Tag Archives: nreum

Playing The Field With Your Investments

For some, casually dating can be fun and exciting. The same goes for trading and speculating – the freedom to make free-wheeling, non-committal purchases can be exhilarating. Unfortunately the costs (fiscally and emotionally) of short-term dating/investing often outweigh the benefits. Fortunately, in the investment world, you can get to know an investment pretty well through fundamental research that is widely available (e.g., 10Ks, 10Qs, press releases, analyst days, quarterly conference calls, management interviews, trade rags, research reports). Unlike dating, researching stocks can be very cheap, and you do not need to worry about being rejected. Dating is important early in adulthood because we make many mistakes choosing whom we date, but in the process we learn from our misjudgments and discover the important qualities we value in relationships. The same goes for stocks. Nothing beats experience, and in my long investment career, I can honestly say I’ve dated/traded a lot of pigs and gained valuable lessons that have improved my investing capabilities. Now, however, I don’t just casually date my investments – I factor in a rigorous, disciplined process that requires a serious commitment. I no longer enter positions lightly. One of my investment heroes, Peter Lynch, appropriately stated, “In stocks as in romance, ease of divorce is not a sound basis for commitment. If you’ve chosen wisely to begin with, you won’t want a divorce.” Charles Ellis shared these thoughts on relationships with mutual funds: “If you invest in mutual funds and make mutual funds investment changes in less than 10 years…you’re really just ‘dating.’ Investing in mutual funds should be marital – for richer, for poorer, and so on; mutual fund decisions should be entered into soberly and advisedly and for the truly long term.” No relationship comes without wild swings, and stocks are no different. If you want to survive the volatile ups and downs of a relationship (or stock ownership), you better do your homework before blindly jumping into bed. The consequences can be punishing. Buy and Hold is Dead…Unless Stocks Go Up If you are serious about your investments, I believe you must be mentally willing to commit to a relationship with your stock, not for a day, not for a week, or not for a month, but rather for years. Now, I know this is blasphemy in the age when “buy-and-hold” investing is considered dead, but I refute that basic premise whole-heartedly…with a few caveats. Sure, buy-and-hold is a stupid strategy when stocks do nothing for a decade – like they have done in the 2000s, but buying and holding was an absolutely brilliant strategy in the 1980s and 1990s. Moreover, even in the miserable 2000s, there have been many buy-and-hold investments that have made owners a fortune (see Questioning Buy & Hold ). So, the moral of the story for me is “buy-and-hold” is good for stocks that go up in price, and bad for stocks that go flat or down in price. Wow, how deeply profound! To measure my personal commitment to an investment prospect, a bachelorette investment I am courting must pass another test…a test from another one of my investment idols, Phil Fisher, called the three-year rule. This is what the late Mr. Fisher had to say about this topic: “While I realized thoroughly that if I were to make the kinds of profits that are made possible by [my] process … it was vital that I have some sort of quantitative check… With this in mind, I established what I called my three-year rule.” Fisher adds, “I have repeated again and again to my clients that when I purchase something for them, not to judge the results in a matter of a month or a year, but allow me a three-year period.” Certainly, there will be situations where an investment thesis is wrong, valuation explodes, or there are superior investment opportunities that will trigger a sale before the three-year minimum expires. Nonetheless, I follow Fisher’s rule in principle in hopes of setting the bar high enough to only let the best ideas into both my client and personal portfolios. As I have written in the past, there are always reasons of why you should not invest for the long term and instead sell your position, such as: 1) new competition; 2) cost pressures; 3) slowing growth; 4) management change; 5) valuation; 6) change in industry regulation; 7) slowing economy; 8) loss of market share; 9) product obsolescence; 10) etc, etc, etc. You get the idea. Don Hays summed it up best: “Long term is not a popular time-horizon for today’s hedge fund short-term mentality. Every wiggle is interpreted as a new secular trend.” Peter Lynch shares similar sympathies when it comes to noise in the marketplace: “Whatever method you use to pick stocks or stock mutual funds, your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed.” Every once in a while there is validity to some of the concerns, but more often than not, the scare campaigns are merely Chicken Little calling for the world to come to an end. Patience is a Virtue In the instant gratification society we live in, patience is difficult to come by, and for many people ignoring the constant chatter of fear is challenging. Pundits spend every waking hour trying to explain each blip in the market, but in the short run, prices often move up or down irrespective of the daily headlines. Explaining this randomness, Peter Lynch said the following: “Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100% correlation between the success of a company and the success of its stock. It pays to be patient, and to own successful companies.” Long-term investing, like long-term relationships, is not a new concept. Investment time horizons have been shortening for decades, so talking about the long-term is generally considered heresy. Rather than casually date a stock position, perhaps you should commit to a long-term relationship and divorce your field-playing habits. Now that sounds like a sweet kiss of success. Disclosure: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page .

