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After Rebalancing, CEFL February Dividend Will Bring Yield To 18.8%

The Rebalancing will result in a smaller, but still large yield. However, the discount to book value will make CEFL more compelling. Leveraged income and carry plays such as MORL and CEFL have underperformed what might have expected given the 10-year treasury bond at 1.80% and Federal Funds still at 0.25%. This underperformance is because, among other reasons, those who said the spike in interest rates was imminent three years ago are even more vocal and convinced it is imminent now. The UBS ETRACS Monthly Pay 2x Leveraged Closed-End Fund ETN (NYSEARCA: CEFL ) underwent a rebalancing at the end of 2014. The first monthly dividend based on the new composition of the index upon which CEFL is based, will be paid in February 2015. The dividend will be based on those components that had ex-dividend dates in January 2015. Of the 30 index components, 29 now pay monthly. Only MORGAN STANLEY EMERGING MARKETS DOMESTIC DEBT FUND INC (NYSE: EDD ) now pays quarterly dividends in January, April, October and July. Thus, it will not be included in the February 2015 CEFL monthly dividend calculation. Additionally, some of the monthly paying components do not have ex-dates in January 2015. These are PRUDENTIAL GL SH DUR HI YLD (NYSE: GHY ), ING Global Equity Dividend & Premium Opportunity Fund (NYSE: IGD ) and PRUDENTIAL SHORT DURATION HIGH YIELD (NYSE: ISD ) . Thus, they also are not included in the February 2015 CEFL monthly dividend calculation even though they have pay dates in February 2015. Those components that have not declared dividends but pay regular monthly dividends are included using the most recent dividend they declared. My calculation using the 26 components expected to have ex-dividend dates in January 2015 is for a February 2015 dividend of $0.2721. This would be the smallest monthly dividend since the February 2014 of $0.2461. In February 2014 there were more quarterly payers in the index than now. The rebalancing is the major reason for the smaller monthly dividends. PIMCO High Income Fund (NYSE: PHK ), one of the highest yielding components has been removed. Some people may be quite happy with this since PHK had such a high premium to book value. The rebalancing is done by a formula and thus any investor complaints about PHK played no part in its’ removal. It could even be considered a case of “be careful what you wish for”. Removal of PHK did significantly improve the discount to book value for CEFL as a whole, but also reduced the dividend. I generally do not do much in-depth analysis of the components in the leveraged ETNs I follow. I take much more of a “top-down” approach rather than a “bottoms-up” approach. Not that there is anything wrong with than a “bottoms-up” approach. It is a matter of how I began to first look at mREITs, then ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN (NYSEARCA: MORL ) and then CEFL as a high yielding diversifier for MORL that also met my top-down Macro outlook. A few years ago I became convinced that short-term rates were likely to remain low for an extended period (see my article: Federal Reserve Actually Propping Up Interest Rates: What This Means For mREITs ), and I concluded that agency inverse floaters would be the ideal investment vehicle to take advantage of that scenario. I was told by dealers in agency securities that there were very few agency inverse floaters around anymore and that you would not want the ones that were. I wanted an investment with negligible credit risk and no margin call risk that would profit from an extended environment of very low short-term interest rates. As agency inverse-floaters and swaps paying-floating and receiving-fixed were not available to me as a retail investor, I concluded that mREITs and MORL were the next best thing to profit from a continuation of the carry generated by very low short-term rates. This was explained in: Are mREITS The New Inverse Floaters? A few years ago there were many who were very bearish on mREITs based on their view that the period of low interest rates would soon be ending. If I had asked even the most bearish person on mREITs three years ago what would happen if in 2015 the rate of the 10-year treasury bond were to be 1.80% and Federal Funds were still to be 0.25%, they certainly would have said something to the effect that: “well then of course you will make a fortune in mREITs and similar leveraged income and carry plays, but that rate scenario is impossible”. We are now have