Tag Archives: david-fabian

PFF Dodges Bullets From The Banking Sector

Preferred stock ETFs were once considered a tiny corner of the alternative income marketplace that had dodged the bullet of credit contraction. High yield mainstays like junk bonds, master limited partnerships, and even REITs have felt the pain of income investors reeling in their risk targets and running for the safety of high quality bonds. That picture changed dramatically this month as the iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) fell 5% from high to low and is scrambling to claw its way out of the abyss. This uptick in volatility may come as a surprise to many who had become accustomed to small prices changes in the index over the last several years. Preferred stocks are somewhat of a hybrid instrument that carry qualities of both equity and debt instruments. Therefore, with interest rates falling, it must be an equity-driven event that is causing this turmoil. A quick check behind the scenes of PFF reveals that this fund owns a diversified mix of 260+ individual preferred securities. Yet the single largest underlying sector is banks (42%) and diversified financial companies (18.50%). Together these two groups make up over 60% of the total portfolio and will therefore contribute an outsized portion of the fundamental price action. An overlay of PFF versus the SPDR S&P Bank ETF (NYSEARCA: KBE ) shows that the preferred stock index began a pronounced downside move in tandem with the sharp dive in publicly traded bank stocks (blue line). Click to enlarge PFF had a much more muted percentage drop than KBE. However, it is clear that the stress in banking stocks is also translating to a measure of fear in the underlying preferred market as well. Another interesting phenomenon with this price action has been the relatively swift and sharper recovery in PFF versus KBE. While banks are barely off their lows, PFF has been able to recover more than half of its corrective move. Only time will tell if this V-bottom formation will hold or if there will be another round of selling that will again test the resolve of income investors. I have owned PFF for clients in my Strategic Income Portfolio for a number of years and have been pleased with its makeup and performance over that time frame. A fund of this nature provides us with exposure to an alternative asset class with a much lower beta than a traditional dividend equity fund. It has also demonstrated a much stronger comparable income stream than a diversified bond fund. We view preferred stocks as a tactical opportunity in the context of a diversified income portfolio . This means that they are typically sized smaller than a core holding and may be added or removed as necessary to accommodate the current interest rate or stock market environment. Moving forward, I will be closely monitoring the price action in this sector to determine if we should scale back our position or continue to hold as this recovery develops further. Either way, our process will entail incremental steps and a thorough evaluation of the income landscape to ensure proper alignment with our conservative mandate . Disclosure: I am/we are long PFF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.

Pessimistic Outlook? Maybe You Should Manage A Bond Fund

Ever notice how pessimistic bond fund managers are? They are some of the most “glass half empty” people you will ever come into contact with. Even the ones who have successfully built legacies that will endure for generations are consistently talking down on the economy, central banks, growth, and other unfavorable data points. Jeffrey Gundlach recently hypothesized that emerging markets could fall as much as 40%. He has also been an outspoken critic of the Federal Reserve’s rate hike agenda and the lack of inflation in the developed world. Gundlach is the head of DoubleLine Capital, which manages $85 billion in fixed-income assets. Similarly, renown bond investor Bill Gross railed about the problems with government debt and social service liabilities in his 2016 investment outlook . He seems very concerned about demographic trends and workforce shortages. Gross ran one of the biggest bond funds in the world at PIMCO prior to his separation from the firm he founded and transition to Janus Capital Group. These are just two of the most vocal and well-known bond managers in the world, but there are countless others that are quick to point out cracks in the global economic picture. Talking Your Book In the business we call this “talking your book” or simply slanting the facts and opinions towards a conclusion that favors your trade. Volatility, uncertainty, and fear are a bond managers dream come true. They have built empires on the back of investors fleeing the stock market in a rush to safety. Stocks usually drop in tandem with interest rates, which means that bond prices rise in kind. This favors their performance story and leads to a wave of new assets that quickly enter and are slow to leave. The returns are steady, the volatility is low, and the fees are reasonable – why would you ever want to depart that warm cocoon? These bond fund titans are simply saying ” take my hand and I’ll guide you around all the pitfalls and uncertainty “. Bless their hearts. Active managers in particular are able to shape the underlying holdings of their funds in accordance with their views. They have certain limits and mandates according to the prospectus guidelines. However, there is always some leeway to reduce exposure to areas they are concerned about, add to undervalued opportunities, or build in hedges as appropriate. This can lead to a measurable boost in performance over the benchmark if they are on the right side of the market. The best bond fund managers have risen to their status because they are right more often than they are wrong. My review of Gundlach’s predictions for 2015 were pretty spot on with the exception of his call on gold. I have been a long-time fan of his flagship strategy in the Doubleline Total Return Bond Fund (MUTF: DBLTX ) and continue to hold it in my own account as well as for my clients. The rigors of managing billions in bonds is a stress that I will likely never have to endure. As a result, I have a more even-keeled outlook for the future that balances the dangers of a bear market or recession against the opportunity for a resurgence in risk assets. This allows for a more flexible (if guarded) approach that has served me well in riding out the ups and downs of this fickle market. The Bottom Line Understanding the motivations of an investment manager can be useful in deciphering their market calls and help frame their message in the context of your personal outlook. In addition, it’s always advantageous to dig a little deeper to see how their actual portfolio is positioned versus what they are saying publicly. If there is a disconnect between these two points, it may be best to err on the side of their actions versus their words. Remember that everyone has a motivation or bias in the investment world (even me). By understanding this perspective, you can more acutely discern brains from bullshit and act accordingly.

