Tag Archives: mutual funds

Can Airlines Funds Take Off On Profit Outlook, Low Fuel Cost?

The Airline sector is witnessing improving trends right now, and the momentum is much needed to ensure profits for investors in this space. While much of the encouragement comes from fundamentals within the airline space, another key catalyst for the sector’s growth is the slumping oil price. Airline stocks will likely continue their bull run into 2016 as recently reinforced by the encouraging outlook provided by the International Air Transport Association (IATA). Separately, weakness in oil prices, which has lasted for well over a year now, is nothing short of a godsend for the airline space. Airline profits depend largely on fuel prices, which form nearly 30% of operating expenses and are also the major variable component in the industry. Operating expenses of airline companies have gone down considerably as fuel accounts for one of the major input costs for air carriers. Thus, it is time to focus on funds that have investments in the airline space. Please note that there is hardly any fund that focuses solely on airline stocks. However, the sector attracts heavy investments from many mutual funds that focus on the transportation sector. The funds we discuss may not carry a favorable Zacks Mutual Fund Rank at the moment, but an improving trend in the airline space demands attention on them. Airliners Fly High as Crude Hits Ground Stocks in the airline space soared following the Dec 4 decision by the Organization of the Petroleum Exporting Countries (OPEC) – the international cartel of oil producers – to not curb output of crude. A blip came thereafter as Southwest Airlines (NYSE: LUV ) revealed a disappointing outlook with respect to its operating revenue per available seat miles (RASM) for the fourth quarter of 2015. Nonetheless, the low oil price environment makes airline stocks attractive. The drop in oil prices has reduced airline companies’ operating expenses significantly, thereby boosting the bottom line. OPEC’s decision not to curb output despite the slump in prices means that the oversupply will continue to haunt the energy space. This implies good times ahead for airline carriers. Weak oil prices have resulted in tremendous savings and improved bottom lines for carriers in the past quarters. The massive savings have certainly supported the financial health of carriers and prompted them to launch share buyback programs, hike dividend payments and significantly reduce their debt levels. Buoyed by their sound financial health, several carriers intend to invest heavily in upgrading overall facilities for better customer satisfaction. This is likely to result in greater travel demand, improved goodwill and eventually, a higher top line. Although it is true that most carriers struggled to post meaningful revenue growth in the third quarter of 2015 courtesy of a strong US dollar, their bottom lines benefited owing to low fuel costs. IATA’s Outlook Buoys Airliners Further The International Air Transport Association now expects profits in the aviation industry to touch $36.3 billion in 2016 with a net profit margin of 5.1%. IATA also projects profits of around $33 billion in 2015 with net profit margin of 4.6%, marking an improvement from the previous guidance of $29.3 billion, which was released in June 2015. Christmas holidays and summer vacations will contribute to traffic. IATA projects 6.7% and 6.9% growth in air traffic in 2015 and 2016, respectively, with load factor or percentage of seats filled by passengers pegged at 80.7%. IATA also believes that 3.8 billion passengers will travel in 2016. Moreover, increased fleet restructuring programs, retiring older and less efficient aircraft and new aircraft orders are anticipated to enhance the performance level of the company by trimming fuel and operating costs, and rendering a comfortable flying experience. Moreover, most carriers are focused on augmenting ancillary revenues by launching value-added services at affordable rates. Funds In Need of a Turnaround Although there is no airline-specific mutual fund category, the space represents a substantial portion of the transportation sector. Mutual funds from the transportation sector with significant focus on airliners are the ones to watch out for. Not all of them may be carrying a favorable rank right now, but the positives are much needed to turn the tide for them. Fidelity Select Transportation (MUTF: FSRFX ) seeks growth of capital. FSRFX invests the majority of its assets in common stocks of firms mostly involved in providing transportation services or ones that design, manufacture and sell transportation equipment. FSRFX is the only fund that carries a Zacks Mutual Fund Rank #2 (Buy). FSRFX has not been able to stay in the green in recent times, as its year to date and 1-year returns are -16.7% and -13.7%, respectively. The 3- and 5-year annualized returns are, however, respectively 19.2% and 11.8%. Annual expense ratio of 0.81% is lower than the category average of 1.14%. FSRFX carries no sales load. Among the top 10 holdings, FSRFX holds airline companies such as Southwest Airlines, American Airlines Group Inc (NASDAQ: AAL ) and Delta Air Lines Inc. (NYSE: DAL ). Rydex Transportation Fund Investor (MUTF: RYPIX ) invests a large chunk of its assets in domestically traded companies from the transportation sector and in other securities including futures contracts and options. RYPIX may allocate a notable portion of its assets in companies having market capitalization within the range of small to medium size. RYPIX may also invest in ADRs in order to gain exposure to non-US companies and may also invest in US government securities. RYPIX currently carries a Zacks Mutual Fund Rank #4 (Sell). The year to date and 1-year losses of RYPIX are 12.4% and 8.6%, respectively. The 3- and 5-year annualized gains are 19.4% and 11%, respectively. Annual expense ratio of 1.35% is higher than the category