tag:blogger.com,1999:blog-92135389273780128852024-03-05T01:55:29.673-07:00Life, Investments & EverythingThe Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.comBlogger58125tag:blogger.com,1999:blog-9213538927378012885.post-30908004871645899972014-02-17T01:00:00.000-07:002014-02-17T01:00:08.525-07:00Natural Gas At A Crossroads: Heading For A Shortage Or is The Market Still Oversupplied?<strong><em><span style="font-size: large;">Against The Backdrop Of An Extremely Cold Winter, The Natural Gas Market Wavers</span></em></strong><br />
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Natural gas prices have been in the dumps for a couple of years as the drillers found lots and lots (and lots) of gas reserves onshore in the US that are extractable at a reasonable cost using modern production technology. As producers went hog wild in drilling wells, inventories piled up, prices crashed ($2/MCF natural gas was not that long ago) and natural gas consumers (utilities, chemical companies, etc.) starting burning up as much of the stuff as they possibly could. It seemed the glut of natural gas would never go away and prices would always be low. However, the winter of 2013-2014 has proven to be one of the coldest in a couple of decades and demand has suddenly ballooned for natural gas as heating fuel. The overhang of excess supply is about gone as everyone tried to stay warm and prices have risen to in excess of $5/MCF for the front month future and $4 and change for the rest of the futures curve. In times past when supplies have gotten short in the natural gas (and just about every other commodity) market, it has not been uncommon to see parabolic upward moves in the price of the commodity. However, natural gas is nowhere near panicky shortage pricing that has been seen in the past (natural gas was $20/MCF after the 2005 hurricane season), perhaps due to the view that we are still standing on a sea of natural gas and any shortfall in supply will be temporary. Which way will natural gas prices move in coming months and more importantly how can an investor most appropriately make money off whatever direction the market moves?<br />
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There is no denying that the US has ample natural gas reserves. Even the laziest Google search will bring up estimates of a 75 year supply at current consumption rates, ever-increasing recoverable reserve estimates, etc. The important question is what price for gas will be necessary to induce natural gas drillers to pull the stuff out of the ground and supply the market? That price has varied wildly over the last decade, ranging from below $2/MCF to (briefly) $20/MCF. Technology has greatly changed the nature of the US onshore natural gas industry. Advanced drilling techniques have increased producers' ability to find gas reserves and have greatly reduced production costs. Entire new gas fields have been discovered (Marcellus and Utica Shales, to name two recent finds) and in many cases the only impediments to ramping up production are getting a high enough price for the gas and building out the pipeline and gas processing infrastructure to connect new wells to end users. Gas producers were so successful in finding and producing more gas that they crashed the price of gas, landing themselves in cash flow binds and crushing their stock prices in the process. A big part of the rush to drill was the need to fulfill the terms of the leases they struck with the owners of the land where the gas resides. Under "held by production" terms, the gas producers had to do a minimum amount of drilling within a certain time in order to gain a long term right to the gas reserves. Since there was a land rush going on with several competing companies racing to secure reserves in newly discovered fields, there was a lot of required drilling going on and a consequent oversupply of the market.<br />
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However, things seem to be changing. One of the most undisciplined land grabbers (Chesapeake Energy, CHK) ran out of cash and was essentially forced by circumstances and its capital providers to dramatically scale back both reserve acquisition and drilling activity and live within its means. This seems to have been a watershed event for the industry as CHK's peers and competitors felt less pressure to compete for reserves and in many cases ran out of cash to continue doing so. With less land grabbing going on, the frantic drilling of wells to hold reserves by production has gradually tailed off and drillers seem to have largely ceased such activity. As you can see, the count of active rigs is down significantly: <br />
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There are some problems with relying on reported natural gas rig counts, as oil well drilling often results in significant incidental natural gas production. However, it is hard to escape the conclusion that the industry has been forced to exercise more restraint and discipline in how much gas is supplied via new wells. In the face of decade-low gas prices there is only so much the capital markets will allow you to borrow to engage in what amounts to vanity production with no obvious economic returns underpinning the activity.<br />
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Despite the ratcheting down of supply, inventories were quite heavy until the very cold winter weather of the last few months spiked demand. Unless you live in southern California or the tip of Florida, US residents have experienced gripping cold and consequent high demand for all forms of heating fuel. With natural gas being a popular choice for home heating, excess inventories have been burned up rapidly. The following table shows natural gas inventories in the US in billions of cubic feet (BCF):<br />
<br />
<table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse; width: 173px;">
<colgroup><col style="mso-width-alt: 2901; mso-width-source: userset; width: 61pt;" width="82"></col>
<col style="mso-width-alt: 3242; mso-width-source: userset; width: 68pt;" width="91"></col>
