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Fed Up Of Rate Hike Timing? Stay Invested In REIT-Focused Funds

Comments from key Federal Reserve officials and improving economic data have added fuel to rate hike hopes. In September, hopes of a lift-off had fizzled out as the date for the FOMC meeting approached. However this time, factors that will help in deciding on the rate hike have growing in numbers. Moreover, market volatility is now at a level that should help the cause against the high levels seen in September. Investors may be ‘fed up’ of Fed’s actions or inactions and the effects of both is a story that has been done to death. But we have to remind investors about funds that would be the best buys before ‘Fed ups’ the rate for the first time in a decade, even at the cost of repeating ourselves. Fed Comments Several Fed officials pointed toward a series of rate hikes at a moderate pace. Atlanta Fed President Dennis Lockhart stated that he was “comfortable” with a rate hike “soon.” Cleveland Fed President Loretta Mester said the central bank had not firmed up on a December rate increase. However, Mester added that: “Things are on track.” Fed vice chairman Stanley Fischer mentioned that “some major central banks” could quit the near-zero interest rate policy “in the relatively near future.” New York Fed president William Dudley and St. Louis Fed president James Bullard also made similar comments. According to a Dow Jones report, William Dudley said on Friday that the central bank may approach the goals needed to hike rates, but it still has time to decide on whether or not it will hike rates in December. The timing is data-dependent and Dudley expects to see indications of increasing inflation soon enough. He mentioned that the US economy is in “good shape”, helping the Fed meet the criteria for rate hike in the near future. Separately, James Bullard reportedly said that the central bank may move back to an era of uncertain rate hikes based on meeting-by-meeting basis after the first rate hike. FOMC Minutes Minutes from the Federal Open Market Committee’s (FOMC) meeting in October stated that most officials anticipated that conditions to lift short-term interest rates “could well be met by the time of the next meeting” in December. The Fed is waiting for further improvements in labor market conditions and inflation to touch its target rate of 2% before hiking rates. Fed officials with a hawkish stance also said that further delay in raising rates will show lack of confidence in the economy. Fed officials said volatility in the financial markets has subsided since September. According to them, “the U.S. financial system appeared to have weathered the turbulence in global financial markets without any sign of systemic stress.” Moreover, officials believe that there is “solid underlying momentum” in business and consumer demand, despite a slowdown in third-quarter GDP growth. Economic Data Last week, economic data was inclined toward the positive side. The U.S. Department of Commerce reported in its “second” estimate that the economy grew at a pace of 2.1% in the third quarter, compared to earlier projected growth rate of 1.5%. Also, third quarter’s growth rate came in higher than the consensus estimate of 2% growth. An upward revision in business inventories emerged as the main reason behind the expansion in quarter. Business inventories were revised upward from $56.8 billion reported in “advance” estimate to $90.2 billion. However, third-quarter growth remained below second quarter’s rate of 3.9%. The U.S. Department of Commerce reported that new orders for manufactured durable goods rose by $6.9 billion or 3% in October to $239 billion, significantly beating the consensus estimate of a 1.6% rise. Increase in demand for large, commercial airplanes was mainly behind the gain in October. It was preceded by a 0.8% decline in September. Moreover, the Labor Department reported that jobless claims in the week ending November 21 declined by 12,000 from the previous week to 260,000. According to the Commerce Department, personal income rose $68.1 billion or 0.4% in October, in line with the consensus estimate. It was higher than September’s increase of 0.2%. These strong data added to rate hike possibility. REITs: You Can Actually Buy Them Now Interestingly, we have a contrarian view about what to do with REITs. Many would say that REITs should be offloaded and they are not very wrong given that these thrive in a low rate environment. Low rates imply low borrowing cost for the Real Estate Investment Trusts (REITs) that allow them to purchase or develop real estate. Moreover, REIT stock yields become more attractive when Treasury yields fall (REITs are often treated as bonds because of their high dividend paying nature and therefore, Treasury yields end up playing a significant role in their price movement). Rising interest rates lead to an increase in interest costs as REITs usually look for both fixed and variable rate debt financing to pay back maturing debt, and fund their acquisitions, development and redevelopment activities. Therefore, REITs