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The Global X FTSE Portugal 20 ETF: The Case Of The Double Edged Sword

Portugal may have decided to end its EU support too soon. The domestic corporate structure is too diversified, involving many holding companies. The private banking system has remained weakened by a 2014 default. For Europe’s smaller economies, European Union membership, as well as adopting the Euro has been a double edged sword. The idea was for commerce to have the same ease of access similar to the United States of America. Imagine, if you will, what it would be like if goods in Pennsylvania had to make border stops, use passports or visas and pay tariffs as they crossed the New Jersey, then New York, then Connecticut state’s borders! It’s difficult to imagine, but that’s essentially how European nations conducted cross border business before the EEC. Without those ‘technical, legal and bureaucratic barriers’, smaller European economies, such as Portugal, not only had an unimaginably large market for its products, but now had a new employment opportunities for its citizens as well as the potential to expand its manufacturing and financial services base. The ‘icing on the EU cake’ was being able to do away with unstable legacy currencies and adopt the Euro, further leveling the playing field. Indeed, the EU economy expanded pulling along the smaller economies but at an unsustainable rate. When the global credit market collapsed in 2008, the other edge of the sword cut smaller economies to pieces, causing a deep recession, high unemployment and unsustainable debt to GDP ratios, literally putting many governments on the edge of bankruptcy. Since then, the EU has had a slow, uneven recovery. However, having the support of the larger community, many smaller economies have pulled back from the brink of disaster. This is the point: is this the right time to establish a position in the smaller EU economies, such as Portugal? If the investor wished to, there seems to be one available ETF: the Global X FTSE Portugal 20 ETF (NYSEARCA: PGAL ) . The premise for risking your hard earned savings is based on the old Wall Street premise to ” buy low and sell high .” The question is whether the worst is over for Portugal and what the potential is, versus the risk. If a picture is worth a thousand words, the potential for capital appreciation might be interpreted by the fund’s chart since inception in November of 2013. (click to enlarge) The fund closed its first day of trading at $15.05. Within four months the ETF gained 22.8%. At that time, the entire EU economy was struggling with deflation. At the June meeting, ECB President Draghi imposed negative interest rates. Portugal was experiencing a nascent recovery. Portugal’s sovereigns had also recovered. Now able to finance the government on its own to meet its budget the government passed on a scheduled final EU bailout tranche. German Finance Minister Wolfgang Schaeuble noted that: Portugal is now managing without European aid and can stand on its own two feet. That’s a big success. However, within months, a subsidiary of one of Portugal’s major financial institutions missed a debt repayment. Banco Espirito Santo ( OTCPK:BKESY ) , the parent company, had its shares suspended from trading. The Portuguese stock market fell sharply. The default put the entire Portuguese banking system into question. This is an important issue to understand before investing in Portugal through the fund. However, Portugal’s economic stability goes further than the banks. It’s worth examining the fund’s holdings. First, it’s difficult to separate the fund into sectors. For example although classified as a Telecommunications services company, Sonacom (OTC: OTC:SOVTY ) also provides IT services with software and system information services. Sonae Capital (OTC: OTC:SGPMY ) is listed separately as a Consumer Discretionary company and also as a Consumer non-cyclical. Sonae is in the Hospitality and Recreation industry as well as retail food services, superstores, supermarkets, and drug stores. The Sonae brands fall under the management of one holding company. On a larger scale this is not out of the ordinary. However, this seems typical in Portugal’s small economy. Consumer non-cyclical and Discretionary Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business Jeronimo Martins OTCPK:JRONY $7.520 1.86% NA 26.97 13.38 23.84 Retail food, distribution; supermarkets, drug stores. Portugal and Poland Sonae SGPMY $2.00 3.30% 38.03 11.46 6.04 61.62 Retail food; superstores, supermarkets, franchise outlets; sporting goods, fashion and electronics Sonae Capital SGPMY $0.101 0.00% 0.00% 150 6.49 42.82 Tourism and Hospitality; resorts, marina, catering, fitness and golf courses Second, the quality of the Financial Services metrics indicates the underlying weakness in the sector. It was difficult to determine any metrics of Banif Banco Internacion do Fuchal (Lisbon: Banif) as it is a privately held company. The bank provides a broad range of banking services from retail to corporate, as well as asset management and insurance. Another of the holdings is Banco Espirto Santo ( OTCPK:BKESF ) , the bank which triggered Portugal’s banking crises shortly after the government had successfully restored its credibility in the sovereign debt market. Financial Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business Banco BPI OTCPK:BBSPY $1.46 0.00% 0.00% 82.27 9.54 57.63 Banking Services; corporate, institutional, retail, insurance, credit cards. Subsidiaries in Angola and Mozambique Banco Commercial Portugues OTCPK:BPCGY $2.85 0.00% 0.00% 67.95 11.94 149.69 Privately owned; financial services; asset management, mortgages, consumer credit, insurance Banco Espirito Santo Lisbon: BES $0.613 0.00 0.00 NA NA 237.84 Domestic, corporate and retail banking; credit cards, debit cards, savings accounts, management and insurance One bright spot is the Utilities sector, two of the holdings having respectable yields and one of those has a sustainable payout