Tag Archives: united-states

Third Avenue Focused Credit’s Investor Freeze Re-Affirms Advantage Of Closed End Funds

Third Avenue Focused Credit shutting the gate on redemptions. A reminder that traditional open-end mutual funds can suffer “runs on the bank” if they hold illiquid assets during nervous market periods. Reminds us that closed end funds are the safer vehicle to hold high yield and other more illiquid asset classes. Third Avenue Focused Credit Fund ( TFCIX , TFCVX ) just dropped the bombshell that they are freezing the fund and barring investor withdrawals as it seeks an orderly liquidation. TFCIX, as a sort of “vulture fund,” operates at the lowest end of the high-yield bond spectrum, specializing in bankruptcies, turnarounds and other bottom-of-the-barrel opportunities. I had personally been quite enamored of the fund when it was launched in 2009 as a vehicle to take advantage of post-crash credit market bargains. In that sense I saw it as a vehicle for retail investors to get in on the opportunities typically only available to hedge fund and other institutional investors. The fund’s “Achilles Heel” turned out to be its status as a traditional “open end” mutual fund, where investors could liquidate their positions on a daily basis. In fact, in recent years it was the only open-end mutual fund I had continued to hold, feeling personally more comfortable with closed end funds where, if other investors want to bail out, they have to sell their fund on the open market, and cannot demand the funds’ portfolio managers cash them out at NAV by selling fund assets. That is a much safer vehicle for holding potentially illiquid assets, as high yielding assets like junk bonds, MLPs, BDCs, etc. have turned out to be recently. I started selling out my TFCIX a few months ago (as I explained in an article in early November), not because I was worried about the fund freezing its assets (I wasn’t that smart), but rather because I saw a unique opportunity, since it was an open-end fund offering cash back at full NAV value, to take advantage of that and put the funds back into the market via closed end funds at 10% discounts (or more.) So that’s what I did, completing my exit later in the month. By way of post mortem, I ran the numbers on my total investment in TFCIX over the past six years. I collected back 34% of the total investment in dividends over the holding period, about 8% per annum, accounting for the timing of the investment (i.e. it wasn’t all outstanding the entire period). Then I gave back about 25% of the total investment in capital loss. That means I only made about 9% in total on my money, spread over 6 years. An opportunity cost, for sure, and a waste of earning power, since if invested better it would have been earning 6-7%. But – fortunately – not a disaster. To me this reinforces: · The attractiveness of closed end funds as the vehicle of choice for holding high-yielding illiquid assets, since you have the option of sitting out periods of market volatility while clipping your coupons and waiting for the storm to pass; and · The advantages of holding high yielding assets (equity and fixed income) in general, as a hedge against market losses, since the cash flow acts as a buffer over time to offset market depreciation.

