still paying $0.03 per share a month which takes the distribution return up to 8% at the current price. It reports a NAV of $5.47 per share as of 9/16/2015 and therefore is selling at a 17% discount to its assets. The market price of NRO is down about 7% from the beginning of the year. This coincides with the price drop seen in REITs from the beginning of the year. It appears that investors are running scared from REITs because the FED is threatening to increase interest rates. I am convinced that the threat is much greater than the reality. It will be a long time before the FED gets interest rates up to 2% and REITS will continue to fare well in this low interest rate environment. If I am correct, both the NAV and the market price of NRO will do well over the next year or two. The price of REITs will rise when people realize that government bonds and CDs are not going to pay much more than they currently offer over the next few months. Investors will again pour their funds into REITs to reap a much better return and that in turn will likely cause the price of NRO to rise. The price of NRO’s holdings will rise since it has many REITs where prices have declined because of investor fears over interest rates. A list of the top 10 holdings by number of shares and their price decline is shown below: Ticker Description Shares Price 1/2/15 Price 9/16/15 Difference Current Yield SRC Spirit Reality Cap 617,000 12.06 9.25 -25% 7.4% ROIC Retail Opp. Inv. 593,000 16.98 16.40 -3.5% 4.1% STWD Starwood Prop. Trust 583,000 23.41 21.52 -8% 8.9% BPY Brookfield Prop. Ptnrs. 553,100 22.95 21.40 -7% 5.0% NRF Northstar Realty Fin. 531,900 17.88 13.96 -22% 11.5% CBL CBL & Assoc. Prop. Trust 509,700 19.75 14.68 -25% 7.2% LXP Lexington Realty Trust 497,200 11.19 8.30 -26% 8.2% KIM Kimco Realty Corp. 474,600 25.46 23.60 -7% 4.1% NRFpB Northstar Pref. B 444,484 25.00 24.27 -3% 8.3% UBA Urstadt Biddle Class A 425,693 22.10 18.67 -16% 5.5% Source: My own work with figures from Interactive Brokers The chart indicates that the prices of all REITs have dropped; Some REITs declined as much as 25% to as low as 3%. The REITs that dropped the most are mortgage REITs since high interest rates would hurt their earnings the most. The following chart lists the top 10 holdings of NRO by dollar value and the decline in prices from the beginning of the year. Ticker Description Shares Price 1/2/15 Price 9/16/15 Difference Current Yield OHI Omega Healthcare Inv 396,700 40.43 33.64 -17% 6.5% PSA Public Storage Reit 70,100 187.23 205.65 +9% 3.3% STWD Starwood Prop. Trust 583,000 23.41 21.52 -8% 8.9% HCP HCP Inc. Reit 321,800 44.85 32.72 -27% 6.0% KIM Kimco Realty Corp. 474,600 25.46 23.60 -7% 4.1% HIW Highwoods Prop. Inc. 272,880 44.94 39.00 -13% 7.2% BPY Brookfield Prop. Ptnrs. 553,100 22.95 21.40 -7% 5.0% NRFpB Northstar Pref. B 444,484 25.00 24.27 -3% 8.3% PSApY Public Storage Pref Y 400,000 26.37 26.10 -1% 6.1% ROIC Retail Opp. Inv. 593,000 16.98 16.40 -3.5% 4.1% Source: My own work with figures from Interactive Brokers This chart shows nearly the same declines as the prior chart. There is one major difference in that PSA actually increased in price between the beginning of the year and now. It is also surprising to see the 27% decline in the price of HCP. HCP is a hybrid REIT that invests in both property and loans in the healthcare industry. The price has declined as if it were a pure mortgage REIT. Doing this chart for NRO indicates that HCP should be poised to rise quite a bit as well. Both charts indicate that prices of most of the investments that NRO holds as of 7/31/2015 have declined considerably since the beginning of the year. As these prices regain momentum after investors realize that interest rates are not rising as fast or as soon as expected, the discount between the stock price of NRO and NAV will increase or the price of NRO must increase with them. Conclusion: With NRO currently offering an 8% return along with a huge discount from NAV, it looks like an outstanding buy. Furthermore, it appears to be positioned to make some capital gains as investors begin to realize that interest rates are not going to rise very quickly over the next 2 years. The landscape for this closed fund looks especially good at the current time for an outstanding dividend and possible capital gains in the future. Disclosure: I am/we are long NRO, OHI, HCP, SRC, LXP. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The Big, Bad Floating NAV Is Coming Your Way