cannot practically run away from the impact of rate hikes. But the extent of such an impact would depend on the nature of their leases and funding activities. As for the contrarian view, an improving economy will step up REIT activities and thus an increased demand for space. Since supply has been slow with tepid economic recovery in the past, this increase in demand would lead to higher rents and occupancy rates. Also, if rate hike is gradual, REITs will get enough time to adjust. The REIT sector investors in particular should get a boost from a stronger U.S. job market, improving consumer confidence and stable housing recovery. Adjustments with the rate environment would be comparatively easier for sectors with the advantage of pricing power like hotel, storage and apartment REITs that have shorter-term leases. Meanwhile, a NAREIT study shows that out of the 16 periods of significant interest rate rise since 1995, listed equity REIT returns were positive in 12. This implies that REITs actually gather more steam amid rising rates. Moreover, REITs have been proactive in the capital market in recent years. They have opportunistically used the low rate environment to make their finances more flexible, which is encouraging down the line for their operational efficiencies. 3 REIT Funds to Buy On that note, investing in funds focused on REITs would be a prudent move. Below we present 3 funds, which have significant exposure to REITs and carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy). Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund. Cohen & Steers Real Estate Securities A (MUTF: CSEIX ) seeks total return. CSEIX invests a large chunk of its assets in common stocks of companies whose operations are related to the real estate domain and REITs. CSEIX is expected to invest not more than 20% of its assets in non-U.S. companies including that from emerging economies. CSEIX currently carries a Zacks Mutual Fund Rank #1. Over year-to-date and 1-year periods, CSEIX has gained 6.7% and 9.3%, respectively. The respective 3- and 5-year annualized returns are 15.4% and 13.6%. CSEIX has an annual expense ratio of 1.21%, which is lower than the category average of 1.29%. T. Rowe Price Real Estate (MUTF: TRREX ) seeks capital appreciation over the long run with growth in current income. TREEX invests a majority of its assets in companies from the real estate domain. TRREX also allocates a notable share of its assets in real estate investment trusts (REITs), including equity REITs and mortgage REITs. The fund may also invest in non-U.S. firms. TRREX currently carries a Zacks Mutual Fund Rank #2. Over year-to-date and 1-year periods, TRREX has gained 4.7% and 7.1%, respectively. The respective 3- and 5-year annualized returns are 13.5% and 12.7%. TRREX has an annual expense ratio of 0.76%, which is lower than the category average of 1.29%. Franklin Real Estate Securities A (MUTF: FREEX ) invests most of its assets in securities of companies that qualify under federal tax law as REITs and in companies that earn at least 50% of their revenues from residential or commercial real estate activities. FREEX currently carries a Zacks Mutual Fund Rank #2. Over year-to-date and 1-year periods, FREEX has gained 2.4% and 4.6%, respectively. The respective 3- and 5-year annualized returns are 12.3% and 12.4%. FREEX has an annual expense ratio of 0.99%, which is lower than the category average of 1.29%. Original Post

8 ETFs To Watch In December

Traditional investors may pin hopes on the Santa Claus rally in the most successful month of the year, i.e., December, but they should note that this time Christmas might be a little dull, defying the natural progression of the end-of-season rally. A consensus carried out from 1950 to 2013 has revealed that December has ended up offering positive returns in 49 years and negative returns in 16 years, with an average return of 1.59%, as per Moneychimp , the best of the year. But this year, the Fed is scheduled for a rate hike after a decade, provided the economic momentum remains the same. And though the move now seems well digested by the market, a certain shock is inevitable post lift-off. In any case, 2015 had been quite downbeat so far. Even historically strong months couldn’t live up to investors’ expectations. All these made December a keenly watched month for the investing legion. We thus pinpoint a few ETFs that are highly in focus and could hop or drop in December. iPath U.S. Treasury Flattener ETN (NASDAQ: FLAT ) As the Fed hikes the benchmark interest rate, the initial blow would be at the short-end of the yield curve. The investing world has already started to prepare for the move. As a result, yield on the 6-month Treasury note soared 15 bps, from the 0.27% level seen at the start of November to 0.42% on November 30. In the same time frame, the yield on the 10-year Treasury note rose just 1 basis point to 2.21%. In fact, in the recent sessions, yields on 10-year U.S. Treasuries declined, indicating a flattening of the yield curve. So, a keen watch on the inverse bond ETF FLAT is needed to earn some quick gains from the bond