Tag Archives: etf-hub

NCZ: Is It Time To Enjoy This Fund’s 14% Distribution?

Summary NCV and NCZ offer yields over 13% and near 14% on a diversified corporate bond and convertible bond portfolio. The NAV of both funds has fallen over 6% YTD and premiums have fallen as the funds and corporate bonds have fallen out of favor. Despite these risks, both funds offer a sustainable payout thanks to previous purchases of bonds at modest discounts. Allianz Global Investors offers two funds with very high distributions and similar investment objectives: the AllianzGI Convertible & Income Fund (NYSE: NCV ) and AllianzGI Convertible & Income Fund II (NYSE: NCZ ). The funds get little attention, with average daily volume of a little over 400,000 shares and few articles on this site. The lack of attention is unfair to these funds because, despite the risks involved, they currently trade at a relatively low premium and offer monthly payouts that can buttress an income portfolio without significant risk of a dividend cut in the near term. Instead of a dividend haircut, the bigger risk in both funds is the depletion of net assets, which have fallen 6.5% year-to-date for NCZ and 6% for NCV, according to Allianz’s website (for NCZ ). These are real risks to consider before investing in either fund, although I will not discuss what has driven this trend or whether it is likely to continue in this article. Instead, I want to focus on the sustainability of these funds’ payouts over the next three years by taking a closer look at NCZ. I am choosing this fund because its higher payout (13.9%) will make it more attractive to investors at first glance, although its premium to NAV (5.2%) is higher than its sibling’s premium (NCV is at a 1.9% premium), which would also imply that it offers less value at the moment. For a rundown of the virtues of NCV, the recent article by Betalyst is valuable and illuminating. The Sustainability of the Payout As with all high yield funds, there is substantial fear that these funds’ monthly payouts are unsustainable. NCZ’s distributions to NAV ratio is 14.4%, while the fund’s 33% leverage puts the fund at risk of destructions to the fund’s value if its holdings fall too low in value or default rates spike. Nonetheless, the distribution to NAV ratio is misleading, because the fund has partly funded distributions from capital paid in excess of par. These payments are not returns of capital; they are profits from sold bonds and convertible notes that the fund has held and liquidated. These accounted for 18.9% of the fund’s total payouts in June. Excluding this, we see that the fund’s net investment income to NAV ratio is a much more modest 11.68%: (click to enlarge) With both of these income sources, the fund is earning enough to cover distributions. Thanks to the fund’s past investments, it is able to earn 11.68% on its bond holdings, while bumping returns higher with gains from selling issues above par. Since the fund’s average coupon rate is 7.52%, it is clear that the fund is buying its holdings at a discount. How much of a discount does the fund need to get in the market to sustain its payouts? This is an important question, because the larger the discount, the greater the default risk (at least in theory) and the greater the risk profile of the fund. The fund’s current NII comes out to less than what the fund would get if it purchased issues at an average 3% discount, so the fund is buying bonds at a relatively small discount. This also means the fund’s ability to earn more NII will increase substantially if it finds more issues trading at an even higher discount: With corporate yields rising, the opportunity to buy more bonds in the secondary market at a discount will only increase. As a result, NCZ will be able to make new purchases at steeper discounts and higher yields, although its high use of leverage of course limits how much it can buy. NCV is similarly using 33% leverage and may be limited in purchasing power; on this point, the PIMCO High Income Fund (NYSE: PHK ) is slightly better positioned to buy issues at discounts, thanks to its 29% leverage. Better still are the PIMCO Income Strategy Fund II (NYSE: PFN ) with 23.3% leverage and the AllianceBernstein Global High Income (NYSE: AWF ) with 14.15% leverage. Other funds from other firms may also be well positioned to buy more issues at discounts in the future. Even with its high leverage and limited buying power, both NCZ and NCV should have no difficulty maintaining income payouts with their current holdings, and the low average duration of the funds’ portfolios (2.4 years for NCZ and 2.41 for NCV) suggest that both will have freed up capital in the medium term. If the economy improves and Treasury and corporate bond yields rise throughout 2017 and beyond, the fund will be ideally positioned to buy more issues at higher rates. On this point, it is worth noting that yields on corporate bonds have already begun to rise from the year’s lows: (click to enlarge) Additionally, as of the end of Q1’15, the fund had 10.07 cents in undistributed net investment income (UNII) that it can deploy if necessary. While investors often take solace in UNII, this should not be the primary focus of an investment decision, since UNII tends to be lumpy and too much UNII can indicate an inefficient use of capital. Nonetheless, this buffer does indicate a bit of safety with the fund’s distributions in a pinch, although no pinch is expected by most in the market, regardless of sensationalist headlines about Greece, China and the NYSE blackout. Conclusion: NCV or NCZ? With the similarities of both funds, investors looking for a high monthly distributions may find it difficult to choose between the two. At the moment, NCV is trading at a premium of less than 1%, while NCZ is trading at a 5.2% premium. For those who abhor buying CEFs at a premium, NCV may be more tolerable; for those looking for a high yield in the short term, NCZ may be more appropriate. However, if you believe interest rates are going to rise in the short term and the value of these funds’ holdings will fall, both face the threat of further declines in the short term as NAV has fallen 6.5% year-to-date. If not, these funds can be an attractive addition to an income-producing portfolio on their ability to maintain payouts and see NAVs rise when redemptions come and issues at higher rates are for sale. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NCV over 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.

