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Is DCA Ready To Bounce Back From Tax Loss Selling?

Summary This balanced closed-end fund has been hurt this year by its energy holdings. The 17% discount to NAV is higher than average due to tax loss selling. The high 10.9% distribution yield helps you earn alpha even if the discount does not narrow immediately. This is a good time of the year to look for closed-end funds that have been beaten down by tax loss selling. There is seasonal tendency for many of these funds to bottom out in late December and then rally the first few months of the next year. The Virtus Total Return Fund (NYSE: DCA ) was formed in February 2005. It is a global balanced fund that invests about 60% in equities and 40% in fixed income. The fund’s objective is total return, consisting of both capital appreciation and current income. (Data below is sourced from the Virtus website unless otherwise stated.) The equity portion of the fund invests globally in owners/operators of infrastructure in the communications, utility, energy and transportation industries. Its performance has been hurt this year by a 21% equity allocation to the energy sector including positions in Williams Companies (NYSE: WMB ), Kinder Morgan (NYSE: KMI ) and Enbridge (NYSE: ENB ) in the top ten holdings. The fixed income portion of the fund is designed to generate high current income and total return using extensive credit research. The fund managers seek to capitalize on opportunities across undervalued sectors of the bond market. About 43% of the fixed income allocation has been in corporate or emerging market high yield which has also hurt performance this year. The fund uses an option income strategy where it purchases and sells puts and calls, creating option spreads. The fund also uses leverage and borrows at short-term rates to invest at higher yields. There could be a good medium-term trading opportunity in DCA setting up from now until year-end because of tax loss selling. Over the last year, the average discount to NAV has been -12.42%, while it is currently around -17%. The 1-year discount Z-score is -1.58, which means that the current discount to NAV is about 1.5 standard deviations below the average. Source: cefanalyzer Five Year Historical Premium/Discount for DCA (click to enlarge) From an overall asset allocation perspective, DCA is similar to a global 60-40 balanced fund, but because of the leverage and sector concentration, it has higher risk than a typical balanced fund you would find at Vanguard or Fidelity. These were the asset allocation breakdowns as of Sept. 30, 2015: Equity Sector Allocation Breakdown Utilities 37.25% Energy 21.85% Telecommunications 18.58% Industrials 14.40% Financials 5.36% Consumer discretionary 2.56% Fixed Income Sector Allocations Corporate- High Yield 38.92% Corporate- High Quality 14.94% Bank Loans 11.55% Non-Agency Residential MBS 7.69% Non-Agency Commercial MBS 6.21% Mortgage Backed Securities 5.11% Asset Backed Securities 4.39% Emerging Market- High Yield 4.00% Yankee- High Quality 3.98% Non-USD 1.54% Treasury 1.52% Taxable Municipals 0.16% DCA has had about average long term NAV performance. But it may be good for a swing trade now because of the very high discount to net asset value. Since inception, it had big losing years in 2007 and 2008, and it is also struggling a bit this year. Here is the total return NAV performance record since 2006 along with its percentile rank compared to Morningstar’s World Allocation category: NAV Performance Table DCA NAV Performance World Allocation NAV Percentile Rank in Category 2006 25.40% 21.21% 100 2007 -41.41% 11.85% 100 2008 -66.08% -39.30% 65 2009 +27.75% +46.71% 91 2010 +48.54% +23.98% 25 2011 +6.29% -3.21% 13 2012 +15.29% +19.81% 78 2013 +13.12% +11.07% 56 2014 +13.60% +6.14% 20 YTD -4.98% -3.05% 64 Source: Morningstar The tables below are compiled as of September 30, 2015: Top 5 Countries United States 49.49% Canada 9.50% United Kingdom 8.43% Australia 5.10% France 3.91% Top 10 equity holdings Williams Companies, Inc ( WMB ) 3.62% Kinder Morgan Inc. class P ( KMI ) 3.57% AT&T Inc. (NYSE: T ) 3.36% Verizon Comm. (NYSE: VZ ) 3.28% Enbridge Inc. ( ENB ) 3.09% National Grid Plc (NYSE: NGG ) 2.87% NextEra Energy, Inc. (NYSE: NEE ) 2.66% Crown Castle Intl. (NYSE: CCI ) 2.25% Transurban Group Ltd. ( OTCPK:TRAUF ) 2.23% Atlantia S.p.A ( OTCPK:ATASY ) 2.13% Fixed Income Ratings Distribution Aaa 8.74% Aa 3.34% A 5.34% Baa 27.87% Ba 23.00% B 18.96% Caa 8.74% Not Rated 3.61% Fund management DCA is run by a team of three portfolio managers. All three managers have been with the fund since 2011. Connie Luecke, CFA Industry start date: 1983 Randle Smith, CFA Industry start date: 1990 David L Albrycht, CFA Industry start date: 1985 Alpha is Generated by High Discount + High Distributions The high distribution rate of 10.90% along with the 17% discount allows investors to capture alpha by recovering some of the discount whenever a distribution is paid. The fund has been paying a $0.10 quarterly distribution since April, 2014. Whenever you recover NAV from a fund selling at a 17% discount, the percentage return is 1.00/ 0.83 or about 20.5%. So the alpha generated by the 10.90% distribution is computed as: (0.1090)*(0.205)=0.0223 or about 2.23% a year. Note that this is more than the 1.58% baseline expense ratio, so you are effectively getting the fund managed for free with a negative effective expense ratio. Here are some summary statistics on DCA: Virtus Total Return Fund ( DCA ) Total Assets: 173 Million Total Common assets: 122 Million Annual Distribution (Market) Rate= 10.84% Last Regular Monthly Distribution= $0.10 (Annual= $0.40) Fund Baseline Expense ratio: 1.58% Discount to NAV= -17.08% Portfolio Turnover rate: 56% Effective Leverage: 27% Avg. 3 month Daily Volume= 75,964 (Source: Yahoo Finance) Average Dollar Volume = $280,000 DCA is a moderately liquid stock and usually trades with a bid-asked spread of one cent. You can often get some price improvement on marketable limit orders and buy or sell between the bid-asked spread. Because the price is so low, some care should be taken when trading DCA. DCA appears to be an attractive purchase for a swing trade at current levels with a discount to NAV of 17%, if you believe that the underlying portfolio has potential to bounce back from tax loss selling early next year.