average of 1.14%. RYPIX carries no sales load. Among the top 10 holdings, RYPIX holds airline companies such as Delta Air Lines, Southwest Airlines and American Airlines Group. Fidelity Select Air Transportation Portfolio (MUTF: FSAIX ) seeks long-term capital growth. FSAIX invests the major portion of its assets in companies primarily engaged in providing air transport services all over the world. FSAIX focuses on acquiring common stocks of companies depending on factors such as financial strength and economic condition. FSAIX currently carries a Zacks Mutual Fund Rank #4 (Sell). The year to date and 1-year losses of FSAIX are 6.5% and 3.2%, respectively. The 3- and 5-year annualized gains are 23.1% and 15%, respectively. Annual expense ratio of 0.83% is lower than the category average of 1.14%. FSAIX carries no sales load. Among the top 10 holdings, FSAIX has airline companies such as Southwest Airlines, American Airlines Group, Delta Air Lines and Spirit AeroSystems Holdings (NYSE: SPR ), which is one of the largest independent suppliers of commercial airplane assemblies and components. Original Post

Long/Short Equity Funds: The Best And Worst Of November

After posting losses in September and gains in October, Morningstar’s long/short equity mutual fund category was flat for the month of November – but this doesn’t mean there weren’t standout funds. Indeed, one of the worst performers from October was able to bounce back into the top three for November. In this review of the category, we look not only at the one-month returns of the month’s best and worst funds, but also the composition of their three-year returns in terms of alpha and beta, as well as their three-year Sharpe ratios and standard deviations. A quick refresher: Beta refers to the risk level of a security relative to the market. A beta of 1.0 implies the same risk level as the market, while a beta of more than 1.0 means the security (or fund in this case) is riskier than the market. A beta of less than 1.0 implies a risk less than the market. Alpha is the amount of performance in excess of a security’s beta adjusted benchmark. Sharpe ratio is a measure of return (above the risk free rate) per unit of risk – the higher, the better. (click to enlarge) Top Performers in November The three best-performing long/short equity mutual funds in November were: For the second straight month, a Catalyst fund topped the list. But while October saw the Catalyst Hedged Insider Buying Fund (MUTF: STVIX ) lead all long/short equity mutual funds, in November it was the Catalyst Insider Long/Short Fund that led the pack at +7.21%. For the first eleven months of the year, CIAAX returned an even 2%, and its three-year return through November 30 stood at an annualized 4.42%. The fund had a negative alpha (-0.60) for the three-year period, with a three-year beta of 0.39, and a Sharpe ratio of 0.35. The Burnham Financial Long/Short Fund was November’s second-best-performing long/short equity mutual fund, with returns of +5.53%. While its gains lagged those of the Catalyst Insider fund, BURFX’s longer-term numbers are much more appealing: Its three-year return of 20.31%, and alpha of 11.98%, was accomplished with a relatively low level of volatility (9.17% standard deviation) and a beta of just less than half the market (0.45). The fund’s three-year Sharpe ratio of 2.07 is outstanding. Finally, the Turner Medical Sciences Long/Short Fund was the third-best long/short equity mutual fund to own in November, boasting returns of +5.36%. This was a turnaround for the Turner fund, which was the third-worst performer in October, with losses of 4.99%. Over the past three years, TMSCX has returned an annualized 14.61% with a beta of just 0.19. This has resulted in the fund’s alpha of 11.94% ranking just 4 basis points less than the Burnham fund above, despite a much lower 3-year annualized return. However, with it’s higher standard deviation over the period, the fund’s Sharpe ratio stood came it 0.93 for the three-year period, a bit less than half the Burnham fund’s Sharpe ratio. (click to enlarge) Worst Performers in November The three worst-performing long/short equity mutual funds in November were: The Philadelphia Investment Partners New Generation Fund, the month’s worst performer, lost more than the month’s top-performer gained, with a one-month return of -7.55%. Its dismal three-year returns of -5.45% can be broken down into a 0.80 beta and -17.54 alpha, resulting in a Sharpe ratio of -0.49 for the three years ending November 30. The Clinton Long Short Equity Fund hasn’t been around long enough to have three-year return data, but its one-month losses of 4.84% in November made it the second-worst long/short equity mutual fund to own that month. For the first eleven months of 2015, WKCIX lost 13.49% of its value. The Whitebox Tactical Opportunities Fund ( WBMIX ) was November’s third-worst long/short equity fund, with returns of -3.58%. For the first eleven months of 2015, WBMIX generated losses of 19.50%, and its three-year returns of -3.17% through November 30. The fund has a low 3-year beta of 0.13 and a -4.90 alpha. The fund’s three-year Sharpe ratio stood at -0.33 as of November 30. (click to enlarge) October’s Best and Worst: Follow-Up The Catalyst Hedged Insider Buying ( STVIX ), Tealeaf Long/Short Deep Value (MUTF: LEFIX ), and Giralda Manager (MUTF: GDAMX ) funds were October’s top three long/short equity mutual funds, with respective one-month returns of 10.71%, 9.05%, and 8.73%. In November, STVIX returned a category-matching 0.00%, while LEFIX and GDAMX posted respective one-month returns of 3.02% and 0.15%. October’s worst performers were the CMG Tactical Futures Strategy Fund (MUTF: SCOIX ) and the Highland Long/Short Healthcare Fund (MUTF: HHCAX ), which lost 6.74% and 5.54%. In November, those funds continued their losing ways with returns of -2.02% and -1.55%, respectively. Past Performance does not necessarily predict future results.