5 Ways To Beat The Market: Part-3 Revisited

In a series of articles in December 2014, I highlighted five buy-and-hold strategies that have historically outperformed the S&P 500 (SPY). Stock ownership by U.S. households is low and falling even as the barriers to entering the market have been greatly reduced. Investors should understand simple and easy to implement strategies that have been shown to outperform the market over long time intervals. The third of five strategies I will revisit in this series of articles is the “low volatility anomaly” which has seen lower volatility stocks produce higher risk-adjusted returns over time. In a series of articles in December 2014, I demonstrated five buy-and-hold strategies – size, value, low volatility, dividend growth, and equal weighting, that have historically outperformed the S&P 500 (NYSEARCA: SPY ). I covered an update to the size factor published on Wednesday , and posted an update to the value factor on Thursday. In that series, I demonstrated that while technological barriers and costs to market access have been falling, the number of households that own stocks in non-retirement accounts has been falling as well. Less that 14% of U.S. households directly own stocks, which is less than half of the amount of households that own dogs or cats , and less than half of the proportion of households that own guns . The percentage of households that directly own stocks is even less than the percentage of households that have Netflix or Hulu . The strategies I discussed in this series are low cost ways of getting broadly diversified domestic equity exposure with factor tilts that have generated long-run structural alpha. I want to keep these investor topics in front of the Seeking Alpha readership, so I will re-visit these principles with a discussion of the first half returns of these strategies in a series of five articles over the next five days. Reprisals of these articles will allow me to continually update the long-run returns of these strategies for the readership. Without further ado, one of my favorite and most oft discussed strategies on Seeking Alpha… Low Volatility Since the groundwork behind the Modern Portfolio Theory was laid fifty years ago, it has been axiomatic that riskier portfolios should expect to be compensated with higher returns. More recent academic research has shown that this assumption holds less well at the extremes – the least risky stocks tend to outperform the most risky stocks on both a risk-adjusted and an absolute basis. In a 2012 paper by Nardin L. Baker of Guggenheim Investments and Robert A. Haugen of Haugen Custom Financial Systems entitled: ” Low Risk Stocks Outperform Within All Observable Markets of the World “, the pair demonstrated that in their thirty-three country sample the highest risk decile of stocks, rebalanced monthly, underperformed the lowest risk decile of stocks in each locale. Source: Nardin & Baker (2012) In 2013, Andrea Frazzini, David Kabiller, and Lasse Pedersen, each affiliated with hedge fund AQR Capital Management, published ” Buffett’s Alpha “, which deconstructed the return profile of Berkshire Hathaway ( BRK.A , BRK.B ). In “Buffett’s Alpha”, the authors determined that the public stocks owned by Buffett in 13F filings had only a market beta of 0.77 from 1980-2011. Over that thirty-one year period, Buffett outperformed the market while owning in the public portion of his portfolio securities which on average had only three-quarters of the market beta. At the 1999 Berkshire Hathaway Annual Meeting, Buffett, during the rising crescendo of the tech bubble stated: “We’re more comfortable in that kind of (traditional) business. It means we miss a lot of very big winners. But we wouldn’t know how to pick them out anyway. It also means we have very few big losers – and that’s quite helpful over time. We’re perfectly willing to trade away a big payoff for a certain payoff.” From the chart above by Haugen and Baker, the end of the 1990s was the period when the most volatile stocks were actually outperforming the least volatile stocks as earnings multiples for start-ups in the tech space reached stratospheric heights. Buffett, as his 1999 quote illustrates, chose to pass and his relative performance in the short-run faltered, but over the long run he avoided the tech bubble-fueled market meltdown. Missing these major market corrections has been a predominant source of Buffett’s sustainable alpha. This is consistent with the return profile for the low volatility strategy as seen in the cumulative graph of the S&P 500 Low Volatility Index versus the S&P 500 below. Low volatility stocks underperformed during the run-up to the tech bubble, but strongly outperformed in the aftermath and through the financial crisis. (click to enlarge) Source: Standard and Poor’s; Bloomberg Buffett has historically