Terraform Power’s Recent Moves Support Dividend Growth Of At Least 15% In 2016

Summary Terraform Power closed the first part of their planned transaction with Invenergy, 832MW of net wind power plants, increasing their current portfolio from 1.9GW to 2.8GW. I found it interesting that the company ended up changing the financing package for this transaction, which is expected to deliver unlevered CAFD of $139mil in 2016. Terraform also recently updated their purchase agreement with SunEdison for the producing assets of SunEdison’s deal to buy Vivint Solar. The updated deal projects that Terraform will pay $799mil to purchase 470MW of producing assets. These assets should produce annual CAFD of around $73-75mil. Both transactions support an increased dividend in 2016. The actual amount will depend on the timing of the transactions, but I expect 2016 exit rate of at least $1.60/share. Terraform Power (NASDAQ: TERP ) has had a pretty busy last couple of weeks. The company completed a large part of their planned transaction with Invenergy on Wednesday, buying 832MW of wind assets. This comes on the heels of the announcement last week of a renegotiation of the terms of SunEdison’s (NYSE: SUNE ) purchase of Vivint Solar (NYSE: VSLR ). The updates have removed many of the concerns investors have had with TERP, and the stock has responded in kind, as it has almost doubled from its late November lows. As I explain below, these transaction also support a continued dividend increase in 2016. TERP data by YCharts TERP came out with solid 3rd Quarter results in early November, but management’s unwillingness to confirm their previously estimated 2016 dividend increase to $1.75, and liquidity concerns at sponsor SUNE, led to the stock plunging over the next two weeks $6.73. At that point, the current yield was 20%. The market finally came to its senses when David Tepper announced a large stake and sent an open letter to management. Invenergy Transaction: Sources/Uses of Fund Changed One of the interesting takeaways from TERP’s announcement of the Invenergy transaction is the fact that they changed the way they ended up financing it. Back in July when the deal was made, the plan (see page 17) was to place half the MW into TERP immediately, and hold the other half in a SUNE warehouse. From August thru the 3Q earnings call in November, the plan (see page 18) was to only drop down 265MW and place the rest in a structured warehouse. Now it seems that management has decided to place all of the projects directly into TERP immediately. Sources of Cash   Uses of Cash   Non-Recourse Project Debt assumed or incurred with respect to transaction $801m 832MW of Wind Assets located in US and Canada $1,962m Pro-rata portion of $500mil new non-recourse term loan $417m     Cash on Hand (incld proceeds from TERP $300mil senior note offering in July 2015) $744m       $1,962m   $1,962m The press release notes that, “once all projects are operational, the first year adjusted EBITDA (before minority ownership) is expected to be $147 million, and unlevered CAFD (before all project and HoldCo debt payments) is expected to be $139 million.” Unfortunately, this doesn’t clarify how much we should expect the project and HoldCo debt payments to be, so it’s tough to predict how much of the unlevered CAFD will actually be available for dividend payments. My best estimate is to use the initially projected cash on cash yield of 8.4%, which equates to about $62mil (8.4% x $744mil cash on hand). We’ll have to wait for TERPs 4Q results for more details. The new $500mil term loan charges LIBOR + 5.5%, with a 1% LIBOR floor, meaning that TERP is currently paying 6.5%. It matures in 2019 and can be prepaid anytime, so it’s very likely that TERP will refinance this as soon as they can organize something with better terms. Vivint Transaction Terms Improve Last week TERP and SUNE announced that they had improved the terms of the Vivint transaction. TERP was able to reduce their initial purchase commitment from $922mil down to $799mil, by only paying for completed installations, and paying a reduced fee of $1.70/MW. The final total will depend on the actual number of producing MW transferred when the Vivint deal closes sometime during Q1 2016. In their Q2 earnings presentation, management noted that they expected the 523MW to generate average unlevered CAFD of $81 annually, so I project that the 470MW delivered at close will generate $70-75mil annualized unlevered CAFD. Considering the fact that TERP used substantially all of their cash on hand at the end of Q3 to fund the Invenergy transaction, it’s likely that they will be drawing on their revolver for much of the $799mil. The revolver’s rates are currently under 3%, so the annual interest would be about $24mil. Thus, I expect final CAFD to be about $50mil. 2016 Updated CAFD Projection Based on their 3Q presentation, TERP expected to generate CAFD of about $208mil before taking into account the Invenergy and Vivint transactions. If we assume that the Vivint transaction closes by the end of Q1, we should see annualized CAFD at the following levels next year: Quarter End Q1 Q2 Q3 Q4 Annualized CAFD $270m $320m $320m $320m CAFD distributed (85%) $230m $272m $272m $272m Per Share Quarterly Distribution $.35 $.40 $.40 $.40 The quarterly distribution estimates include the effect of SUNEs IDRs. I don’t expect TERP to actually increase the dividend to $.40 for Q2, even though it seems that operations would allow this. Rather, it’s likely that they will prefer to show steady quarterly increases up to $.40/share in Q4. This confirms my view that these transactions will cause TERP to increase their dividend by at least 15% over the next year.