ratio. Utility Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business Energias de Portugal OTC:ELCPF $9.64 5.39% 17.64% of cash flow 11.69 3.62 225.55 Electric and gas in Portugal and Spain Renovaveis OTC:EDRVF $5.22 0.61% 47.56% 34.57 7.25 81.00 Spain based; renewable energy; hydro, wind, solar, tidal and biomass; EU, Brazil, Canada and US Redes Energeticas Naciona OTC:RENZF $0.810 6.14% 14.6% of cash flow 9.52 2.47 206.08 High voltage transmission; electricity; natural gas transmission and storage Portugal’s Basic Materials is concentrated in cements and cement related products. What is a very interesting feature of Portugal’s industrial Sector is its presence in Africa as well as South America, particularly in Brazil. On one hand this is a ‘plus’ as these companies provide their services in regions with a high growth potential like Egypt and South Africa. On the other had the investments in Brazil presents a problem for the fund as Brazil’s economy has recently been brought to a halt, along with a sharp currency devaluation, because of the collapse of commodity prices as well as a political scandal. Basic Materials Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business Portucel Lisbon: PTI $2.68 11.26% 104.94 14.42 9.26 47.89 Paper pulp, craft pulp Cimpor-Cimentos De Portugal OTC:CDPGY $0.320 0.55% nil 17.10 1.58 503.71 Cement and aggregate (clinker); ready-mix; Portugal, Egypt, Cape Verde, Angola, Mozembique, South Africa, Brazil, Argentina and Paraguay The Telecom Services are run-of-the-mill as far as the Telecom Sectors go. However it does present another example which lends to the confusion of how some holdings should be classified. Pharol (OTC: OTCPK:PTGCY ) is described as a ‘capital management company’ with a 27% holding interest in Brazilian Telecom Oi (Brazil: OIBR4) . Pharol seems to be more of a hedge fund specializing in the Telecommunications Services Sector, while also investing in other holding companies. Telecom Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business NOS SGPS OTCPK:ZONMY $3.53 1.86% 72.07% 45.12 8.81 98.06 Cable, Satellite, movies, series sports and children programming, mobile and landline voice, data Pharol SGPS PTGCY $0.338 24.10% NA NA NA 0.00 Capital management of Brazilian and Portuguese Telecoms Sonacom SOVTY $0.598 2.13% 30% of cash flow 14.15 12.63 0.94 Telecom mobile and landline; voice, data, television; also some IT software and system information Portugal’s industrials are focused on paper-pulp manufacturing. There are three paper-pulp manufactures in the fund, two of which fit into the Industrials Sector and one in Materials. There’s one major construction company, Mota Engil (OTC: OTC:MTELY ) providing engineering and construction including transportation infrastructure and then managing those projects after completion. Industrials Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business Correios de Portugal OTC:CTTPY $1.295 4.89% NA 18.95 14.70 0.57 Courier services, parcel delivery; financial services, transfers, money orders, digital mail Altri SGPS OTC:ASGSY $0.890 1.68% 74% of cash flow 9.87 6.56 192.25 Paper pulp; generates electricity from waste biomass Semapa-Sociedade de Investimento e Gestao OTC:SEMMY $0.967 2.88% 40.50 14.29 3.18 NA Paper pulp, cement, pre-casts, recycling of cooking oil. Tunisia, Angola, Poland, France Mota Engil SGPS OTC:MTELY $0.445 5.02% 12.8% of cash flow 15.26 2.50 485.19 Engineering, Construction; Environment and Transportation construction and management Lastly, there’s one position in the energy sector, a holding company, GALP Energia (OTC: OTC:GLPEF ) . Galp Energia produces, refines and markets gasoline and petroleum products. Another segment provides oil exploration services in 40 countries. Energy Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business GALP Energia GLPEF $7.06 3.78% N/A N/A 12.74 65.61 Holding Company, energy exploration, production As far as the fund metrics, management fees total 0.61% compared to the industry average of 0.44%. It’s a small fund with about $37.5 million in net assets. Since its November 2013 inception its cumulative return is -26.85% and an average annualized return of -14.70%. The price to earnings for 2015 is 15.37 and price to book 1.35. When referring back to the price history chart, it looks like the fund might be a really good opportunity for a capital appreciation investment. However, upon closer inspection, it was really too far out in front of its potential when it reached its all-time high of $18.48. Further, the private banking sector really needed a restructuring before the government ended the EU restructuring program, as Portugal’s domestic banking crises demonstrates. Some events of the banking crisis are noted on the chart. The price earnings ratio of the holdings weren’t all that bad. Excluding from the count any holding for which the data wasn’t available, and any extreme numbers, it averaged out to 26.20 which doesn’t seem too bad. However, many holdings would not be marginable in US equities markets, in particular, being priced below $5.00 per share. This raises another point. The combination of a low P/E and a low stock price may be an indication of ‘fair value’. Hence, the fund may be close to fair value at this level. It’s unlikely that Portugal’s economy can generate enough investment interest in the foreseeable future in order for the fund to work its way back to the 2014 high. On the bright side, this is a situation where the EU benefits the smaller economies, as it’s a potential safety net for the economy, if it’s necessary. In the current situation, Portugal is now attempting to restructure a weak banking system without direct EU support. An analogy may be made here between Portugal’s economy and the Greek economy. They are in similar straits; however the Greek government has (with difficulties) stuck with the EU bailout program. Portugal may have to reestablish its commitment to the EU restructuring plan. This would be a good fund to ‘bookmark’, and follow the news and events; however, it might not be the right time to establish a position.