Why I Will Likely Be A Buyer Of High Yield In 2016

The yield in junk bonds has been steadily rising as the price of the bonds in the underlying portfolio have been falling. The biggest concern in this fixed-income sector has been the decoupling from U.S. equity markets. From a psychological standpoint it seems like we have gone from complacency to extreme fear in a hurry. By now you have probably read everything about the death of high yield bonds, the investor lockup at Third Avenue, and the risk that these “junky” assets pose to exchange-traded funds. Believe me, the financial media is just getting started slicing and dicing this thing up. Everyone loves to sink their teeth into an investment that is tanking. It makes for great headlines and offers a curiously similar effect as gliding by an accident on the freeway. Despite our best intentions, we all slow down to take a peek. As an avid watcher and owner of ETFs , I have been closely monitoring the price action of the iShares iBoxx High Yield Corporate Bond ETF (NYSEARCA: HYG ) and the SPDR Barclays High Yield Bond ETF (NYSEARCA: JNK ) this year. These two ETFs represent the lions share of the below-investment grade fixed-income space, with combined assets of $25 billion. HYG is now down nearly 10% from its 2015 high and currently sports a 30-day SEC yield of 7.20%. That yield has been steadily rising as the price of the bonds in the underlying portfolio have been falling. The biggest concern in this fixed-income sector has been the decoupling from U.S. equity markets. The SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) is 5% off its high and still in the middle of its 52-week trading range, while high yield bonds continue to make new lows. That is uncharacteristic of the typical correlation between these two asset classes and has many wondering if stocks are going to follow lower or junk bonds will ultimately rebound. You would probably be hard pressed to find anyone admitting to owning these investments at this stage of the game. However, there are literally millions of investors who own some form of junk bonds. That may be through direct exposure in a fund such as HYG or indirectly through diversified corporate funds, aggregate indexes, bank loans, or a multi-asset fund structure. It’s become an ubiquitous part of the chase for yield over the last several years and far more common than most investors understand. From a psychological standpoint it seems like we have gone from complacency to extreme fear in a hurry. HYG peaked in April, yet the accelerated nature of the sharp sell off in the last six weeks has investors whipped up into a frenzy. This is the inner monologue that I imagine has taken place in many heads this year: HYG down 2% – “Bit of a sell-off here. Time to add to my holdings.” HYG down 4% – “Spreads are so juicy at these levels. I’ll nibble on a little more” HYG down 6% – “Well this turned ugly quickly. Maybe I bit off more than I can chew.” HYG down 8% – “Get me the hell out. Cash is king.” HYG down 9% – “Haha, who would be dumb enough to still hold this stuff? Glad I sold down here. Now I’m safe”‘ HYG down 10% – “Wow, look at it still cratering. Maybe I should go short….” That last one made me cringe as I saw several probing articles and social media anecdotes pointing out funds that short junk bonds last week. They certainly do exist, although if you are asking about them at this stage of the game, you are probably a little late to that trade. That’s just my personal opinion – things can always get worse, and we may still face a high volume capitulation event before a true bottom is formed. There are two important points that should be understood at this juncture: This whole thing is probably not as bad as everyone has made it out to be. The “bubble has burst” or “high yield is dead” is likely driven more by headline artists than true investors in this space. We see the same type of sentiment and conviction when stocks go through a 10% corrective event. It’s always the end of the world and yet somehow it’s not. The same psychological cycle of greed and fear that we are accustomed to in stocks is going to take place in this fixed-income sector as well. It will seem cataclysmic and disastrous until it reaches a point where everyone who is going to has sold. That will be the inflection point that will ultimately create a sustainable bottom and drive prices higher. It may be in the form of a V-shaped reversal or a more rounded consolidation that takes months to stabilize and swing higher. No one knows for sure when that inflection point may be. However, I’m closely watching technical indicators such as prior support levels, volume, sentiment, high yield spreads, and other key variables. These will be the pieces to the puzzle that give us some indication that junk bonds have turned the corner. Rather than getting overly bearish at this juncture, I’m viewing the sell off as a long-term tactical opportunity. The key is knowing how this sector fits within the context of your diversified income portfolio and sizing your exposure correctly to your risk tolerance . My plan is to purchase an income-generating asset class at attractive levels relative to other bond alternatives. That’s likely a contrarian view right now, but in 2016 it may look quite different. For now, I’m keeping my powder dry and my eyes open. I suggest that other serious income investors do the same and consider scaling into any new positions slowly over time. This will allow you the flexibility to size your holdings appropriately and use time or price to your advantage.