What If I Had Stayed Away From The ‘Sell’ Button?

Summary Does it pay off to sit on one’s hands and do nothing? I wanted to know and carried out a brief review of my past sell decisions. Holding clearly outperformed selling, but selling seems to have lowered both, returns and risk. Never look back? With regards to closed positions I used to follow a strict ‘never look back’ policy, because I considered it unhelpful to spend time thinking about what could have been. Recently, I broke with this paradigm. Not because I like to kick myself, but rather to test which of the following competing concepts would work better for me: Monitoring all holdings closely and trying to optimize capital gains and portfolio structure by selling when the time has come (whenever that may be) Sitting on my hands and doing nothing while accumulating shares. It may not have been a conscious decision, but I happened to follow the former approach in the past. I felt not looking after the portfolio might be irresponsible. However, when looking after the portfolio I found there were always reasons to worry. Typical reasons to sell were: Concerns about the respective company’s business model Immediate issues with unclear outcome (e.g. accounting issues, legal disputes) Perceived lofty valuations Then I wondered: What are the worst losses that I managed to avoid through trading and what are best opportunities that I missed out on? Would I be better off if I stayed hands-off? Looking back Past sell decisions can help to find answers to these questions. If you are happy to gain valuable, but potentially painful insights, you might want to carry out a review as follows: Put together the data on all positions that you ever closed. Establish the respective cost base of these positions and the profit/loss that you realized when you closed the positions. Look up the current prices of the securities you sold. Calculate what your former holdings would have been worth today. Compare with the realized profit/loss. Results This is what I did and here is what I found as I went through the 32 trades that are on my records of the past four years: I made a profit on 29 positions. The average gain was 16% with the largest gain being 58% (these are total, not annualized gains in local currencies, including all trading fees, but no dividends). I made a loss on three positions. The average loss was -19% with the biggest loss being -33%. The average profit across these 32 trades was 13%. Comparing the realized profits and losses with current prices, I figured out that I made 15 good exit decisions (=current prices are below the prices at which I sold) and 17 poor exit decisions (=current prices are above the prices at which I sold). All three stocks that I sold at a loss were among the good exits. Also, pulling the plug on my long-term government bonds in late January this year turned out to be a good move. A further pattern is that it was mostly a good idea to get rid of the more speculative plays (special situations, turnarounds). The biggest loss that I managed to avoid was -56 percentage points (=my realized profit was 9% and I would be under water by -47% now had I kept the stock). The poorest exit decisions were taken more than two years ago. Today, I find it difficult to understand what made me sell, since I cannot remember any red flags. The best explanation I can offer is that the share prices did not go up as I expected and I lost patience assuming that I missed something in my assessment. In that situation I was almost looking for black cats in dark alleyways. The biggest gain that I missed by selling was 300% percentage points (=my realized profit was 1%, but the stock has gained a further 299% since I have sold). Had I kept all the positions that I sold the total gain would have been 37% rather than 13%. Conclusions The interpretation of the results is not straight forward. Given the overall bull market for stocks and bonds in recent years, it had to be expected that keeping would win over selling on average. My brief review did only compare selling against keeping. It did not compare keeping against reinvesting of realized proceeds. Also, of course, I did not consider time frames in that I only looked at overall returns not at annualized ones. Still, there are some conclusions that I find useful: When I sold it was due to concerns (or fear if you like). The ‘never look back’ policy implied already that I could miss out on opportunities by selling, but I never realized by how much missed opportunities can outweigh risks in total even when some of the risks do eventually materialize. Being lazy, I was actually hoping to find evidence that a complete hands-off approach would be superior to my trading activity. Things turned out to be a bit more complicated, though. It feels reassuring that I proved to be right whenever I closed a position at a loss. The best and worst performers in my current portfolio have returned +191% and -17% respectively so far which compares against +300% and -57% among my past holdings. Although it was not an outspoken goal, I do feel more comfortable in the current range that seems to offer a more limited downside. Apparently, I could not expect the portfolio to be low maintenance, when (some of) the stock picks were not. Now that I have eliminated the stocks that were a bit too exciting for me, it may have become easier to stay away from the sell button. Stocks In order to keep the focus on method and results, I decided not to mention specific stocks above. If you are curious about the stocks behind the numbers, here is a small list: Largest realized gain: Novartis (NYSE: NVS ) Biggest realized loss: Finavera ( OTC:FNVRF ) Biggest avoided loss: Power REIT (NYSEMKT: PW ) Biggest opportunity I missed: Royal Wessanen ( OTC:KJWNF ) Best performer in my current portfolio: I.A.R. Systems ( OTC:IARSD ) Worst performer in my current portfolio: HCP (NYSE: HCP ). Disclosure: I am/we are long IARSD, HCP. (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.