<tbody>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border: 0.5pt solid windowtext; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">04-Oct-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: windowtext windowtext windowtext black; border-style: solid solid solid none; border-width: 0.5pt 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">3577</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">11-Oct-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">3654</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">18-Oct-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">3741</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">25-Oct-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">3779</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">01-Nov-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">3814</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">08-Nov-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">3834</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">15-Nov-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">3789</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">22-Nov-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">3776</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">29-Nov-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">3614</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">06-Dec-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">3533</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">13-Dec-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">3248</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">20-Dec-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">3071</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">27-Dec-13</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">2974</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">03-Jan-14</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">2817</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">10-Jan-14</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">2530</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">17-Jan-14</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">2423</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">24-Jan-14</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">2185</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">31-Jan-14</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">1923</span></td>
</tr>
<tr height="18" style="height: 13.2pt;">
<td class="xl67" height="18" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 13.2pt; width: 61pt;" width="82"><span style="font-family: Calibri; font-size: x-small;">07-Feb-14</span></td>
<td class="xl69" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px; width: 68pt;" width="91"><span style="font-family: Calibri; font-size: x-small;">1686</span></td>
</tr>
</tbody></colgroup></table>
Source: EIA<br />
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Supplies are now below the 5 year average for this time of year. More cold weather has been hitting the major consuming regions (Midwest and East) lately, so significant withdrawals from inventories are likely in the next few weeks. Traditionally, withdrawals from storage related to heating season end about April 1. Depending on the weather, there could be a lot more withdrawals from storage before the cold weather is over.<br />
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Against the backdrop of less extensive supply, natural gas prices have risen from about $2/MCF to between $4 and $5/MCF depending on which month of the forward curve you look at. While this is helpful to natural gas producers, even $5 gas is just enough to keep these companies alive, especially since many producers have weakened balance sheets in the aftermath of persistent low gas prices. The industry really needs sustained $6/MCF or higher price to make solid profits, pay down debt and reward long equity positions. What would it take to get back to $6/MCF or better? At least in the short term, a shortage of natural gas would almost certainly do it. With a bit more heating demand, it is entirely possible that natural gas inventories could drop below 1 trillion cubic feet (TCF) this year. The last time inventories dropped below 1 TCF was the end of February 2003. This shortage occurred after a prolonged period of low gas prices ($2/MCF) and a number of natural gas producers were in financial distress (sound familiar?). The most convenient way to see the effects of the shortage on natural gas prices is via the price history of the March 2003 natural gas future:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEihJ86yS9wxAwObbJ-RSIk7l1yZv1FVCJY-KbfjpO9aYyG25nKKSI_Fdds5oJZcO47SRyQ1IZjVg1JhYlrWjHPqL2FsH-gu8NG0VcRNJ1cP2QhvgHzZGeuxDewmxPgP-wZ1LN8UzFNyrgE/s1600/NG32003.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEihJ86yS9wxAwObbJ-RSIk7l1yZv1FVCJY-KbfjpO9aYyG25nKKSI_Fdds5oJZcO47SRyQ1IZjVg1JhYlrWjHPqL2FsH-gu8NG0VcRNJ1cP2QhvgHzZGeuxDewmxPgP-wZ1LN8UzFNyrgE/s1600/NG32003.png" height="147" width="640" /></a></div>
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The graph seems to have lost its dollar values, but the contract spent much of its time between $2 and $4/MCF until the shortage unfolded. Within the space of a few months, the contract ground upward as supplies dropped and then as inventories dropped below 1 TCF the price spiked dramatically. The contract peaked at just over $10/MCF and settled at over $9/MCF. Gas prices subsequently settled out at about $6/MCF, sometimes higher, in subsequent months. Since this occurred back in 2003, inflation adjusted prices would be about 27% higher in 2014. Not surprisingly, 2003 was an extremely remunerative year for investors in natural gas equities.<br />