Summary Prime money market funds are going to be reporting their net asset values on a floating basis due to recent SEC rules. The effect will be to render these funds costlier, both on an accounting and a tax basis, and might lead to an outflow from these funds. However, the weighted average maturity of these funds, one measure of their riskiness, is well within SEC guidelines. The big, bad floating NAV is coming your way In 2014 the SEC adopted amendments to rules that govern certain types of money market funds. In particular prime money market funds – those that invest in corporate debt securities will have to report floating Net Asset Values (NAVs) instead of posting fixed NAVs as has hitherto been the case. Thus at any given time, capital appreciation or depreciation will have to be reported, leading to a move towards money market funds with a Treasury or municipal bond focus. Instead of assuming a fixed NAV of $1.00, investors will have to confirm the posted NAV price. There will also be liquidity management issues, since the use of these money market funds for intra-day liquidity management will be much diminished, given the uncertainties about the NAVs for these funds. Companies would have to monitor the marking-to-market value of these funds on their balance sheets. Finally, all sales of money market fund shares would become taxable events. Rule 2A-7 risk limiting provisions amended Traditionally SEC’s Rule 2A-7, adopted in 1983, allowed money market funds to use amortized cost to value the funds so long as they kept within very strict parameters. Since money market funds are not insured by the FDIC, they have traditionally had to keep within limits about the three primary risks they face. Of course, the first was interest risk, credit risk and liquidity risk (the risk that a borrower will not pay its obligations when due). Of course, the first two kinds of risks do not affect money market funds which invest in Treasuries or municipal bonds. But all three risks affect prime money market funds. With a fixed NAV based on amortized cost, investors did not need to track their capital gains and losses, since all of the return of a money market fund is paid out in dividends. In addition, a stable NAV allowed these funds to offer such services as check-writing and the other general features available to deposit accounts, while allowing investors to have access to some upside features. The daily dividend on the fund is based on the accrued interest based on amortized cost. At least that was the situation before the recent amendments by the SEC. On Weighted maturities and interest rate sensitivities. Given the above mentioned advantages of the stable NAV for money market funds, it was imperative to keep the funds within certain risk bounds. One way to do this was to limit the maximum weighted average maturity (WAM) of the funds. An increase in interest rates would decrease a fund’s shadow price. One measure of the sensitivity of any fund with respect to a change in interest rates is the fund’s weighted average maturity (the WAM). The WAM is the measure of the average maturity of the bonds in the fund’s portfolio, and the SEC rules provided that funds, in order to use amortized cost, could have a maximum WAM of 60 days. The higher the WAM, the more sensitive the shadow price of the fund would be to changes in interest rates. When redemption of funds is high, especially in times of crisis, (as was the case between 2007 and 2008), then shadow prices will fall below $1, and the WAM is especially helpful to understand the riskiness of these funds. Recent measures of WAM show relatively low riskiness. Money market funds are obligated to disclose their net assets, 7-day interest rates and WAMs on a monthly basis. Extracting some of this data from the SEC web site for four representative prime money market funds (those of BMO, BNY Mellon, Legg-Mason and Fidelity) show that all of these funds have WAMs well below 60 days. The shadow prices (not shown) are $1 for BMO and BNY Mellon, $1.002 for Fidelity and $1.0001 for Legg Mason in the period shown. Legg Mason, with a WAM over the period for its prime funds of 6 days, carries a 7-day rate on average of .23%. (The figures below come from the N-MFP disclosures on the SEC website). Does this mean there is no cause for concern? The above-mentioned trends do not mean that there is no cause for concern. Shadow prices of these funds are notoriously resistant to reflecting trends in markets. In September of 2008, 90 percent of prime money market funds had shadow prices within 5 basis points of $1, as reported by the ICI. Nevertheless, when floating NAVs become part of the investor’s framework, it is likely that they will not be as volatile as feared if current trends in the weighted average maturity are any indicator. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

PKW: Does It Outperform Because Of Strategy Or Sector Allocation?

