Tag Archives: pro

YieldCo Index ETF: The YieldCo Model Breaks – It’s A Bigger Lesson Than You Think

YieldCos were supposed to do for utilities what LPs did for energy companies. The potential appeared huge, with increasing investment in renewable power. Only the model just broke, and Global X YieldCo Index ETF is the evidence. The postmortem here is more instructive than you may think. Investors appear to always be on the lookout for the next big thing that will make them rich. Wall Street, meanwhile, is always ready to sell investors something that appears to meet that desire. Only time and time again, the opportunity doesn’t pan out. YieldCos are the current asset melting down. The Global X YieldCo Index ETF (NASDAQ: YLCO ) is proof of it. What’s the bigger picture lesson? What’s a YieldCo? A YieldCo is basically a company created or spun off by another company with utility assets that it would like to sell, but not necessarily lose control of. The YieldCo raises capital in the markets by issuing shares and debt, and then buys the assets of its erstwhile parent. The assets usually come with long-term contracts, so the revenues are reasonably certain to materialize, and the parent normally has operational control. The allure for investors is a stated goal to pay out large, growing distribution streams backed by more acquisitions. If this sounds roughly similar to the model that pipeline owners have used in the limited partnership space for years, it should. That’s basically the building block on which YieldCos have been created. It sounds like a win for everyone involved. Only, there’s one small catch. Access to capital markets. Talk about timing Wall Street’s financial alchemists have a habit of pushing things too far. And YieldCos now appear to be falling into that category. The best example I can provide is YLCO, an ETF that came public in late May of this year. Its shares have fallen by nearly a third since that point. YLCO stands as a warning to investors to not get caught up in the hot new thing. That can be hard to do, I know. Hot new things always seem to come with really compelling stories about how they are a “can’t lose” investment. Which is why you should always ask yourself why something you are looking at could blow up on you. In the case of YLCO, the answer to that is pretty clear: the fund would tank if the YieldCo space in which it invests doesn’t hold the promise that Wall Street believes it does. However, that’s not a deep enough answer, and it would be too easy to glass over the issue and stop there. After all, YLCO is buying a basket of YieldCos, which reduces risk through diversification. That’s why you need to go further and ask: What would kill a YieldCo’s potential? And could that happen across the YieldCo space? We know the answer now Looking at these questions in reverse order, we know that the chances of a broad YieldCo meltdown was pretty high. But what was the problem on the individual company level? The answer is access to capital. For a company that pays out most of its revenues to investors via distributions, growth has to come from acquisitions. But acquisitions can only happen if the company can sell more debt and equity at decent prices. If investors aren’t willing to provide that capital at desirable rates, the YieldCo loses its ability to grow. That will likely lead to a stagnant distribution and even fewer reasons for investors to buy its shares. The parent company, meanwhile, is stuck with a child that isn’t nearly as desirable to have around. And more or less everybody winds up a loser. For evidence of this take a look at the current troubles of NRG Energy (NYSE: NRG ) and NRG Yield (NYSE: NYLD ). NRG Yield makes up around 7.5% of YLCO, by the way. Commenting on NRG Yield, credit watcher Moody’s is taking a dim view of the future. Moody’s vice president Toby Shea noted, “The review for downgrade is prompted by NYLD’s lack of access to the equity markets due to the large, approximate 30 percent fall in its stock price in recent months. The ongoing inability to access the equity market creates uncertainty regarding the company’s financial strategy going forward.” Basically, the model is broken. Don’t stop there But what are the real takeaways? First, Wall Street’s hot new products are often better for Wall Street than main street and shareholders. I don’t want to be cynical, but this is as true today as it has always been in the past. And I find it hard to believe the future will be any different. It’s difficult, but try to keep this in mind whenever you see something new offered up as the next big thing. Second, YieldCos are probably not worth owning right now. And clearly, neither is YLCO. The risks far outweigh the rewards for all but the most aggressive investors. Third – and this is the one you really need to think about – what about other companies that have business models built on accessing the capital markets for growth? Limited partnerships are the most salient example, since they are facing their own demons right now. But they aren’t the only ones. For example, Student Transportation Inc. (NASDAQ: STB ) is rolling up the school bus space. But if it couldn’t access capital markets, its growth prospects would quickly fade. Then there are real estate investment trusts, or REITs. As a whole, I wouldn’t be too concerned about REITs. But not all REITs are created equal. I doubt that an industry leader like AvalonBay Communities (NYSE: AVB ) will be completely shut out of the capital markets. But what about apartment competitor NexPoint Residential Trust (NYSE: NXRT ), which is a relatively new entrant buying up second-tier assets with the intent of sprucing them up? It’s already leaning hard on the debt markets, if it can’t do that anymore, what does it do for growth capital? These two companies obviously sit at opposite ends of the spectrum, but there are variations all along the way. It’s worth taking a moment to ask the question for both new companies like NXRT, and also more established names – just in case. Stapled Shares One of the reasons why I brought up Student Transportation is because it came to market in a very different form. At the IPO, it was a stapled share, essentially pairing a share of stock with a piece of debt. The distribution was a combination of dividend and bond interest. It was a hot Wall Street idea not too long ago, meant to sate investors’ desire for income. Only, it didn’t work out as planned. And now most, if not all, of the handful of companies that came out as stapled shares have either gone away or converted their shares to plain old regular stock. The end result was usually a dividend cut for shareholders on top of capital losses. I watched stapled shares come and go. I owned a few. I got burned. It’s one of the reasons why I’ve been sitting on the sidelines with YieldCos. And why I’m watching single family home REITs with extreme interest, but I’m not buying any. Too new, too much of a fad, and the model could break down. It’s better to give Wall Street’s big ideas time to prove themselves. You certainly could miss out on gains, but you’ll also protect yourself from ideas that end up enriching Wall Street at your expense. YLCO is a symptom of a bigger issue, but it offers up an important lesson. Could YieldCos work out in the long run? Sure. Could YLCO turn out to be a great income opportunity in the ETF space? Yes. But for anyone who bought into the YieldCo story early, things aren’t working out quite as planned right now and there’s real potential that the idea is fatally flawed. It’s hard to resist the temptations of Wall Street, but when it comes to new things (corporate forms, IPOs, new products like esoteric ETFs) you are far better off stepping back and waiting. At the very least, take the time to consider what happens if the rosy projections offered up don’t pan out. In other words, always look for a reason why you shouldn’t buy something as you are reveling in the reasons why you want to.