the 10-year treasury bond at 1.80% and Federal Funds are still at 0.25%. A large part of the underperformance of leveraged income and carry plays such as MORL and CEFL relative to what one might have expected given the accuracy of my interest rate outlook, is due to a number of factors. Most significant is that mREITs and closed-end funds have gone from premiums over book value to large discounts. This is because, among other reasons, those who said the spike in interest rates was imminent three years ago are even more vocal and convinced it is imminent now. My previous procedure was to take my monthly prediction of the next dividend to be paid by a leveraged ETN such as CEFL and then add the two prior months to get a projected quarterly figure. This would smooth out any “small month” – “big month” effects due to some components paying monthly and some quarterly. Then I would annualize that figure on a compounded basis. That procedure may not now be appropriate for CEFL at this point in time. The composition of the index has changed significantly. Also, adding up the February 2015, the January 2015 and the December 2015 months would a bias the yield upward since it would include the year-end special dividends paid by some of the closed-end funds. Thus, to get a better measure of the annualized compounded yield I took all of the components and determined a average monthly dividend for each including the quarterly payer EDD and those that pay monthly but did not have ex-dates in January 2015. This results in a monthly average dividend rate of $0.3147. This actually may be too conservative since it assumes there will be no special additional dividends during the entire year. Using the average monthly dividend method this results in an annual payout of $3.78 for a simple yield of 17.3% and a compounded annualized yield of 18.8% with CEFL as $21.80. Using the prior method of adding the projected $0.2721 February dividend to the two prior months would result in an annual payout of $4.69 for a simple yield of 21.5% and a compounded annualized yield of 23.8% with CEFL as $21.80. That also would be biased upwards by the year-end special dividends paid by some of the closed-end funds. See: CEFL January Dividend Gives Yield Of 23% for a listing of the CEFL components that paid special year-end dividends and a description of how the contribution to the monthly dividend from each component is calculated. If someone thought that over the next five years interest rates and economic conditions would remain relatively stable and thus CEFL would continue to yield 18.8% on a compounded basis, the return on a strategy of reinvesting all dividends would be enormous. An investment of $100,000 would be worth $236,305 in five years. More interestingly, for those investing for future income, the income from the initial $100,000 would increase from the $18,800 initial annual rate to $44,425 annually. The table below shows the price as of January 16, 2015, ex-date, pay date, dividend, imputed value and the imputed number of shares for all of the 30 CEFL components. CEFL components as of January 16, 2015     Weight Price ex-div pay date dividend frequency value $mil imputed shares dividends Alpine Global Premier Properties Fund AWP 4.51 6.76 1/21/2015 1/30/2015 0.05 Top of Form m Bottom of Form 16682549 2467833 123392 MFS Charter Income Trust MCR 4.44 8.67 1/13/2015 1/30/2015 0.05 m -.002 16423618 1894304 85244 GAMCO Global Gold Natural Resources & Income Trust GGN 4.39 7.43 3/13/2015 3/24/2015 0.07 m -.02 from2014 16238667 2185554 152989 Clough Global Opportunities Fund GLO 4.38 12.21 4/15/2015 4/30/2015 0.1 m +.005 from2014 16201677 1326919 132692 FIRST TRUST INTERMEDIATE DUR FPF 4.34 22.08 12/29/2014 1/15/2015 0.16 m ex in dec 16053716 727070 118149 MORGAN STANLEY EMERGING MARK EDD 4.32 10.57 12/17/2014 1/15/2015 0.25 q 15979736 1511801 377950 DOUBLELINE INCOME SOLUTIONS DSL 4.28 19.51 1/14/2015 1/30/2015 0.15 m 15831776 811470 121720 BLACKROCK CORPORATE HIGH YIE HYT 4.24 11.3 12/29/2014 1/9/2015 0.08 m 15683815 1387948 104790 Eaton Vance Limited Duration Income Fund EVV 4.23 14.01 1/8/2015 1/20/2015 0.1 m 15646825 1116833 113582 PRUDENTIAL GL SH DUR HI YLD GHY 4.17 16.26 2/19/2015 2/27/2015 0.13 m no ex in jan 15424884 948640 118580 PIMCO Dynamic Credit Income Fund PCI 4.09 20.35 1/8/2015 2/2/2015 0.16 m big ext paid jan 15128963 743438 116199 Western Asset Emerging Markets Debt Fund ESD 4.08 15.86 2/18/2015 2/27/2015 0.12 m 15091973 951575 109431 Eaton Vance Tax-Managed Global Diversified Equity Income Fund EXG 4.04 9.33 1/21/2015 1/30/2015 