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Sounds pretty enticing as a long story, eh? Of course, there is always the counter-argument. There is no avoiding the fact that natural gas producers have been extremely poorly disciplined when it comes to balancing the supply they bring to market with demand. Many natural gas drillers operate via a very simple mantra: if they get a dollar, they use it to drill. It does not matter whether the dollar is borrowed, earned, raised via an equity issuance, or stolen: they use it to drill. The few exceptions to this sorry track record include some of the largest, most profitable, most admired companies in the world (e.g. ExxonMobil). That aside, there is definitely some possibility that the response of the natural gas industry to even modestly higher prices will be to once again flood the market in an orgy of overproduction. Clearly, there is a sizable number of investors who believe that this will be the case. Many natural gas producers including CHK and Ultra Petroleum (UPL) have significant shrt positions in their shares. This assumption is also likely a major reason why natural gas producer equities have had a restrained upward movement in the face of natural gas prices more than doubling from the lows. <br />
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There are people and organizations who spend all their time following natural gas consumption trends, weather impacts, etc. there are very well informed analysts following trends at the well level to monitor what the natural gas producers are doing. It is highly unlikely that I or any other generalist or retail investor will outguess the specialists. All we can do is try to play the odds, especially when there appears to be an asymmetric risk-reward balance. Over the past 6 months natural gas futures have risen significantly while natural gas equities have risen modestly, as you can see from this graph:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjpHDT-qhfDKHDw2Ri8a-7s2UgGTf17MY4KmQJ1Rgcm82aU7PzplZzHldnFNMSLAsvL0BLCP1asoLJGV9et_Swtq6SYqjL6MN8qLVWsHfFrA-LiWKow8dcF0Nw68fO1YcASFY4jE5DfJT8/s1600/fcg+vs+ung.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjpHDT-qhfDKHDw2Ri8a-7s2UgGTf17MY4KmQJ1Rgcm82aU7PzplZzHldnFNMSLAsvL0BLCP1asoLJGV9et_Swtq6SYqjL6MN8qLVWsHfFrA-LiWKow8dcF0Nw68fO1YcASFY4jE5DfJT8/s1600/fcg+vs+ung.png" height="379" width="640" /></a></div>
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FCG is an ETF that holds natural gas driller equities, while UNG is an ETF that tracks natural gas futures. The equities in the space have not risen nearly as much as natural gas prices even though most of these companies have material balance sheet leverage and operating leverage to the price of natural gas. I suspect that this is because investors are not convinced that the rise in natural gas prices will be sustained and there is a good chance that the companies in this industry will soon flood the market and find themselves in exactly the same predicament they were in 6 months ago. However, this situation offers a potentially lucrative trade opportunity. If natural gas prices decline back to the $3 to $4/MCF range after the end of the heating season, it is likely that natural gas equities will decline 5 to 10% as they return to the valuations they had before natural gas crested $5 on the front month future. On the other hand, if the 2013-2014 winter results in inventories falling below 1 TCF and this becomes a watershed event for the industry, natural gas equities are likely to offer outsized returns to investors. As an example, between mid-February 2003 and mid-February 2005 CHK went from $8/share to $18/share.<br />
<br />
Will a shortage of natural gas develop? It is wise to remain agnostic. However, for the first time in years there is a realistic possibility that gas prices may rise enough to take this much-beleaguered and widely-shorted industry out of its doldrums. A position in natural gas equities via an ETF like FCG or individual company equities may offer strong potential upside in the next several months.<br />
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As always, this is not intended as investment advice. Consult your advisors, do your own due diligence, take your own risks. Commodity producer equities are risky and you could definitely lose money on this stuff.<br />
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Disclosure: I am long CHK equity and UPL equity and calls.<br />
The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com2tag:blogger.com,1999:blog-9213538927378012885.post-26682972571857910112014-02-12T14:19:00.000-07:002014-02-12T14:19:26.524-07:00Stable Value Funds: 8th Wonder Of The World Or Smoke And Mirrors?<strong><em><span style="font-size: large;">How Stable Value Funds Work And How Best To Use Them</span></em></strong><br />
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<em><span style="font-size: x-small;">Get it? A stable.</span></em></div>
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Many 401k and 403b plans have a stable value fund (AKA interest income fund) as one of the investment options. These funds don't have a ticker symbol, have sometimes rather vague and opaque disclosure documents available on them, and it is hard to get any research or informed opinion on them. Stable value funds are only offered in "qualified" retirement plans such as 401ks and 403bs. All most plan participants know about them is that they are "stable" and sometimes what the current interest rate offered by the fund has been recently. In this post I will discuss how these funds are constructed and the best way to use them in your 401k or 403b.<br />
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First, what exactly is in these funds? In days of yore, these funds were primarily made up of "Guaranteed Investment Contracts (GICs) issued by a large, creditworthy life insurance company. Traditional GICs typically have a fixed rate of return promised for a specific time period and the insurer generally agrees that the funds can be withdrawn before the scheduled maturity of the contract if the stable value fund experiences large withdrawals by 401k/403b participants. GICs are fairly simple instruments that resemble a jumbo (millions of dollars) deferred fixed annuity or a CD. Traditional GICs were the mainstay of the stable value fund industry and remain a important component of stable value funds. However, they have a couple of key drawbacks. First, these are unsecured promises from an insurance company. There is no FDIC equivalent for life insurers, so if the insurer goes belly-up, the manager of the stable value fund gets to get in line with all of the other policyholders and creditors in the hopes of getting some recovery. Second, stable value fund managers are very picky about which insurers they will buy traditional GICs from because of their unsecured nature. As a result, they will generally only buy traditional GICs from the largest, best-rated insurers which presently total 6 or 7 life insurance groups in the US. With only a handful of insurers to buy from and given that the creditworthiness of all these insurers is probably highly correlated between one insurer and the rest, relying solely on traditional GICs to assemble a stable value fund means that such a fund would be very poorly diversified. Since these funds are meant to be the least risky investment option in a retirement plan, a lack of diversification is simply not acceptable.<br />