been called a “value investor”, but as we saw in my second article in this series, while value investing produces higher long-run returns, it also has higher variability of returns. The AQR researchers saw low volatility investing and leverage as key to Buffett’s success, and I have chosen to discuss them in this series as separate, but related strategies. From an analytic standpoint, the correlation coefficient of the S&P Pure Value Index and the S&P Low Volatility Index has been roughly equivalent to the correlation between the S&P 600 Smallcap Index ( covered in my first article in this series ) and low volatility stocks, and few would argue that the latter pair has exposure to similar risk factors. Certainly, Buffett’s ability to miss the bursting of the tech bubble was highly correlated with the return series for low volatility stocks above. If we can take a subset of the broader market, low volatility stocks, and demonstrate that they have outperformed, then another segment of the market must be underperforming. Over the twenty-year plus time period we are examining, high beta stocks have fit that mold, and that underperformance is captured in the graph of the cumulative returns of low volatility stocks and high beta stocks below: (click to enlarge) Source: Standard and Poor’s; Bloomberg Two of the three authors of “Buffett’s Alpha”, Andrea Frazzini and Lasse Heje Pederson also collaborated on ” Betting Against Beta ” where the researchers demonstrate that since leverage constrained investors bid up high-beta assets, that high beta is necessarily associated with lower alpha. The articles demonstrates the underperformance of high beta across more than 20 global equity markets and several fixed income markets. This analysis makes intuitive sense. Long-only active managers who are benchmarked against an index naturally seek higher beta assets as a means to outperformance, but the cumulative effect of this preference for riskier assets lowers their expected forward returns as compared to disfavored lower beta stocks. Behavioral explanations including lottery preferences, representativeness, and overconfidence have also been suggested for the relative underperformance of high volatility stocks. The S&P 500 Low Volatility Index is replicated through the exchange traded fund, Powershares S&P 500 Low Volatility Portfolio (NYSEARCA: SPLV ), which carries a 0.25% expense ratio. The raw beta of this fund over the trailing 1-year is just 0.84, which compares reasonably to the historical beta that Buffett had realized in the aforementioned study. My favorite part of this low volatility strategy for buy-and-hold investors with a long-term horizon is that the strategy has outperformed when the stock market has been falling, besting the broader market in 2000-2002 and 2008. The low volatility strategy underperformed the most in 1998 and 1999 as tech multiples ballooned and Buffett was forced to defend his underperformance, but the strategy far outpaced the broader market in the 2000-2002 correction. While low volatility stocks have historically outperformed the broader market, they lagged in the first half of 2015. Part of this underperformance mirrors the weak relative performance by low volatility stocks during the rate-related selloff in 1994 (see first half returns below). As the rate selloff in 2015 has reversed in the very early days of the second half of the year, low volatility stocks have outperformed the broader market by nearly 2%, quickly erasing over half of their year-to-date deficit. While the Low Volatility Index will be more sensitive to higher interest rates than other segments of the equity market, I continue to expect that low volatility stocks will continue to offer attractive risk-adjusted returns over the business cycle. As I wrote in my 10 Themes Shaping Markets in the Back Half of 2015 , stretched equity multiples domestically will necessitate that valuations be driven by changes in earnings, tempering further price gains. As equity prices rise, investors may look to opportunistically rotate into underperforming rate-sensitive assets and lower volatility assets. Given the tendency for lower volatility assets to outperform in falling markets, investors may desire to rotate to lower volatility stocks which have underperformed in 2015. I will be publishing updated results for two additional proven buy-and-hold strategies that can be replicated through low cost indices over the next couple of days. Disclaimer My articles may contain statements and projections that are forward-looking in nature, and therefore inherently subject to numerous risks, uncertainties and assumptions. While my articles focus on generating long-term risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon. Disclosure: I am/we are long SPY, SPLV. (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.