A Critic Of Valuation-Informed Indexing Offers A Concise Case For Why Buy And Hold Is Superior

By Rob Bennett There’s only one difference between Buy and Hold and Valuation-Informed Indexing. Both are numbers-based strategies rooted in peer-reviewed research. The difference is that Valuation-Informed Indexers always make adjustments for valuation levels (believing, as Shiller showed in 1981, that valuations affect long-term returns) while Buy and Holders never do (believing that the market is efficient and that, thus, the market can never be overpriced or underpriced). I thought that this week I would present here a concise and clear and simple and sincere case for Buy and Hold that one of my critics posted as a comment at my site. Then I’ll offer my response to his words. To me, as a self-described ACTUAL Buy-n-holder, it’s this simple: Markets tend to go up over time. Ownership of common stocks have proven to be the best way for an average person to participate in, and profit from this ongoing economic growth. It has proven impossible to determine which particular stocks will outperform, or when they might do so. Buying, and then holding a market basket of ALL stocks that constitute the market, on a regular and recurring basis, without respect to ‘timing’, removes the uncertainty of guessing which particular stocks will be best, or which is the best time to purchase them. That’s it. People can refine, add gimmicks, accessories, etc., or even purposefully misconstrue (AHEM, looking at YOU, Rob!) but to me, THIS is the essence of buying and holding. So, for you to go on a decades long intense daily public jihad against those principles, and the people who espouse, and apply them, seems frankly… well, insane. You are free to use whatever market timing scheme, or other method you chose to invest, or course. But for you to characterize the above technique as “Get Rich Quick,” just to irk people and to hopefully draw attention to yourself, shows how both intellectually feeble, and also morally challenged you are. (I dare you to publish this.) Is it a “gimmick” to consider valuations when making decisions as to what stock allocation to go with at a particular time? I don’t think so. The research shows that the long-term return earned by an investor changes with changes in valuations. That means that stock investing risk is variable rather than constant. It follows that an investor seeking to keep his risk profile roughly constant MUST change his stock allocation in response to big valuation shifts. Why do the Buy-and-Holders have such a hard time with this idea? It’s because they start with an assumption that the market is efficient. That’s another way of saying that the investors who set the market price are rational. Is it? Are they? I don’t think so. I have engaged in discussions with tens of thousands of investors over the years. I certainly have seen many rational arguments advanced. But I have also seen many emotional arguments advanced. If investors are as emotional when making decisions as to their stock allocations as they are when presenting arguments on internet discussion boards, I think it would be fair to say that it would be dangerous to assume that the stock market is priced rationally. That said, I believe that the market in the long term really does set prices properly. It has to. The purpose of a market is to get prices right. In the long term, the stock market is like all other markets. But in the short term, it is not. That makes all the difference. Take a look at the disparity between the irrational price that applies today and the rational price that applies in the long term and you know in which direction prices will be headed over the next 10 years or so. It always works. We have 145 years of stock market history available to us. For that entire time period, investors have been able to effectively predict the price that will apply in 10 years by looking at the price that applies today. That’s amazing. That changes our understanding of how stock investing works in a far-reaching way. It means that, when prices go up by more than the 6.5 percent gain justified by the economic realities, we are collectively borrowing from our future selves to fool ourselves into thinking that we are richer than we really are today. That causes devastating problems down the line. Investors cannot plan their financial futures effectively if they believe numbers on their portfolio statements that do not reflect the long-term realities. And the bear market that must follow a bull market causes an economic crisis as trillions of dollars in pretend wealth disappears, causing hundreds of thousands of businesses to fail and millions of workers to lose their jobs. For numbers-based strategies to work, it is critical that we get the numbers right. And, if Shiller is right that valuations affect long-term returns, it is impossible for Buy-and-Holders – who do not make adjustments for valuations – to get any of the numbers right. The valuations factor is not a small factor. It is huge. A regression analysis of the historical data shows that the most likely annualized 10-year return in 1982 was 15 percent real but that the same number was a negative 1 percent in 2000. Yowsa! The bad news is that it is very hard for Buy-and-Holders to accept these realities. They have staked their lives on the old understanding of how stock investing works. The good news is that Shiller’s “revolutionary” (his word) findings change things in a highly positive way. If we can effectively predict long-term stock returns, stocks are not nearly as risky an asset class as we have long believed them to be. Perhaps I am wrong. But, if I am right, the future of stock investing will be a lot better for all of us than anything that we have seen or even dared to hope for in the past. Disclosure: None.