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The solution was the development of the "synthetic GIC." Stable value fund managers really have three requirements for their funds: a high degree of safety and liquidity, accounting treatment such that the NAV of the fund never fluctuates aside from the increase due to interest income, and a reasonable rate of return. The traditional GIC provided all three, but required accepting a material degree of counterparty risk and a lack of diversification. So stable value managers began deconstructing the traditional GIC to meet the requirements of stable value funds. What insurers do with the cash generated by selling a traditional GIC to a stable value fund is invest the money in a portfolio of liquid, highly rated fixed income securities that mature about the time the GIC matures. The insurers then earn more in interest on the portfolio of bonds than they pay out to the stable value fund in interest. Stable value fund managers usually also manage large portfolios of bonds, so they chose to cut out the middle man. Rather than handing over money to insurers on an unsecured basis and getting less than the resulting investments earned, the stable value managers kept the money in the stable value fund and invested it in a high grade bond portfolio. This satisfies two of the three requirements for stable value fund assets, namely safety & liquidity and a reasonable rate of return.<br />
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However, such a portfolio would not qualify for accounting treatment of no NAV fluctuations as the fund would drift up and down with the market price of the bonds. To achieve a stable fund NAV, managers of these funds contract with financial institutions (including insurers and banks) to have the stable NAV guaranteed by the institution in return for a fee. These contracts are known as "stable value wraps" or "synthetic CGICs" and usually have the financial institution guarantee a specified pool of assets for an agreed upon period of time. Synthetic GICs also usually have numerous terms and conditions, including the allowed make-up of the guaranteed bond portfolio, where the specific contract stands in line if there is a large withdrawal from the fund, and even restrictions on competing investment options available to plan participants (no money market funds allowed, for example) or how plan participants can move their money among investment options (the so called "equity wash" - more on this later). Once again, the stable value wrap contract is an unsecured exposure of the stable value fund to the financial institution counterparty. Although this is a risk to the fund, because the fund retains the invested assets rather than having the insurer control them the risk of insurer insolvency is reduced to the amount the guarantee comes into the money rather than the entire invested amount (in most cases, a synthetic GIC might have 5% of the counterparty risk that a traditional GIC would have). The inclusion of banks and other financial institutions in the stable value wrap market also allows much greater counterparty diversification compared with the 6 or 7 life insurers that dominate the traditional GIC market. Not surprisingly, stable value fund managers have made extensive use of stable value wrap contracts and most stable value funds have a mixture of traditional GICs and synthetic GICs.<br />
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To summarize, stable value funds typically contain a mixture of insurance contracts from the largest, most highly rated life insurers plus pools of high grade bonds with a guarantee extended by the largest and most highly rated financial institutions. These underlying instruments will typically have maturities ranging from 2 to 5 years and be of AA/Aa2 or better average credit quality. This is not equivalent to an FDIC-backed instrument like a CD, but the diversification, very low credit risk, and modest interest rate risk of stable value funds means that it is very unlikely that plan participants will ever lose money on the stable value fund in their plan. The nature of these funds also means that their returns over time will approximate the yield on medium term, high grade bond funds. Unlike bond funds, stable value funds do not expose investors to fluctuations (both positive and negative) in NAV due to market price movements in the underlying bonds.<br />
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So now that you know what is in these funds and how they work, what is the best way to use a stable value fund in your portfolio? By far, the lowest hanging fruit is to use stable value funds as a stand-in for a money market or short term bond fund if you choose to hold that asset class in your tax deferred portfolio. Stable value wins on both counts: lower risk and usually higher return than either alternative. Another good use for a stable value fund is as a core bond holding when rates are rising. In a rising rate environment it is likely that a stable value fund and a bond index fund will have similar yields, yet the bond fund NAV and total return get hurt by the mark to market losses on the bonds while the stable value fund remains, umm, stable. This is similar to buying a long term D with a small early surrender penalty: if rates rise you stay in the CD or stable value fund until market rates have moved up enough to make chasing them worth the risk to principal, then you get out at par without having suffered all the losses that bond investors took as rates rose. Note that when rates are falling, you would be better off in a bond fund than in a stable value fund. Again, both funds will have similar yields but the bond fund NAV and total return move with the market values of the underlying bonds while the stable value fund does not. So if market rates are falling and bonds are appreciating in value, bond funds will offer greater total return than stable value. Finally, a third good use for stable value funds is for investors with a very conservative orientation who simply wish to reduce their total portfolio volatility. Since stable value funds are effectively a pile of very high quality bonds with a put option that allows you to dump them at par any time you like, they are a great choice as a core holding for the risk averse.<br />