Is It Time To Buy Energy CEFs?

Summary Energy CEFs have been hit hard over the past year, resulting in potential bargains. Energy CEFs offer enticing income while you wait for the sector to recover. My picks are PEO and TTP for long term risk-adjusted performance when the bull returns. I am primarily an income investor but I have a contrarian streak and believe in the wisdom of Warren Buffet when he opined: “Be greedy when others are fearful.” This advice has never been truer than now when you consider the total collapse of the energy market. West Texas Intermediate (WTI) oil has plummeted from $104 per barrel in June of last year to less than $50 a barrel today. This has driven down energy stocks to what I consider bargain basement levels. The rapid fall of energy stocks is illustrated by plot of the price of the Energy Select Sector SPDR Exchange Traded Fund (NYSEARCA: XLE ) shown in Figure 1. This ETF is a passive cap-weighted fund that tracks the price of 41 of the largest energy companies. It has an expense ratio of only 0.15% and yields 2.9%. The plot shows that prices peaked in July of last year and has since fallen over 33%. (click to enlarge) Figure 1: Plot of XLE over past 3 years I am not clairvoyant and have no idea how long it will take the energy sector to recover. However, I am confident that over the long run, oil will again return to its glory days. This is based on past history coupled with the number of trouble spots around the world that could disrupt the supply of oil. So I have begun accumulating beaten-down energy stocks. To accomplish this, I am a fan of using Closed End Funds (CEFs) because they are actively managed and offer attractive distributions while you wait for the recovery. There are only four CEFs that focus on energy and have at least a 3 year history. I did not include CEFs that invest primarily in precious metals or master limited partnerships (NYSEARCA: MLPS ). If you are interested in MLPs, please see my article that I recently wrote on Seeking Alpha. The CEFs I included in the analysis are summarized below. Adams Natural Resources (NYSE: PEO ). This CEF was formerly known as Petroleum and Resources and is one of the oldest CEFs, having begun trading on the NYSE in 1929. The fund sells at a discount of 15.2%, which is a slightly larger discount than the 3 year average of 14%. The portfolio consists of 39 companies in the energy and natural resource sectors. It utilized less than 1% leverage and has an expense ratio of 0.6%. The distribution is $0.10 per quarter which is only 2% but it also typically distributes a large capital gain at the end of the year. Last year the capital gain was $1.59, which brought the yearly distribution to $1.99 or almost 10%. None of the distribution was return of capital (NYSE: ROC ). The fund has an exceptional track record and has paid capital gains for 63 consecutive years and dividends for 80 consecutive years. The fund has made a commitment to pay distributions equal to at least 6% of the fund trailing 12 month average price. BlackRock Energy and Resources (NYSE: BGR ). This CEF sells at a discount of 11.4%, which is a larger discount than the 3 year average discount of 7%. This fund is concentrated and has only 30 holdings, all from the energy sector. About 75% of the companies are domiciled in the United States with the rest primarily Canadian and European companies. The fund does not use leverage and has an expense ratio of 0.3%. However, the fund may use options to enhance dividend yield. The distribution has been $0.135 per month but was dropped to $0.11 for August. The fund distributed $1.14 in December of last year. Unfortunately the distributions this year have been mostly return of capital. It is difficult to assess if this is destructive ROC because of the option income plus the fact that the Undistributed Net Investment Income (UNII) is only slightly negative. If readers have more insight, please let me know. First Trust Energy Infrastructure (NYSE: FIF ). This CEF sells at a discount of 15.3%, which is a larger discount than the 3 year average of 7.7%. The portfolio has 70 holdings and focuses on energy infrastructure, with 26% in MLPs and the rest invested in energy companies. About half the holdings are in the pipeline industry and about 24% are associated with electric power. This fund utilizes 25% leverage and has an expense ratio of 1.8%. The distribution is 0.11 per month with capital gains of $1.43 paid last November. Most of the distributions do not rely on ROC and UNII is positive. Tortoise Pipeline and Energy (NYSE: TTP ). This CEF sells for a discount of 15.1%, which is a larger discount than the 3 year average of 8.5%. The portfolio has 60 holdings consisting of 24% MLPs, 65% pipeline corporations, and 10% integrated oil companies. About 30% of the holdings are domiciled in the U.S. The fund utilizes 22% leverage and has an expense ratio of 2.1%. The distribution is 5.3%, consisting of income, capital gains, and a relatively small amount of ROC. The UNII is large and positive, which is a good sign. Voya Natural Resources, Equity (NYSE: IRR ). This CEF sells at a discount of 13.2%, which is a larger discount than the 3-year average discount of 8.6%. The portfolio consists of 84 holdings with 20% from integrated oil companies, 26% from exploration and production companies, and 16% from oil services. About 89% of