Increase Your Portfolio’s Return By Dropping International Funds

Summary International stocks have underperformed historically – performing even worse in the recent past. Multiple hypothetical portfolios demonstrate the poor returns of international stocks. Short periods of outperformance by international stocks do not make up for their overall performance. Will International Stocks Really Outperform? With emerging markets in the dumps and international funds trailing the returns of domestic funds, analysts everywhere are calling for investment in international stocks, claiming that the chronic underperformance is a sign that they are “due” to outperform. International stocks may very well outperform in the next few years. There is nobody who can know that for sure. I am here to present the facts, and the facts show that international stocks have not been delivering on the promise of outperformance given their higher risk. An investment portfolio built entirely from U.S. stocks can outperform international portfolios while avoiding the political and currency risks of other smaller countries. Hypothetical Portfolios For the sake of this hypothetical situation, let us assume that the owner of this portfolio will be investing in 100% equities and plans to maintain that portfolio for the next decade before moving into some safer bonds. The owner of this portfolio currently has $300,000 invested. Let us see how this portfolio would have performed from 2005 to 2015. First, a control sample: 100% U.S. equities for the entire investment period, invested in the broadest manner possible with the Vanguard Total Stock Market ETF (NYSEARCA: VTI ). In this case, the portfolio would be worth $654,240 at the end of the investment period. Not too shabby, the portfolio has more than doubled with an annualized rate of 8.12% ( Source ). Let’s say the investor wished to broadly diversify his equity portfolio with companies from around the world, putting the U.S. weighting at around 40% with the Vanguard Global Equity Fund (MUTF: VHGEX ). In this case, the portfolio would be worth $533,880 at the end of the investment period. The portfolio has increased at an annualized rate of 5.93%. The investor has missed out on $120,360 ( Source ). Perhaps the investor believed that emerging markets would be a good addition to his U.S. equities. Let’s say the investor allocated 20% to emerging markets with the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ) and 80% to Vanguard Total Stock Market ETF. In this case, the portfolio would be worth $625,080 at the end of the investment period. The portfolio has increased at an annualized rate of just over 7.542%. The investor has missed out on $29,160 ( Source ). Let me note that emerging markets are the only international option I would consider. Emerging markets have outperformed U.S. markets from time to time and their current weakness has much to do with the strong U.S. dollar and oil prices. However, emerging markets do not represent all international stocks and therefore I still stand by the statement that international stocks, as a whole, underperform – as seen by the performance of broad international funds such as VHGEX. In all hypothetical portfolios, the investor would have been better off simply investing in the United States market and would have even paid lower fees (and perhaps taxes as well) while doing so. The below table and graph illustrate the results of including international stocks in your portfolio. (click to enlarge) (Excel, using data from Vanguard.com) (click to enlarge) (Excel, using data from Vanguard.com) International Stocks have Underperformed Historically U.S. funds have beaten international funds the past five, 10, 15, 20 and 25 years. Over the past 25 years, large-cap U.S. funds have gained an average 691%, vs. 338% for international funds. The graph below illustrates the difference in performance. (Please note I am not in favor of investments in managed futures. Managed future data is subject to extreme survivorship bias and the results are thus skewed. Survivorship bias is the logical error of concentrating on the people or things that “survived.” inadvertently overlooking those that did not because of their lack of visibility.) (click to enlarge) (AutumnGold) Small Bursts of Outperformance by International Stocks Don’t Make Them a Good Investment Some will argue that there are periods of time when international stocks outperform. This is true. However, these periods of time are often small and they haven’t made up for the underperformance both historically and lately, assuming investors invest gradually over time. For long term investors, a long history of strong performance is needed before an investment can be made. The United States stock market has provided that performance for over a century now. The below chart shows the periods of outperformance for domestic and international equities for roughly the past 20 years. As you can see, in the mid-80s international stocks did very well and mildly