Summary The PKW portfolio is built to take advantage of companies that are repurchasing shares. Over the last several years PKW has performed very well. The holdings are fairly concentrated but a focus on sectors with more buybacks could indicate less exposure to price based competition. My concern about the sector allocations is that they feel exposed to recessionary problems. If I was going to use PKW, I would want to include a heavy position in a long term treasury ETF to offset the risk in the portfolio. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. I’m working on building a new portfolio and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the PowerShares Buyback Achievers Portfolio ETF (NYSEARCA: PKW ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio The expense ratio on the fund is arguably the largest drawback. At .68%, the expense ratio eats into the long term value that can be generated by the fund. If it continues to outperform the market that won’t be a problem, but that feels like a dangerous bet on the system continuing to work. If it does, then all economic theories based on efficient markets should be called into question. Largest Holdings The largest holdings represent very material portions of the ETF. The analysis of the portfolio is further complicated by the potential for substantial amounts of turnover within the ETF which may cause the holdings and sector allocations to change materially over time. When they change, the risk profile also changes. The ten largest holdings are included in the chart below: Heavy allocations to both Home Depot (NYSE: HD ) and Lowe’s (NYSE: LOW ) are interesting. If both companies are heavily committed to using their cash for buybacks rather than expanding competition against each other, it could be a favorable sign for both companies and help them see boosts in earnings. While I’ve been critical of industries that are destroying margins through excessive competition, seeing Lowe’s and Home Depot together seems like a positive sign. Of course, the companies will also be heavily influenced by other factors such as demand for their goods which will be tied to other factors in the economy. Sectors The sector allocation is heavily focused on consumer discretionary while staples are extremely low. Health care and utilities are also fairly light weight which leaves me concerned about how the portfolio would fair if the economy slipped substantially. I love how well the ETF has performed, but I’m wondering how much of that is a function of their methodology and how much is simply a measure of sector allocation during a period of low interest rates with expanding GDP and high corporate profits relative to total GDP. Building the Portfolio This hypothetical portfolio has a slightly aggressive allocation for the middle aged investor. Only 30% of the total portfolio value is placed in bonds and a third of that bond allocation is given to emerging market bonds. However, another 10% of the portfolio is given to preferred shares and 10% is given to a minimum volatility fund that has proven to be fairly stable. Within the bond portfolio, the portion of bonds that are not from emerging markets are high quality medium term treasury securities that show a negative correlation to most equity assets. The result is a portfolio that is substantially less volatile than what most investors would build for themselves. For a younger investor with a high risk tolerance this may be significantly more conservative than they would need. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. (click to enlarge) A quick rundown of the portfolio The two bond funds in the portfolio are the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEARCA: EMB ) for higher yielding debt from emerging markets and the i Shares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) for medium term treasury debt. IEF should be useful for the highly negative correlation it provides relative to the equity positions. EMB on the other hand is attempting to produce more current income with less duration risk by taking on some risk from investing in emerging markets. The position in the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) offers investors substantially lower volatility with a beta of only .7 which makes the fund an excellent fit for many investors. It won’t climb as fast as the rest of the market, but it also does better at resisting drawdowns. It may not be “exciting”, but there are plenty of other areas to find “excitement” in life. Wondering if your retirement account is going to implode should not be a source of excitement. The position in makes the portfolio overweight on companies that are performing buybacks. The strategy has produced surprisingly solid returns over the sample period. I wouldn’t normally consider this as a necessary exposure for investors, but it seemed like an interesting one to include and with a very high correlation to SPY and similar levels of volatility it has little impact on the numbers for the rest of the portfolio. The core of the portfolio comes from simple exposure to the S&P 500 via the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ), though I would suggest that investors creating a new portfolio and not tied into an ETF for that large domestic position should consider the alternative by Vanguard’s Vanguard S&P 500 ETF (NYSEARCA: VOO ) which offers similar holdings and a lower expense ratio. I have yet to see any good argument for not using or another very similar fund as the core of a portfolio. In this piece I’m using SPY because some investors with a very long history of selling SPY may not want to trigger the capital gains tax on selling the position and thus choose to continue holding SPY rather than the alternatives with lower expense ratios. Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. To make it easier to analyze how risky each holding would be in the context of the portfolio, I have most of these holdings weighted at a simple 10%. Because of IEF’s heavy negative correlation, it receives a weighting of 20%. Since SPY is used as the core of the portfolio, it merits a weighting of 40%. Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio and with the S&P 500. Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. Conclusion PKW has a high correlation to the S&P 500 and a similar level of volatility. When looking at the max drawdowns, it appears that during periods when the market shows fear the portfolio is more exposed to taking a hit. While I’m thoroughly impressed with the performance the ETF has shown, I am not buying into the theory that it will continue to outperform the market. I get the feeling that a really solid extended negative period for the market (rather than one week or so of free falling) could put a major dent into the portfolio. If I was going to build a portfolio with a large position in PKW, I would want to include a very material position in a long term treasury ETF for the negative correlation at -.42. The negative correlation would provide a better chance of gaining on the treasury ETF if fear or a recession took hold of the market and the underlying holdings began to suffer large setbacks. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.