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Income Investors In Risky, Energy-Related Products Get Creamed

Brokers who pitched energy based structured products during the recent oil boom to conservative clients will be flooded with phone calls from angry clients. As the price of oil has crashed from $100 a barrel less than two years ago to below $30 on Thursday, investors who bought structured products looking to generate income have been crushed. The pain felt by investors in the futures market, energy partnerships, high-yield corporate bonds and the shares of oil and gas companies is well known, noted Wall Street Journal columnist Jason Zweig last weekend. But the plummeting price of oil is also “wreaking havoc” on opaque and complex structured products tied to the price of oil, Zweig reported. In 2015, the biggest names on Wall Street, including Bank of America (NYSE: BAC ), Morgan Stanley (NYSE: MS ) and Goldman Sachs (NYSE: GS ), issued at least 300 so-called “structured notes,” which are short-term borrowings with returns linked to the price of oil or other energy-related assets. Remember those heady days, just a year ago? It was a perfect time for Wall Street to pump out high-risk products and sell them to Mom and Pop investors. The stock market had gone up in almost a straight line since March 2009, the depths of the credit crisis. The demand for commodities seemed vast, and the U.S. energy industry, with the boom in fracking, looked invincible even though oil prices had started to slide. Those structured securities issued last year total at least $1.3 billion, with most maturing later this year. Investors have a bit of time for oil to bounce back, however, if that bounce doesn’t happen, expect a flood of investor complaints to be filed against the brokers and broker-dealers who sold the structured notes. The allure of the notes and structured products is that investors can make a lot of money if oil goes up just a smidge, with some notes tripling gains at a capped rate. But in some cases there is no protection on the downside, so investors will see “dollar for dollar losses, without limit,” if the fund goes down, noted Zweig. But getting back to even will not be easy, noted one analyst cited by Zweig. “They vast majority of them are underwater,” said the analyst. “And a lot are materially underwater. On many of them, you’d need a 50% to 100% jump in the price of oil from today’s levels to get to break-even.” “This is not really an investment strategy so much as a wager on which way oil prices are going,” another analyst told Zweig. “And some of the risks and costs of that wager are masked by the complexity of it.” Hidden risks and costs, a complicated investment structure based on derivatives – readers, these are red flags in any market. “Many people who thought they were buying black gold on the cheap appear to own a black hole instead, with limited means of escape,” concludes Zweig. We couldn’t agree more. Zamansky LLC are securities and investment fraud attorneys representing investors in federal and state litigation against financial institutions. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

First Trust To Launch Second Actively Managed Commodity ETF

In 2013, First Trust launched the actively managed First Trust Global Tactical Commodity Strategy ETF (NASDAQ: FTGC ), a fund that takes long positions in commodity futures. The time since has been difficult for commodities markets, and as a result, FTGC’s performance has suffered along with other funds in the category: For the year ending January 31, for instance, the ETF has returned -20.52%. However, these returns ranked in the top quintile of funds in its category. Long and Short Positions Perhaps in response, First Trust’s second actively managed commodity ETF – for which it filed paperwork with the Securities and Exchange Commission (“SEC”) on January 28 – will pursue an absolute returns strategy . This means the fund will take both long and short positions in pursuit of positive returns, irrespective of benchmarks, while aiming for lower volatility than traditional funds. The ability to take short positions will obviously help the fund produce positive returns, should commodities remain in a bear market. A long/short approach in the commodity sector has been very effective for the LoCorr Long/Short Commodity Strategy Fund (MUTF: LCSAX ), one of the few long/short commodity fund competitors in the mutual fund and ETF space. That fund has bucked the downdraft in the commodities markets and has generated annualized returns of 12.79% over the past 3-years through January 31. Offshore Subsidiary Like FTGC (and many other funds that use commodity futures), the new fund will invest up to a quarter of its assets in a subsidiary based in the Cayman Islands. This subsidiary will invest in commodity-based futures contracts, with certain tax advantages, while the remainder of the fund’s assets will be invested in cash and short-term debt. Commodities markets have been struggling, largely due to the extreme bear market in crude oil, but this has actually led to increased interest in actively managed commodity funds. As pointed out by ETF.com, Elkhorn and Van Eck have both filed for such funds over the past few months, but First Trust’s new fund is the first to include a short component. This, combined with the firm’s pedigree as the first to launch an actively managed commodities ETF of any kind lends gravitas to the new fund, which will be known as the First Trust Alternative Absolute Return Strategy ETF. Jason Seagraves contributed to this article.