market. This product provides inverse exposure to the Barclays US Treasury 2Y/10Y Yield Curve Index, which delivers returns from the steepening of the yield curve through a notional rolling investment in U.S. Treasury note futures contracts. FLAT was up 1.3% in the last one month. ALPS Barron’s 400 ETF (NYSEARCA: BFOR ) This all-cap U.S. equity ETF could be in watch in December. The fund could be used as a representative of the total stock market performance in a volatile (expectedly) month. It is made up of high-quality U.S. stocks. Since the month of December is likely to stay volatile and large-cap stocks might be hurt by a rising greenback post Fed tightening, an all-cap quality U.S. ETF might be the key to win ahead. ALPS U.S. Equity High Volatility Put Write Index ETF (NYSEARCA: HVPW ) The markets are likely to be wobbly post lift-off, and volatility levels should spike. Going bull on high-beta stocks may lead you to losses then. If this happens, investors can have a look at alternative ETFs like HVPW. The fund looks to take advantage of the stocks with the highest volatility in the U.S. equity markets. As the volatility in a given stock rises, so does the price of the options traded on it. The underlying index of the fund seeks to generate income by selling put options on the most volatile stocks in a given two-month period, along with interest earned on T-bills. HVPW added over 0.6% in the last one month. Vanguard High Dividend Yield ETF (NYSEARCA: VYM ) Since income ETFs underperform when rates rise, this high-income U.S. equities ETF might fall out of investors’ favor in December. However, still-subdued inflation and global growth worries might keep the yields on benchmark 10-year U.S. Treasury from rising fast. If this happens, VYM may not be as hit as it is feared right now. As of November 30, 2015, the fund yielded about 3.09%, while the yield on benchmark 10-year U.S. Treasury is 2.21%. VYM is down about 0.9% in the last one month (as of November 30, 2015). iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) Even in a rising rate environment, there are ways beat to the benchmark Treasury yield and earn smart income. Preferred stocks are one such option. Preferred stocks are hybrid securities that are characterized by both debt and equity. They have a higher claim on assets and earnings than common stock. These securities are less volatile than stocks, and yield in the range of 5-6%. PFF yields 5.87% as of November 30, 2015, while it charges 47 bps in fees. The fund was up about 3% in the last one month. iShares Russell 2000 ETF (NYSEARCA: IWM ) Small-cap stocks are the barometer of domestic economic health. So, when the U.S. economy shifts gear in December and experiences policy normalization, small-cap stocks should be the most beneficial zone. While small-cap growth ETFs like the PowerShares Fundamental Pure Small Growth Portfolio ETF (NYSEARCA: PXSG ) and the iShares Russell 2000 Growth ETF (NYSEARCA: IWO ) have already started rallying, we believe these could be high-risk choices, as smaller-capitalization and growth stocks are highly volatile in nature and succumb to a slowdown once the Fed hikes rates. So, investors can keep a close watch on small-cap blend ETFs like IWM. This Zacks Rank #2 (Buy) ETF was up over 3.2% in the last one month. WisdomTree International Hedged Dividend Growth ETF (NYSEARCA: IHDG ) While the Fed is preparing for a hike, other developed economies of the world and a few emerging economies are going the opposite direction. Due to growth issues, global superpowers like Europe, Japan and Australia are presently pursuing easy money policies. While stocks of the concerned region are likely to soar, a currency-hedged approach is essential to set off the effect of a surging greenback. IHDG serves both aspects. Moreover, IHDG takes care of investors’ income too, as the fund selects dividend-paying companies with growth features in the developed world ex-U.S. and Canada. This Zacks ETF Rank #3 (Hold) ETF was up over 1.9% in the last one month and yields 1.86%. Market Vectors ChinaAMC SME-ChiNext ETF (NYSEARCA: CNXT ) China, the epicenter of the global chaos in summer, should also be in focus in December. In any case, this segment is exhibiting excessive volatility lately, throwing shocks and surprises now and then. While Chinese stocks and ETFs soared at the start of November on a flurry of economic and demographic policy easing, it suffered its worst decline since summer to conclude the month. News about securities regulators’ probe into brokerages caused a stock market rout in China. On the positive side, the IMF agreed to declare yuan as a reserve currency, which hints at a stable economy. So, Chinese ETFs are on the fence now, with possibilities and perils on either side, and investors may be interested in tracking its course in December. Original Post

KKR Income Opportunities: Good Entry Point For A 10% Yielder