Portfolio Diversification Strategy During The Fed’s Rate Hike Cycle

Summary Where the Fed, analysts and the market see the Fed funds rate and when. What we’re trading and how to capture the move higher in the Fed Funds rate. How to experiment with any potential outcome for this fully disclosed Fed Funds Trade. HCB Stocks & trading strategy, which I believe will offer a superior return on risk during the rate hike cycle. I believe diversification and objective risk control will be essential during the next 36 months as the Fed gradually hikes rates. My objective of this report series is to introduce new sectors and strategies to capture the major market moves being generated by current extreme economic fundamentals. As opportunities develop in metals, energies and currencies I’ll share what I’m doing in these sectors and how. I encourage your comments on sectors and trades your in with similar or higher returns on risks. The goal of this report series is generating POSITIVE dialogue among fellow TRADERS who share the objective of finding the most effective solutions to the problem of making money. It’s not set up for tradeless academic master debaters who can subjectively criticize but can’t offer objective facts to support their opinion or a solution. In this report I have provided strategy to capture the move higher in the Fed Funds rate over the next 13 months . I’ve also included 11 HCB stocks (high cash buffers) that could benefit from higher rates and included defined risk strategy on how to trade them during the rate hike cycle. The first rate hike in 10 years is on deck in 5 days (16 December 2015). Using this fully disclosed strategy even if the Fed is wrong about the Fed Funds rate the Fed sets, there is no hike on 16 December 2015, this position is structured to maintain and capture any future rate hikes over the next 9 FOMC meetings through 31 December 2016. Last objective guidance where Fed Chair Yellen sees the Fed Funds rate and when (video 1:59) Source Federal Reserve What the move is worth Current contract value = $552 (cash market 0.1325%). Fed projection by December 2016 = $7,500 (1.8000%). Fed projection by December 2017 = $13,125 (3.1500%). Probability = 85.30% for 16 December 2015 . Source Chicago Mercantile Exchange Click here for more information on what this rate is and how it’s set. One simple trade to capture the move higher in the Fed Funds rate through 31 December 2015 . Trading the Fed Funds rate higher requires establishing a short position in the underlying futures contract . To convert the contract price into the rate it represents Take 100.00 – the contract price = the rate. Example 100.00 – a contract price of 99.46 = a rate of 0.54%. Each 0.01 change in price = $41.67 change in contract value. Position Short at 99.46, the December 2016 CME futures contract (ZQZ16) Trading this rate higher from 0.54% Contract value = $2,250 Objective The Fed’s target by 31 December 2016 Contract price = 98.20 Rate = 1.80% Contract value = $7,500 Click here to enlarge the rate, price, valuation chart below Current chart and quotes To experiment with any potential outcome for this trade. Click here and open the interactive risk reward spreadsheet Watch the 5 minute video linked below on how to use it As this position appreciates we’ll update its performance and share hedging strategy/updated spreadsheest showing you how we’re locking in gains. This trade was originally posted on Seeking Alpha 12 October 2015 . Federal Open Market Committe meetings schedule & Fed statements The last tightening cycle from 1.00% June 2004 to 5.25% June 2006 Stock diversification strategy during the rate hike cycle Below are 11 companies that have built sizable cash buffers and links to monitor them on SA moving forward: Apple (NASDAQ: AAPL ), Microsoft (NASDAQ: MSFT ), Alphabet (NASDAQ: GOOG ) (NASDAQ: GOOGL ), Pfizer (NYSE: PFE ), Cisco (NASDAQ: CSCO ), Goldman Sachs (NYSE: GS ), Moody’s (NYSE: MCO ), Oracle (NYSE: ORCL ), AT&T (NYSE: T ), AbbVie (NYSE: ABBV ) and JPMorgan Chase (NYSE: JPM ). From past ratios and what I’m seeing between interest rate hike expectations through December 2018, relative to stock price change, it appears rate hikes might actually fuel these stocks higher. I’m trading these stocks using “collars” to define my risk on all trades and for the duration of every trading period. Example of a “collar” to define risk: Own 1,000 shares of GOOGL at $745 Write the $800 call collecting premium (1,000 shares) Using the collected premium buy the $700 put (1,000 shares) Trade outcomes 1) The market stays the same, if you set the trade up right you should be collecting approximately as much time value on the $800 call you’ve written against your $745 long position as you’ve spent on the purchase of the $700 put to hedge the position. In some scenarios you’ll actually have a credit. 2) Market sells off hard to $500, your loses below $700 are negated by the put you’ve purchased at $700. At $500 you can offset the put for a $200 profit and reestablish a new hedge by buying a new put at $500 lowering your entry cost by $200. Your new average entry price has now dropped from $745 to $545 making recovery more obtainable. 3) The market continues to move higher and the position is called away at a profit at $800, you can always reestablish it. Click here for more on Seeking Alpha on why we’re trading these high cash buffer (HCB’s) stocks and how.

Is There A Merger Arbitrage Opportunity In Cleco?