0.08 m 14944013 1601716 130220 Alpine Total Dynamic Dividend AOD 4.04 8.58 1/21/2015 1/30/2015 0.06 m 14944013 1741726 98408 ING Global Equity Dividend & Premium Opportunity Fund IGD 4.04 8.18 2/2/2015 2/17/2015 0.08 m no ex in jan 14944013 1826896 138844 Eaton Vance Tax-Managed Diversified Equity Income Fund ETY 3.75 11.13 1/21/2015 1/31/2015 0.08 m 13871299 1246298 105063 BlackRock International Growth and Income Trust BGY 3.58 6.75 1/13/2015 1/30/2015 0.05 m 13242467 1961847 96130 ABERDEEN ASIA-PAC INCOME FD FAX 3.49 5.68 1/21/2015 1/30/2015 0.04 m 12909555 2272809 79548 PRUDENTIAL SHORT DURATION HI ISD 3.32 16.37 2/19/2015 2/27/2015 0.12 m no ex in jan 12280723 750197 91899 Calamos Global Dynamic Income Fund CHW 3.2 8.64 12/29/2014 1/6/2015 0.07 m not decl 11836842 1370005 95900 MFS Multimarket Income Trust MMT 2.91 6.31 1/13/2015 1/30/2015 0.03 m 10764128 1705884 54588 BLACKSTONE/GSO STRATEGIC C BGB 2.69 16.15 2/18/2015 2/27/2015 0.11 m 9950345 616120 64693 Allianzgi Convertible & Income Fund NCV 2.52 8.84 1/8/2015 2/2/2015 0.09 m 9321513 1054470 94902 WESTERN ASSET HIGH INC FD II HIX 2.25 8.1 2/18/2015 2/27/2015 0.07 m 8322779 1027504 70898 Blackrock Multi-Sector Income BIT 1.92 17.19 12/29/2014 1/9/2015 0.12 m not decl 7102105 413153 48215 WELLS FARGO ADVANTAGE MULTI-SECTOR ERC 1.75 13.63 1/12/2015 2/2/2015 0.1 m 6473273 474928 45926 Allianzgi Convertible & Income Fund II NCZ 1.63 8.24 1/8/2015 2/2/2015 0.09 m 6029391 731722 62196 Wells Fargo Advantage Income Opportunities Fund EAD 1.35 8.8 1/12/2015 2/2/2015 0.07 m 4993668 567462 38587 Nuveen Preferred Income Opportunities Fund JPC 1.14 9.52 1/13/2015 2/2/2015 0.06 m 4216875 442949 28039 Invesco Dynamic Credit Opportunities Fund VTA 0.91 11.62 1/12/2015 1/30/2015 0.08 m 3366102 289682 21726

How To Build A ‘Lifetime’ Portfolio (Step 1)

Why obsess about what will happen this coming week? That’s the job of people who get paid by the word. Why not take the road less traveled and ignore 90% of the hullabaloo?!! This is the time of year when most investment writers predict what will happen in 2015. What I’d rather offer, however, is what is “most” likely to happen this year, next year, or the next 10, 20 or 50 years. The short and glib answer is the one proffered by J.P. Morgan when asked what the market would do next. “It will fluctuate,” he replied. That may sound offhandedly dismissive of the question, but in fact there is much truth, and the beginnings of what we now call Modern Portfolio Theory (MPT) in his pithy response! Modern Portfolio has much to recommend it and much to eschew. The basic idea is solid: MPT is a way to optimize your returns based on your acceptable level of market risk. You accomplish this by diversification among various asset classes. If you can remember as far back as January 2014, almost every pundit was predicting a disastrous year for bonds, a so-so year for US stocks to digest the gains of 2013, and sector bets all over the place. I don’t know of a single analyst who predicted that the best-performing sector in the USA would be utilities, yet there they are, proudly atop all markets. The matrix below shows what asset class performed best over the past few years. (These are asset classes, not business sectors, so you won’t see utilities there, but you will see “REITs” and both “High Grade” and “High Yield” bonds, both of which are equally-interest-rate-sensitive.) If you look carefully at every year, you will note the results vary considerably. The same holds true over all other, even more extended, periods. Diversification works! Yes, you will sometimes fail to beat the market, “market” being shorthand to most investors for the “Large Caps” represented by the S&P 500, but over most periods other than an out-and-out bull romp in US stocks that means you are likely to do much better. (click to enlarge) You’ll note, for instance, that in 2000, the large caps, as measured by the S&P 500, were the 3rd- worst performing asset class. In 2002, they were “dead last.” In fact, if you look closely, you’ll note that not once was the S&P 500 the top-performing asset class – including the past 6 remarkable years! Being open to other asset classes is the heart of Modern portfolio Theory, but also the heart of Asset Allocation theory, and the heart and soul of our approach to building a Lifetime Portfolio. In a period of low and declining or stable interest rates, the aforementioned utilities, bonds and REITs often outperform stocks, and with considerably less volatility and heartburn. MPT has also become associated with the notion that, since