Third Avenue Focused Credit Fund – Designed To Implode

Summary Third Avenue Focused Credit Fund has been placed in liquidation by its board of trustees. The cause was the illiquidity of its portfolio of deep value high yield securities. The board could not continue to run an open-end mutual fund with such a high concentration of illiquid securities. Will there be contagion for other high yield bond funds? Yes, if they have a high proportion of illiquid securities in their portfolios. On December 10, Third Avenue Focused Credit Fund (MUTF: TFCIX ) announced that it was going into liquidation rather than redeeming any additional securities. It is in all the newspapers. Liquidation is a highly unusual move for an open-end mutual fund to make, but it appears to have been the only rational course of action open to the fund’s board of trustees in the circumstances. The fund, started in 2009, had an unusual, possibly unique investment style. It invested in deep value high-yield bonds – the sort that would not blush when called “junk” – often with the lowest ratings. Third Avenue Management, the fund’s manager, and its chairman, Martin Whitman, are highly regarded value investors. It is not a fly-by-night operation. Indeed, when the Focused Credit Fund opened in 2009, I was an early investor – though I redeemed my shares after about a year because I thought the fund was taking greater risks than I had understood when I invested. The fund had over $2 billion of assets at the beginning of 2015, but due to portfolio losses and redemptions, it was down to $789 million at December 10. Illiquidity of the Portfolio Assets of a mutual fund have two pricing mandates: (1) a mandate under the Investment Company Act that, although detailed in overall methodology, is relatively general regarding specific securities, and (2) a process under Generally Accepted Accounting Principles, which, by dividing valuation into three methodologies, is somewhat more specific. By reason of its specificity, the GAAP definition tends to prevail in the valuation of individual securities. The last SEC-filed report on the valuation of the Focused Credit Fund’s portfolio securities, as of 7/31/15, shows that of the fund’s $1,953 million of assets, $171 million was priced in accordance with level 1 methodology, $1,399 million in accordance with level 2 methodology, and $382 million under level 3 standards. By the standards of most mutual funds, only level 1 assets are deemed to be liquid – that is, capable of being sold at a price near their valuation in a reasonable period of time. The Third Avenue Focused Credit Fund had over half its assets in level 2 and almost 20% in level 3, which sometimes is called “mark to myth.” These figures stand out starkly against the SEC’s general rule that open-end funds are to limit their holdings of illiquid securities to 15% of assets or less. Strategic Illiquidity Looking at Focused Credit Fund’s holdings, it appears that the deep value methodology that the fund adopted almost necessarily led to endemic illiquidity because securities of that type trade infrequently. Looked at in that light, the fund was almost bound to implode if the lowest-rated part of the high yield market declined significantly. And that is just what happened in 2015: The lowest rated high-yield securities performed far worse than the rest of the market. In that circumstance, a high level of redemptions was predictable, and an inability to sell the portfolio’s securities at reasonable prices in reasonable amounts of time also was predictable. Under and Over Valuations – Risks either Way In a way, I am surprised that the Board of Trustees waited so long to put the fund into liquidation because the responsibility for valuing level 2 and level 3 assets falls on the board itself, including its independent members. Although the board usually defers to management and often has a subcommittee that deals with valuations, the board as a whole is responsible. Thus, for a long period of time, the board has been blessing portfolio valuations that are hard to defend, even if they were done in the best of faith. Moreover, those who cashed out and those who held on had conflicting interests. Those who cashed out benefited from higher valuations; those who held on benefited from lower valuations. The board therefore has been or will be sued every which way. Liquidation is the only way to avoid further litigation risk for valuations. It appears from reading press reports that the officers of Third Avenue Management are concerned that they may have overvalued some portfolio securities. That surprised me because looked at from the point of view of a lawyer representing the independent trustees, a role I played often over a 30-year period, and the valuations should be conservative – on the low side. But it appears that the Third Avenue people are concerned about over-valuations. However, I now see that an investment manager has incentives to place valuations of the high side because that will keep the NAV up, which will tend to fewer redemptions