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In order to protect themselves, the providers of traditional GICs and stable value wraps typically underwrite each deal they participate in. In addition to restrictions on the underlying bonds, financial institutions also look at the characteristics of both the plan and the plan participants and they may require certain restrictions be placed on the plans. A common requirement is that there be no money market fund offered to compete with the stable value fund. Since stable value funds are generally better investment options, this is no great loss to plan participants. A somewhat more odious restriction that is fairly common is what is known in the industry as an "equity wash" provision. An equity wash in place means that plan participants cannot trade between bond/money market funds and the stable value fund. This is intended to keep plan participants from moving money around in search of the best rates/returns. However, if you maintain a diversified portfolio in your retirement plan it is easy to do an end-run around the equity wash. Suppose you have a portfolio that is $100,000 bond index fund, $100,000 stable value fund, and $100,000 equity index fund and you wish to sell $50,000 of the bond fund and move the money to the stable value fund. Because the plan has an equity wash rule in place, you are not allowed to sell $50,000 bond index fund and buy $50,000 stable value fund. However, the equity was provision would not prevent you from arriving at exactly the same target portfolio by doing the following: sell $50,000 equity fund, buy $50,000 stable value fund, sell $50,000 bond fund, buy $50,000 equity fund. In both the direct case (prohibited by the equity was rule) and the workaround you end up with the same portfolio:$50,000 bond index fund, $100,000 equity index fund, and $150,000 stable value fund.<br />
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As always, do your own due diligence, consult your advisors, take your own risks. Not intended as investment advice. I suppose it is theoretically possible that someone could lose money in a stable value fund, so be careful.<br />
The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com4tag:blogger.com,1999:blog-9213538927378012885.post-59227339201552018782014-02-07T08:48:00.000-07:002014-02-07T08:48:06.277-07:00Published On Seeking Alpha: Navios Acquisition: A Quality Company At Close To Net Asset ValueWith one of the strongest management teams in the industry and a preference for long term charters to mitigate the high risk inherent in the shipping industry, Navios Acquisition (<a href="http://seekingalpha.com/symbol/nna" title="Navios Maritime Acquisition Corporation">NNA</a>) has survived the global recession, a period of greatly restricted funding for ship owners, and the bankruptcy and financial distress of less well-positioned industry peers. After a recent sell-off from 52 week highs, the company appears to be a good value for investors desiring exposure to the crude and refined products tanker business as the company's shares trade at a small premium to net asset value.<br />
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To see the rest, go here: <a href="http://seekingalpha.com/article/1999401-navios-acquisition-a-quality-company-at-close-to-net-asset-value">http://seekingalpha.com/article/1999401-navios-acquisition-a-quality-company-at-close-to-net-asset-value</a><br />
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As always, this is meant as entertainment rather than investing advice. Consult your advisors, throw the yarrow sticks and get out the <em>I Ching</em>, do your own due diligence, take you own risks.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-28122502003133023572014-02-05T07:57:00.000-07:002014-02-05T07:57:00.564-07:00Update: My Seeking Alpha Article On PTRY Selected As A Top Idea Of The Day Since this is only the second piece I have submitted to Seeking Alpha, I don't know how rare this is for a contributor, but I imagine that its not that common given how few I see in the list: <a href="http://seekingalpha.com/article/1990351-sa-pro-top-long-and-short-ideas-tuesday-february-4?source=notify_popup&notified=1988591">http://seekingalpha.com/article/1990351-sa-pro-top-long-and-short-ideas-tuesday-february-4?source=notify_popup&notified=1988591</a><br />
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Now to find out if I get paid more for such great work...The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com1tag:blogger.com,1999:blog-9213538927378012885.post-30694003054985510162014-02-04T09:01:00.000-07:002014-02-04T09:01:00.439-07:00Published On Seeking Alpha: The Pantry Is Empty: The Pantry Inc. Is Overvalued And OverleveragedThe Pantry, Inc. (<a href="http://seekingalpha.com/symbol/ptry" title="The Pantry, Inc.">PTRY</a>) has made numerous changes to the company and its operations, hired a new CEO, remodeled stores, and even attracted a modicum of activist investor attention. Yet the company continues to see a steady slide in EBITDA, uses all of its cash flow to service debt and spruce up its stores, and has leveraged up its balance sheet in the process to the point where the firm has little room for error. The Pantry appears to be an obvious short based on declining operating performance, high leverage, and management's apparent inability to stem the deterioration of both the business and the balance sheet.<br />