no one can predict what will happen on any given market day (or week, month, year, etc.) why bother? Why not instead select the asset classes that give you a level of risk you are comfortable with and then get reasonable returns year in and year out? Rigorous academic research shows that you will typically come out ahead after even a few years of doing this than you will if you try to “beat the market.” To oversimplify: if your risk tolerance is low, you might create a portfolio of 40% high grade bonds, 20% REITs, 20% high yield bonds and 20% large cap stocks. If you are comfortable seeking greater returns with greater risk, you might select 10% each of high grade and high yield bonds and REITs, with the other 70% of your portfolio split among US Large and Small Caps, International Large and Small Caps, and Emerging Markets. In any scenario you construct, you want to let your profits grow while feeding the areas you have selected that aren’t doing as well. The usual way this is done is to rebalance at some defined period every year (or less). A variation of this is to pick a certain percentage, say 20%, and if one asset class gets “out of whack” by that amount you add to it if it is down, or sell off some of it if it exceeds the 20% higher than your chosen percentage allocation. If you wanted to hold 20% of your portfolio in large caps, for instance, if that asset class appreciates 20% and is now therefore 24% of your total portfolio (20% of 20 is 4), you would “re-balance” to bring that part of the portfolio back to your risk comfort level, using the proceeds to buy, at lower cost, some of the other asset classes that are “currently” lagging. Does this sound boring? It may be, but which sounds better: a 7.4% annual return over 14 years or a 4.3% return? The bottom line on the above chart is that the simplest asset allocation plan imaginable, 40% high grade bonds, 15% each U.S. large caps and international stocks, and 10% each of small caps, emerging markets and REITs, rebalanced annually, still beat the currently-in-vogue “just buy an S&P 500 index fund; active management doesn’t work” mantra. This “just buy an S&P 500 index fund; active management doesn’t work” fable becomes popular once we are well ensconced in a bull market – and dies just as quickly when the market plummets. As the data above shows, the drawdown for the S&P 500 was -37% in 2008. The biggest drawdown for the asset allocation model (AA) was -22.4%. For comparison, our Growth and Value portfolio, in which we used our own variations on asset allocation described below, was down 18.7% that year. On a million dollar portfolio, the S&P would have declined in value to $670,000; our G&V to $813,000, with less position risk and less volatility. How We Diverge From the Standard Model There are scores of ways you might select an asset allocation model that works for you, from changing the percentage allocations to increasing the asset classes to adding a little sentiment, fundamental, historic or technical analysis. We try not to sway too far from the basic principles of asset allocation. We like to think we are merely adding a dollop of common sense and placing history on our side. We believe: Rebalancing based on the calendar is folly. In the chart above, the results tabulated are for a rebalance once a year at the beginning of each year. Macro-trends evidence themselves any time of the year; both black and white swans swoop and dive based upon events, not calendars. We take action when our asset allocation percentages diverge from our intended allocation. Underlying the concept of asset class investing is the assumption that markets are efficient and that investors act rationally. We might give some credence to the first assumption, but the second is patently false! We believe we can benefit from investor emotions. An example today might be early nibbling at the huge integrated oil companies that can slash CapEx and make a profit on their current properties if the price of oil falls even another 50%. Buy them when they’re cheap; don’t obsess if something you buy for 10 times forward earnings and a 5.9% yield falls so that you “might have” bought it at 8 times forward earnings and a 6.4% yield. At times when interest rates are rising, we might be as little as 0-20% in bonds and REITs combined. When falling, we might be at 60-70%. We are dynamic, not static. [This is a very big divergence from the academics’ idea of asset allocation. That’s their way; this is our way.] “To every thing there is a season.” We augment our asset class investing to take