Summary Cleco agreed to be acquired by a group of North American infrastructure investors led by Macquarie Infrastructure and Real Assets (MIRA). We believe the likelihood of the deal closing is high. The deal is expected to close in the first quarter of 2016. Shares look appealing with a weighted return profile of 22.87%. This article discusses the potential merger arbitrage opportunity in Cleco (NYSE: CNL ). On October 20, 2014, a group of North American infrastructure investors, led by Macquarie Infrastructure and Real Assets (MIRA) and British Columbia Investment Management Corporation (bcIMC) (Group), entered into a definitive agreement to acquire Cleco for $55.37 per share in cash. The deal is valued at $4.7 billion, which includes ~$1.3 billion of CNL’s debt. Cleco is a public utility company and owner of regulated electric utility Cleco Power LLC. It has served residents and businesses in Louisiana for almost 80 years. It owns 11 generating units with total capacity of 3,340 megawatts. This partnership will allow the company to operate as an independent and local business, which will help it stay focused on keeping its strong culture. Cleco is a well-run utility with a dearth of knowledge, experience, and expertise. It’s a very attractive infrastructure business, which just so happens to operate in a regulated, but stable industry. These attributes should help the company grow long term. Here’s what Bruce Williamson, Cleco’s chairman, president and CEO, had to day about the deal: “With this agreement, Cleco’s existing investors will receive an exceptional value for their shares to top off a superior total shareholder return of the past few years, and our customers and employees can expect us to retain our strong commitment to service and reliability. The board and management worked together in structuring this transaction to deliver a premium valuation to our public shareholders and ensure a continued local presence in the communities Cleco serves. This agreement is the right transaction for our shareholders, employees, retirees, and customers of all types. The new owners understand the value Cleco brings to the region and are committed to Cleco’s strategy as a safe, reliable electricity provider positioned to meet Louisiana’s long-term power needs.” So is there opportunity as a merger arbitrage candidate? Let’s dive in and find out. Despite the drop in commodity prices, this group led by Macquarie has very deep pockets. The new owners plan on refinancing Cleco’s debt at closing. The group of investors includes Macquarie, British Columbia Investment Management Corporation, and John Hancock Financial. We do not see a high probability of failure given the group’s strong capital position. The deal is said to close in Q1 of 2016 (three months); both sides appear to be excited about the deal and the synergies involved. Final stages of the state regulatory approval process have pushed the initial timeline back to Q1 2016. Initially, the deal was supposed to be finalized in Q4 2015, but utility deals always seem to take longer than expected. The Louisiana Public Service Commission (LPSC) stated that it was “recommending strong commitments” from the investor group. The investor group filed testimony with more than 70 commitments addressing concerns raised by the LPSC. The commitments appear to be more than adequate, and management expects the deal to go through in Q1 2016. Cleco is currently priced at ~14x FCF, which gives an implied yield of 7.26%. In addition, the company sports an EV/EBIT of 14.85. Although shares are not significantly undervalued at current levels, we would be surprised by a takeover either. However, the current commodity depression may hamper and potential bidders. There are many uncertainties around potential mergers, such as anti-trust approvals, multiple government reviews, changes in market conditions, shareholder approval, and due diligence. If the deal was not completed, we would expect prices to drop to the pre-deal price of $48.50, or a loss of $3.55. We give the deal a 95% chance of being complete based on the parties and terms of the buyout offer. If we look at the recent quote, the stock is trading at $52.05 per share, $3.32 below the announced cash offer of $55.37 per share by the investor Group. We calculate our expected return with the probability of a successful deal ($3.32 x .95 = $3.15). And we subtract that from our expected loss with the probability of that loss occurring (3.55 x .05 = $0.18). This is the expected weighted return, which gives us a potential return of 5.72%, or $2.98 per share. To calculate our annualized expected return, we divide that by the expected time of holding in years (three months = .25). This gives us an annualized expected return of 22.87%. Bottom Line The Cleco acquisition is an interesting deal. And we do not see a high probability of failure given the investor Group’s strong capital position. The regulatory interference concerns us some; however, it appears that the recent commitments from the investor Group may be more than adequate for a state regulatory approval. This appears to be an interesting opportunity at current levels with a potential 22.87% annualized return profile. The return appears to justify the risk in this case. Notable Shareholders: Abrams Capital Andromeda Capital Bryn Mawr Capital LMR Partners Adage Capital GAMCO Diamond Hill Capital Please share your thoughts in the comments section below, as I learn just as much from you as you do from me. It can be a time-consuming endeavor, but I answer all of your comments and questions myself. Your patience and understanding are greatly appreciated. Disclaimer: Merger-arb can be tempting for investors to use leverage to increase their annualized return on high probability events…Resist the urge! Many Wall Street firms conduct merger-arb as their main business and they will normally have 50 or more merger-arbitrage investments at any one time. They understand that if a couple of deals go bad, the winners will more than take care of the loses. Merger-arb can be a very crowded strategy at times. Similar to value investing, it can be cyclical and go in and out of favor over time. The key to merger-arb is to focus on the few deals that are highly probable (ideally ALL cash deals) with minimal regulatory hurdles and an acquirer with a great capital base. And if you’re new to merger-arb, watch a few deals play-out over various industries to get an understanding of the deals. If you do invest in merger-arb situations conduct proper due diligence and make sure to spread your risk appropriately. If you are so inclined to learn more about these types of special situation, I highly recommend Graham’s writing on arbitrage in his Security Analysis book.