the holdings are domiciled in the U.S. This fund uses a covered call strategy to enhance returns and does not utilize leverage. The expense ratio is 1.2%. The distribution a huge 15.7%, consisting primarily of short term gains. The fund has not used ROC over the past year and the UNII is positive. To assess the performance of the selected CEFs, I plotted the annualized rate of return in excess of the risk free rate (called Excess Mu in the charts) versus the volatility of each of the component funds over the past 3 years. The risk free rate was set at 0% so that performance could be easily assessed. This plot is shown in Figure 2. Note that the rate of return is based on price, not Net Asset Value (NYSE: NAV ). (click to enlarge) Figure 2. Risk versus reward over the past 3 years. The plot illustrates that the CEFs have booked a wide range of returns and volatilities over the past 3 years. To better assess the relative performance of these funds, I calculated the Sharpe Ratio. The Sharpe Ratio is a metric, developed by Nobel laureate William Sharpe that measures risk-adjusted performance. It is calculated as the ratio of the excess return over the volatility. This reward-to-risk ratio (assuming that risk is measured by volatility) is a good way to compare peers to assess if higher returns are due to superior investment performance or from taking additional risk. In Figure 2, I plotted a red line that represents the Sharpe Ratio associated with XLE. If an asset is above the line, it has a higher Sharpe Ratio than XLE. Conversely, if an asset is below the line, the reward-to-risk is worse than XLE. Note also that Sharpe Ratios are not meaningful if a stock has a negative return. Some interesting observations are evident from the figure. The energy CEFs exhibited a relative tight range of volatilities that were similar to XLE. This was somewhat surprising since I expected CEFs to have higher risks than the passive XLE (because the CEFs are actively managed and some use leverage which could increase volatility). Overall, as expected, energy funds did have great performance over the period. The funds that focused on energy production and exploration fared the worst while the infrastructure funds (FIF and TTP) performed the best. The funds that utilized an option strategy (BGR and IRR) were the worst performers. On both an absolute basis and a risk-adjusted basis, TTP and FIF outperformed XLE. PEO had about the same risk-adjusted performance as XLE but both only managed to eke out a small positive total return. PEO was the least volatile of the group. Since all the funds were associated with natural resources, I wanted to assess how much diversification you might receive by buying multiple funds. To be “diversified,” you want to choose assets such that when some assets are down, others are up. In mathematical terms, you want to select assets that are uncorrelated (or at least not highly correlated) with each other. I calculated the pair-wise correlations associated with the funds. The results are presented in Figure 3. Figure 3. Correlation over the past 3 years The figure presents what is called a correlation matrix. The symbols for the funds are listed in the first column on the left side of the figure. The symbols are also listed along the first row at the top. The number in the intersection of the row and column is the correlation between the two assets. For example, if you follow TTP to the right for three columns you will see that the intersection with IRR is 0.413. This indicates that, over the past 3 years, TTP and IRR were only 41% correlated. Note that all assets are 100% correlated with themselves so the values along the diagonal of the matrix are all ones. As shown in the figure, BGR and PEO were highly correlated with XLE. Thus, you do not receive substantial diversification benefits by purchasing more than one of these funds. On the other hand, FIF, IRR, and TTP were not highly correlated with each other or XLE. Thus, the funds would provide good diversification if you already own PEO or XLE. The 3 year look-back data shows how these funds have performed in the past. However, the real question is how they will perform in the future when the bull market in energy returns. Of course, no one knows but we can obtain some insight by looking at the most recent bull market period from July, 2012 to July, 2014. As shown in Figure 1, this was a great period for energy firms. Figure 4 plots the risk versus reward for the funds over this bull market time frame. As expected, all the funds did well and most (with the exception of IRR and FIF) had about the same risk-adjusted performance. Both IRR and FIF lagged during the bull market but TTP was the best performer. (click to enlarge) Figure 4. Risk versus reward during a bull market Bottom Line Energy CEFs are selling at large discounts and if you believe the bull market in energy will return over the near term, you should consider investing in CEFs. I would recommend PEO and TTP. PEO has a great long term record and I like it better than XLE. I would also consider adding TTP, which is relatively uncorrelated with PEO and did exceedingly well during the last bull market. Both of these funds offer good diversification and income while you wait for the bull to return. Disclosure: I am/we are long PEO, TTP. (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.