advantage of the fact that small caps tend to enjoy the bulk of their outperformance in the first two quarters of the year, that pre-presidential election years are often excellent market years as both parties crank up the PR machines, etc. We don’t chase any single asset class like S&P 500 large caps, REITs, small caps or any other. Nor do we obsess if we fall behind in comparison to any one asset class for an extended period. We maintain our discipline and do our best to grow our portfolios steadily. Sometimes we have setbacks, sometimes we are out of sync, but we’ve always bounced back. In Part II, I will discuss the asset classes that are historically most and least correlated with the S&P 500 (U.S. large caps) and with each other, so you can begin to consider how you might construct a Lifetime Portfolio that works for you. I’ll also discuss the types of mutual funds and ETFs our research and analysis leads us to, including examples and some of our specific current holdings. As Registered Investment Advisors, we believe it is our responsibility to advise that we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice. Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund one year only to watch it plummet the following year. We encourage you to do your own due diligence on issues we discuss to see if they might be of value in your own investing. We take our responsibility to offer intelligent commentary seriously, but it should not be assumed that investing in any securities we are investing in will always be profitable. We do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.

What To Hold In The Face Of Deflation

Deflation is turning into a global threat. Falling prices are bad for the economy, not good. Until government becomes willing to spend buy gold, buy bonds and buy defense stocks just in case. Today’s Great Deflation is creating a lot of casualties. Among the most interesting are big banks’ trading desks and hedge funds. Inconceivable does not mean what they think it does. Goldman Sachs (NYSE: GS ) blamed “volatility” for a bad trading quarter. (Why isn’t it volatility when prices go up?) JPMorgan Chase (NYSE: JPM ) talked up legal costs and nasty regulators rather than admit that their traders got things horribly wrong. Despite all this, the bank’s shares fell below book value , what I like to call the “Mendoza Line” of banking. JPMorgan Chase CEO Jamie Dimon is desperate to keep his bank together because, in the face of ruinous trading losses, many hedge funds are facing, well, ruin. John Paulsen and Carl Icahn got killed by the deflation in oil. Everest Capital saw its main fund wiped out by the Swiss Franc’s sudden revaluation, done in the face of continuing European deflation, and it cost West Ham the shirt off their backs . FXCM (NYSE: FXCM ) was forced into an emergency rescue due its customers’ losses in currencies. Funds have been forced to cut their losses on soybeans. Even the computers are getting killed. Deflation means a shortage of buyers in the face of abundant supply. It is precisely what the world faced in the early 1930s. Unfortunately both policymakers and traders are acting as they did then. They refuse to acknowledge the reality that, without buyers, markets can’t clear, and they’re doing everything they can to discourage buyers as a matter of policy. John Mason is right. The business model of the big banks is flawed . So are their political models. The world is threatened by squeezed margins, cuts in production, business contraction, falling wages – the same negative spiral that Japan has suffered from for two decades. The most dangerous delusion is that the problem will take care of itself and that demand will magically “materialize” because there are so many bargains out there. It didn’t in the 1930s, and it won’t in the 2010s. What the hedge funds and the big banks should be doing is getting on the phone to policymakers and telling them to buy, buy, buy, to spend, spend, spend. Maybe send Elizabeth Warren’s PAC a check. Streetwise Research’s call to buy gold is, unfortunately, good short-term advice. So is the call to hold strong bonds, especially U.S. government bonds, which despite their tiny yields have kept going up in price, delivering big capital gains over the last six months. But that’s short-term advice. At some point governments will realize they need to spend big to stimulate domestic demand and whip deflation. I hope they do it before public demand switches to guns from butter but, just in case, you might want to keep some Boeing (NYSE: BA ) in your portfolio.