Summary KKR Income Opportunities is a closed-end fund that invests in high-yield debt. A weak market in 2015 pressured the stock price and caused the discount to NAV to widen. Broad diversification, a large discount to NAV and a 10% yield make the current price a very compelling entry point. KKR Income Opportunities Fund (NYSE: KIO ) is a name that I have been watching with interest over the last few months. In this article I’m going to provide an analysis of the portfolio of this closed-end fund and explain why I think it is an interesting buying opportunity for income focused investors. What is KIO? KIO is a closed-end fund that provides a high level of current income by investing in a portfolio of loans and fixed income securities in the high-yield space. The fund makes use of leverage in order to enhance its yield and has a credit facility in place for this purpose – at the moment leverage stands at 32%. The company invests predominantly in BB – B – CCC rated securities and is almost evenly split between high yield bonds and leveraged loans, as you can see in their latest factsheet : The portfolio As we enter 2016 a characteristic that I search in a fixed income portfolio is a low exposure to interest rate risk. The portfolio’s duration is 3.4 years even though the average maturity is eight years. This low duration is achieved thanks to the allocation to leveraged loans, which generally offer a spread on top of the LIBOR rate and therefore have limited interest risk exposure. I believe the portfolio also is reasonably diversified, with a total of 95 positions and a concentration in the top 10 names of 32% of NAV. Sector concentration is a bit higher (44% for the top five industries) but what I particularly like is the absence in the top five of the energy sector. Considering how much money energy companies raised in the last few years and the weight of energy in high yield benchmarks (around 12%) I’m very pleased to see that exposure to this sector is below 6%. Credit to the management for that! As of the end of September the yield to maturity in the portfolio was 15.6% while the average coupon stood at 10.6%. As mentioned earlier the portfolio is leveraged with a loan to value of 32%. As of April 30th (date of the latest semi-annual report ) a credit facility was in place for a total of 145 mln at LIBOR + 0.825%. This facility expired on August 28th. I could not find the terms of the new facility but I suspect there must have been some worsening in the spread. The publication of the Annual Report (fiscal year ends on October 31st) will give some insight on this. One last thing that deserves to be mentioned is the management fee: KKR manages the fund and receives a fee of 1.1% of the Fund’s average daily managed assets. That means that also all the assets acquired thanks to the credit facility will pay the management fee. At the current 32% loan to value that means the fee is roughly 1.6% of net asset value. Investment thesis KIO currently trades around $14.4, a 13.9% discount to the most recent NAV. That compares with an average discount since the 2013 inception of 8.9%. I believe closed-end funds should trade at a discount to NAV given the often elevated fees and expenses associated but I believe such a discount should be between 5% and 10%. A 13.9% discount certainly has some appeal. Other two elements make that discount even more appealing to me: This is an income distribution fund: the yield currently stands at 10.45% and dividends are paid monthly. That means that you get a significant portion of your investment back at NAV even though you are investing at a large discount. The discount is close to peak in a disappointing year for high-yield securities. That means you are entering into a market that became cheaper during the year and you are doing so at a larger than usual discount. My biggest concern as I look at this investment is the possibility that the weakness in high yield/leveraged loans is not over yet. If we look at the S&P Leveraged Loans Total Return Index we see a peak to trough of 2.8% this year over six months. That compares with a 5.5% decline in 2011 over one month – in that occasion the decline was completely re-absorbed within six months. For the purpose of giving a complete picture I also have to add 2008: in that case the peak to trough was a massive 29% over six months. Although we can’t exclude a repeat of 2008 I have to say that I find it extremely unlikely. Credit conditions certainly relaxed over the past few years but they are not at the level of pre 2008 and, more importantly, banks have much higher capital cushions and are not as involved in the high-yield space as they used to be. In any case even in the dramatic situation of 2008 the S&P Leveraged Loans Total Return Index re-absorbed all losses within 11 months. Conclusions I believe the quality of the portfolio (measured in terms of diversification, exposure to the now “toxic” energy sector and duration) makes me comfortable in getting long KIO. However I can’t rule out further weakness in the months to come. As a result I’m starting a new position with an amount equal to 50% of my target allocation. The objective is to add to the position over the next few months in case of further weakness or keep it at current levels in case the decline in the market is over.