outperformed in the mid-2000s. However, in all other years the U.S. stock market outperformed and overall U.S. stocks came out far ahead as mentioned earlier, assuming you didn’t throw all your money into international stocks in 1984. However, most people invest over time and if you had done that, you would have had higher returns with domestic stocks. (Bason Asset Management) For the past 15 years domestic stocks have pulled ahead of international stocks by a fairly wide margin. This is achieved even when the domestic market returns are relatively normal compared to historical averages. International stocks have simply underperformed consistently. You would be very hard pressed to find an international broad market fund that has beaten a U.S. broad fund from inception to date with reasonable fees, assuming the inception dates are relatively similar and that the funds didn’t start around 1984. The Vanguard International Explorer Fund is one exception I have found as it has performed very well since inception in 1996. Unfortunately, over the past 10 years it has returned less than 6% annually. Having a Portfolio of Pure U.S. Stocks Outperforms and Provides International Exposure Investing in U.S. stocks doesn’t mean you lose out on foreign growth potential. In fact, U.S. companies are very savvy and have the luxury of being able to choose which countries to do business in. There is no reason the U.S. equity market can’t benefit from the growth of other nations. Companies in the S&P 500 get 46.2% of their earnings from overseas . If you are looking for diversification to reduce the risk of a drastic drop in your portfolio value, international stocks won’t help you. The 2008 stock market crash showed that all equities fell drastically at the same time. Investing in one country or another made no difference. So do the smart thing: invest in domestic funds and enjoy the decent returns, as boring as they may be.

FFC: A CEF Specializing In Preferred Shares Paying 8% Monthly

Summary FFC has been paying $0.13 monthly for 5 years. FFC uses leverage to increase dividends. FFC is a fund that is highly sensitive to interest rates. Flaherty & Crumrine Preferred Securities Income Fund Incorporated (NYSE: FFC ) is a United States based diversified, closed-end management investment company. FFC’s objective is to provide a high yield while preserving capital by using preferred securities. (TD Ameritrade) Flaherty and Crumrine serves as the investment advisor to the CEF. The 5 year chart below shows how successful this CEF has been in meeting these objectives: (click to enlarge) Source: Interactive Brokers The chart shows that FFC has consistently paid the current $0.13 monthly dividend for 5 years. At the end of each year the company adjusts the payout to match its annual earnings and consequently the December payout is often less than $0.13. The share price modulates somewhat but the median price over the past 3 years has been about $19.00 per share. For those of us that need and/or like to have dividends delivered to us monthly, Flaherty & Crumrine Preferred Securities Income Fund might be the right ticket. This closed end fund recently released its quarterly letter and offered the statistics shown below: Source: FFC Shareholders Letter dated 9/22/15 with statistics as of 8/31/15 Source: FFC Shareholders Letter dated 9/22/15 with statistics as of 8/31/15 Source: FFC Shareholders Letter dated 9/22/15 with statistics as of 8/31/15 Currently FFC is selling at a premium to NAV by about 3% since NAV is about $19.06 and the current price is around $20.10 per share. At this share price the CEF is offering an 8% return and about 8.5 % on NAV. FFC is able to offer this high yield because it uses leverage of around 35%. (Information from Morningstar) That means the fund borrows money to buy more shares over and above what it could buy with only its own cash. Operating expenses for FFC including interest for leverage are running at 1.39% of NAV. Excluding interest operating expenses are running at 0.87% of NAV which is relatively reasonable when compared to most other specialized mutual funds. (Taken from FFC’s Form N-Q filed for the 3rd quarter) Conclusion: As a matter of principle I normally don’t invest in a CEF when it is selling above NAV. You can see that at the end of August FFC was selling below NAV and was an opportune time to buy. Since the fund is currently selling above NAV, I recommend waiting until the fund is selling at or below NAV if you see this as a desirable vehicle for steady monthly income.. Be advised that this CEF is highly sensitive to interest rate changes and one should consider the direction of interest rates when buying this CEF. As interest rates rise, the cost of leverage increases which translates into higher expenses for the fund. Furthermore the value of the preferred shares is likely to decline as interest rates escalate hence NAV will drop as well. Capital losses could be excessive in an environment where interest rates are rising rapidly.