and higher management fees. If the valuations were high, then stockholders that did not redeem may have been injured because stockholders that redeemed got more than they should have. In all likelihood, the remaining stockholders have a good class action. The board finally decided it had to liquidate the fund because no matter what valuation methodology it used, it would be subject second-guessing in court. Definition of Liquid Security Over the last year, I have written about the need for a better definition of liquid security. The definition, I have argued, is too loose; therefore, it is likely to lead to some funds holding far greater proportions of illiquid securities than the SEC thought safe – or than I thought safe. The industry has fought a redefinition because it has made money from the old definition. The liabilities that are likely to flow from this event may soften that opposition, and the events will strengthen the forces of reform. Here is what I said on this subject at NexChange.com about six months ago: The genius of the form is that forward pricing at net asset value prevents investors from gaming the system. Whether the market is going up or down, NAV is NAV. (Yes, there are issues with trading in different time zones, but those issues have been minor in most cases.) But the genius of NAV depends on two things: One, that it be a reliable source of true value; and two, that the underlying securities be, for the most part, liquid in substantially all markets. Many open-end bond funds have significant percentages of assets that are liquid under the SEC’s definition of “liquid” but that in a crisis would not be liquid-that is, they could not be sold except at a price far lower than their intrinsic value. If, due to redemptions, some funds were forced to sell such assets, the NAV of all similar funds would fall more precipitously than the intrinsic value of their underlying assets would warrant. This illiquidity problem could be solved by the SEC changing its definition of “liquid asset” to make it more stringent. Open-end bond funds then would have to avoid smaller issues that would likely be thinly traded and have practically no market in a crisis. But that will not happen because the fund industry is making too much money on their bond fund products. Besides, the problem is not likely to have a systemic impact because the illiquid issues are not due immediately and the losses that investors suffer will not, for the most part, be leveraged.” The liquidation of Third Avenue Focused Fund is evidence that my fears were well founded. In the same series of articles at NexChange, I discussed the difference between interest rate risk-based valuation issues and credit quality-based valuation issues. Here is what I said. It is applicable to the Focused Credit Fund style and experience. There is a big difference between wondering whether the interest rate on a particular bond is appropriate in the current market and wondering whether the bond will be repaid. The interest rate question an investor can quantify. At any given rate (the current risk free rate is known), the value, based solely on the interest rate, tenor and repayment options, is known. The spread between the implied market rate on the bond and the market rate on a similar duration Treasury reflects the market’s judgment as to credit risk. Traders will be quick to spot any anomalies and will take advantage of them, in effect stabilizing the interest rate side of the market. But when the issuer’s ability to repay comes into doubt, no one knows what the right price is, and the market may have no floor. That is what owners of sub-prime backed RMBS and their derivatives discovered on 2008. When credit quality is unknown, there may be no market price because there may be no market.” Contagion Will there be contagion for funds that look like Third Avenue Focused Credit Fund? Yes, if they really do look like it. But I expect there are not many of those. The unusual deep value nature of the fund’s strategy met up with that class of assets falling out of favor over the last year and seeing their value drop sharply. The bigger question is whether more ordinary high-yield open-end funds will suffer from contagion. First reactions, including that of the Wall Street Journal, appear to suggest there will be contagion throughout that class of funds. How far it will go remains to be seen. The tide has gone out. Now we will see who is swimming naked – that is, who really has a higher level of illiquid securities than they claim to have. That could be quite a few. According to research using the Schwab search engine, there are 82 high yield bond funds with over $500 million in assets, 28 with over $1 billion, and 3 with over $10 billion. That looks like maybe $48 billion of assets. That is a large number, but it does not seem like enough to be a systemic threat. (Yes, that’s what they said about the subprime mortgage market in 2007.) Two of the biggest are BlackRock High Yield Fund (MUTF: BHYAX ), and JPMorgan’s High Yield fund (MUTF: OHYFX ).