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To see the rest of the article go here: <a href="http://seekingalpha.com/article/1988591-the-pantry-is-empty-the-pantry-inc-is-overvalued-and-overleveraged">http://seekingalpha.com/article/1988591-the-pantry-is-empty-the-pantry-inc-is-overvalued-and-overleveraged</a><br />
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As always, this is for your entertainment only, not investment advice. Consult your advisors, do your own research, take your own risks. I am just some dude spouting off over the interwebs.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-47255138764184871942014-02-03T01:00:00.000-07:002014-02-03T01:00:00.417-07:00Insurer Nastygrams: When Long Term Care Insurance Premiums Rise<strong><em><span style="font-size: large;">Why This Has Been Happening And What To Do If You Are Affected</span></em></strong><br />
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If you are a long term care (LTC) insurance policyholder who has had a policy for five or more years, you are likely to get an unpleasant piece of mail if you have not already: a whopping increase in your LTC insurance premium. Double digit percentage increases are the norm and 85% and higher increases have been levied on some policyholders. Worse yet, just because you had your premium increased significantly does not mean that you will not see your policy cost rise even further in future years. To add insult to injury, several significant players in the LTC insurance market have seen their credit profile degrade resulting in lower claims-paying ratings, raising the chance that they will have difficulty paying claims down the road. In this post I will discuss the economics of LTC insurance, how insurers got themselves into trouble with this product (necessitating giant rate increases), and what to do if you have an LTC insurance policy and get slapped with one or more premium increases.<br />
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First, it is worth taking a peek at the economics of these policies from the insurers' point of view. The product that has been the mainstay of the industry for years requires an annual premium for the length the insured is covered in return for a specified level of coverage (3 years at $XX per day 5 years, lifetime, etc.). These policies are generally sold to customers in their 50s and claims are mostly made by insureds in their late 70s into their 80s. Premiums may be guaranteed for some specified period of time (commonly 5 to 10 years), but after that they can rise if the amount insurers collect on the block of business they have proves to be inadequate. There were single pay and "short pay" (5 to 10 years) policies sold that involved the insured paying a lump sum or set amount for a set number of years and then not having to pay anything further to be covered for the rest of their lives. However, single and short pay policies were always less than 10% of the LTC insurance market due to the very large premiums these policies entailed compared to the annual premium variety.<br />
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From the insurers' perspective, they accepted a payout obligation on an unknown (but hopefully estimable) percentage of their insureds in 30 years' time in return for a stream of payments. These premiums would have to be invested to earn enough money to be able to pay out claims down the road, but insurers had no real way to know what interest rates they would earn when the premiums came in 5, 10 or 20 years hence. They knew that some of the insureds would pay premiums for a while and then stop paying for a variety of reasons (premature death, financial distress, etc.) and no longer be in the pool of eligible insureds when the claims started coming, but there was no way to know for sure how many policyholders would lapse prematurely. To summarize, insurers accepted three major risks by underwriting this business: claims amount and timing, interest rate uncertainty, and lapse risk. Sound scary? Well, they thought, no problem. We have lots of actuaries and they are smart guys; they can figure it out (even though they didn't have a lot of data to work with owing to the relative newness of LTC insurance compared to life insurance).<br />
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Unfortunately, two or three (depending on the insurer) of the three major risks did not go in the favor of the insurance companies. Lapse risk was the first one to give the industry a nasty surprise. When a lot of companies became active in this market in the 1990s they went to market assuming that LTC insurance policyholders would settle out at a annual lapse rate of about 3% annually. Too bad for them that lapse rates were closer to 1%. A 2% difference between expected and actual lapse rates might not seem like that much, but compounded over a few decades it makes a huge difference:<br />
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<table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse; width: 248px;">
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<col span="2" style="mso-width-alt: 3271; mso-width-source: userset; width: 69pt;" width="92"></col>
<tbody>
<tr height="19" style="height: 14.4pt;">
<td class="xl63" height="19" style="background-color: transparent; border: 0.5pt solid windowtext; height: 14.4pt; width: 48pt;" width="64"><span style="font-family: Calibri;">Year</span></td>
<td class="xl63" style="background-color: transparent; border-color: windowtext windowtext windowtext black; border-style: solid solid solid none; border-width: 0.5pt 0.5pt 0.5pt 0px; width: 69pt;" width="92"><span style="font-family: Calibri;">3% Lapse Rate</span></td>
<td class="xl63" style="background-color: transparent; border-color: windowtext windowtext windowtext black; border-style: solid solid solid none; border-width: 0.5pt 0.5pt 0.5pt 0px; width: 69pt;" width="92"><span style="font-family: Calibri;">1% Lapse Rate</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">0</span></td>
<td align="right" class="xl63" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">1000</span></td>