How Regulation Promotes Short-Termism

Every so often some prominent individual in the investment community reaches the erroneous conclusion that earnings guidance is the root of all evil. The latest to promote this idea is Larry Fink, CEO of BlackRock (NYSE: BLK ). BlackRock, which has $4.6 trillion in assets under management, claims to be the world’s largest investment firm. Fink has held the top post ever since he co-founded the company in 1988. He is rumored to be at the top of Hillary Clinton’s list of candidates for Treasury Secretary, should she win the presidential election. Fink might even be petitioning for the job. CNN Money recently pointed out that he is beginning to sound a lot like Clinton herself, even to the point of using the same terminology. Both of them are on the warpath against what they call “short-termism” in corporate America. Fink penned a letter on February 1 to the CEOs of major corporations and used that term in the very first sentence, calling it a powerful force that is afflicting corporate behavior. Frankly, I can’t argue with much of what he says. I agree with him that there is too much attention paid to how a company performs over the short term and not enough paid to how it does over the long term. I consider myself a long-term investor, and I much prefer to see the companies I invest in managed with a long-term perspective in mind. For example, management can easily boost earnings in any particular quarter simply by slashing capital expenditures or by cutting spending on research and development. Yet doing so comes at the cost of long-term growth. I take exception, however, to Fink’s call to CEOs urging them to put an end to quarterly earnings guidance. This is not a new position for me. Because I feel so strongly about this issue, I devoted an entire chapter to it in my 2008 book, “Even Buffett Isn’t Perfect.” I favor guidance for a number of reasons. First, it comes straight from the horse’s mouth. Guidance is provided by the very people who are running the company. These people know better than anyone how the company is likely to do. I want to hear from them in as specific terms as possible. I don’t take what they say at face value. But I do want to hear what they have to say – then it’s up to me to judge what to make of that information. Second, studies show that analysts’ earnings forecasts are not particularly reliable to begin with… and it turns out they are even less accurate when guidance is not provided. Third, although some investors believe that executives are more likely to take actions that will increase company value over the long term if they don’t have to deal with the pressure of living up to quarterly guidance, studies on the topic uncover no evidence that companies increase capital expenditures or investments in research and development after they eliminate guidance. Fourth, studies also show that there is a negative stock price reaction when companies announce that they will no longer provide guidance. Interestingly, although management usually says they are eliminating guidance because they believe it is in the best interest of investors, it turns out they usually eliminate guidance when the company is having financial difficulties. What’s even more interesting is that these very companies often change their minds and begin providing guidance again when business conditions improve. There is one critical issue I wish everybody would understand. While it’s true that there is too much focus on short-term results, this isn’t the result of guidance. The reason investors pay so much attention to quarterly earnings in the first place is that the SEC requires corporations to report their financial results every quarter. That’s right. Short-termism is a direct result of regulation. So if you really believe that short-termism is a problem, instead of urging CEOs to stop providing guidance, it would be more effective if you urged the SEC to end the quarterly reporting requirement. To be clear, Larry Fink is not in favor of that. Neither am I. Perhaps this is the greatest irony of all. Our country recently went through a financial crisis that was in part caused by a lack of transparency. In response, regulators implemented all kinds of new rules specifically designed to increase transparency. Eliminating guidance, however, does exactly the opposite. It reduces transparency. To say that we’d be better off with less guidance is the equivalent of saying that we’d be better off with less information. That’s simply nonsense. As I said earlier, research studies show that there is a statistically significant loss in share value when companies eliminate guidance. These studies also show that companies that eliminate guidance continue to underperform for as long as a year. So if you own shares in a company that has regularly provided guidance and then stops doing so, you might want to think about getting out of that investment. On the other hand, if you are invested in a company that has never provided guidance, you need not worry. Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B ) and Alphabet (NASDAQ: GOOG ) (NASDAQ: GOOGL ) are two companies that have performed well over the long term. Neither one has ever provided guidance.