Achieving 16.7% Returns With The Value Score

Summary What is the OSV Action Score? What is the OSV Value Score? How was the Value Score created? The Quality Score produces 16.8% CAGR in the tests that I’ve performed for the upcoming “Action Score” that I’m implementing into Old School Value. Next is the Value Score. Here is the full table of results again. stocks are bought at the beginning of the year held for one year rebalanced after 1 year commissions and fees are not included into these results If you followed this strategy, the 16.74% is the max return. After fees, it likely comes down to 13-14% range annualized. Here’s How I Created the Value Score When you create a ranking system (or even a screener) the higher the number of criteria, the worse the performance becomes. When picking individual stocks, making sure a stock passes lots of checks is a good strategy because you allocate based on your conviction. However, when you try to employ any sort of quantitative strategy, it is not a good idea to list 20 different criteria that must be passed. Of all the tests I’ve performed, a strategy with lots of checks consistently lose to the market by a wide margin. I mention this because people ask me whether I’ve tried combining several of the best performing value screeners on display. I have. And the results are pathetic. It severely handcuffs the number of stocks that pass and the screen ultimately fails. When you pick stocks individually, you have to be precise and picky. For anything quant based, it needs to be looser as you are buying a bunch. As I mentioned in the Quality Score article, instead of blindly coming up with metrics for each Q, V and G, I already had a list of metrics for each methodology based on previous research papers and proven results. Then the theory was tested and confirmed via backtesting. In its purest form, the Value Score is based on the following 3 factors: P/FCF – best range is less than P/FCF of 10 EV/EBIT – best range is less than 11 P/B ratio – preference for P/B to be less than 3 Here’s the initial backtest to confirm the theory for a 20 stock holding portfolio. Eliminating OTC stocks, financials, energy, mining or utilities and the results continue the outperformance. Great. Backtest works with the selected metrics. It now comes down to how well the same idea can be applied when creating a ranked database. To further clean up the results, additional weightings were applied to each of the above ratios. Then all the stocks are further ranked with the Piotroski score again to eliminate low quality stocks. P/FCF has the biggest impact on the results and receives the highest weighting EV/EBIT does a great job of identifying cheap stocks and receives the second highest weighting P/B acts as a “cleaning” filter to remove stocks where you overpay for assets. Also a way to remove bad stocks you wouldn’t want to own no matter how cheap it looks The Piotroski score is assigned a fairly high weighting so that the list removes “lotto” stocks and potential black swan stocks The Value Rank Results Even if I did follow this strategy, it’s not an easy one to follow. There is a LOT of volatility. If you can’t stomach big moves and have faith in the process, you are doomed. If you focus too much on beating the market each year instead of an absolute long term return, you are doomed. When buying and holding the top 20 ranked Value stocks each year for the entire universe of stocks, the scoring system achieves 16.74% CAGR. If you start with $10k, you’d end up with $138k after 16.5 years. Eliminate OTC, financials, miners, utilities and energy again and the results are shockingly great at 19.4% CAGR. $10k becomes $203.6K after 16.5 years. But what I don’t like about the Value Rank on its own is the lack of downside protection in 2008. Cheap stocks and growth stocks get hammered the most during severe bear years. But a -40% return is a huge blow and a can easily shatter your faith in the system and process. Something to think about. Top 20 Value Stocks from 2015 Here is the list of top 20 stocks that make up the Value Score portfolio starting from Jan 1, 2015 so that you get a sense of what type of stocks the Value Rating is selecting. Disclosure No positions in any stocks mentioned.