Lipper Closed-End Fund Summary: June 2015

For the second consecutive month both equity and fixed income CEFs suffered negative NAV-based returns (-2.84% and -0.74% on average, respectively, for June) and market-based returns (-4.31% and -2.83%). Year to date, however, both groups just remained in positive territory, returning 0.41% and 0.91% NAV-based returns. While the Russell 2000 and the NASDAQ Composite managed to break into record territory in mid-June, advances to new highs were generally just at the margin. However, at June month-end concerns about the Greek debt drama, looming U.S. interest rate increases, Puerto Rico’s inability to service its public debt, and China’s recent market gyrations weighed heavily on investors. A positive finish for equities on the last trading day of June wasn’t enough to offset the Greek debt-inspired meltdown from the prior day, and many of the major indices witnessed their first quarterly loss in ten. Volatility was on the rise in June. At the beginning of the month rate-hike worries plagued many investors after an upbeat jobs report raised the possibility of an interest rate hike this fall. The Labor Department reported that the U.S. economy had added a better-than-expected 280,000 jobs for May, beating analysts’ expectations of 210,000. Despite a rise in the unemployment rate to 5.5% (as once-discouraged job seekers reentered the labor market), many pundits felt the Federal Reserve would be more likely to raise interest rates sooner rather than later. However, European equities showed signs of weakness, and investor handwringing began in earnest as investors contemplated the looming deadline for Greece to make its first debt payment to the IMF at the end of June. And while early in the month the Shanghai Composite rose above the 5,000 mark to its highest level since January 2008, on Friday, June 19, the Shanghai Composite posted its worst week in more than seven years as investors bailed on some recently strong-performing Chinese start-ups. Worries of high valuations and record levels of margin debt sparked the exodus. Investors’ trepidations were not easily dispelled, and by mid-month more talk about a Greek exit (“Grexit”) from the Eurozone and anxiety before the Federal Open Market Committee’s June meeting led to further selloffs in the equity markets. A combination of an impasse in the Greek debt talks along with a purported quadruple-witching day sent the Dow to a triple-digit decline on Monday, June 29, with Treasuries rallying on the news as investors looked toward safe-haven plays. For June the Dow, the S&P 500, and the NASDAQ were in the red, losing 2.17%, 2.10, and 1.64%, respectively, while a strong small-caps rally helped send the Russell 2000 up 0.59%. Nonetheless, interest concerns trumped the Greek drama, and for the month Treasury yields rose at all maturities, except the three-month. The ten-year yield rose 23 bps to 2.35% by month-end. For the third consecutive month none of the municipal bond CEFs classifications (-0.36%) witnessed plus-side returns for June. However, the municipal bond CEFs macro-classification did mitigate losses better than its domestic taxable bond CEFs (-1.12%) and world bond CEFs (-1.45%) brethren. Despite the Greek debt drama, world equity CEFs (-2.04%) mitigated losses better than their mixed-asset CEFs (-2.11%) and domestic equity CEFs (-3.41%) brethren. And Growth CEFs (+0.68%) posted the only positive return in the equity universe for the month, while Energy MLP CEFs (-8.85%) was at the bottom. For June the median discount of all CEFs widened 135 bps to 10.52%-worse than the 12-month moving average discount (8.92%). Equity CEFs’ median discount widened 90 bps to 10.74%, while fixed income CEFs’ median discount widened 162 bps to 10.44% (their largest month-end discount since October 2008). For the month only 5% of all CEFs traded at a premium to their NAV, with 7% of equity funds and 4% of fixed income funds trading in premium territory.