<td align="right" class="xl63" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">1000</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">1</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">970</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">990</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">2</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">941</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">980</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">3</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">913</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">970</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">4</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">885</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">961</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">5</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">859</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">951</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">6</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">833</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">941</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">7</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">808</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">932</span></td>
</tr>
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<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">8</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">784</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">923</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">9</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">760</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">914</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">10</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">737</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">904</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">11</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">715</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">895</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">12</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">694</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">886</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">13</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">673</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">878</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">14</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">653</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">869</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">15</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">633</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">860</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">16</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">614</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">851</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">17</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">596</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">843</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">18</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">578</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">835</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">19</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">561</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">826</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">20</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">544</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">818</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">21</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">527</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">810</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">22</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">512</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">802</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">23</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">496</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">794</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">24</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">481</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">786</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">25</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">467</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">778</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">26</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">453</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">770</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">27</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">439</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">762</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">28</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">426</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">755</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">29</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">413</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">747</span></td>
</tr>
<tr height="19" style="height: 14.4pt;">
<td align="right" class="xl63" height="19" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 14.4pt;"><span style="font-family: Calibri;">30</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">401</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">740</span></td>
</tr>
</tbody></colgroup></table>
<br />
The above table shows a block of 1000 policyholders showing a 3% and a 1% lapse rate over 30 years. The block with the 1% lapse rate has 85% more insureds in it at the end of 30 years than the block with a 3% lapse rate! All those people the actuaries thought would pay out years of premiums and then go away without claiming anything were sticking around in droves. Once insurers realized their error, a number of companies with a smaller presence in this line of business decided to stop writing policies and many of them hit their insureds with significant premium increases.<br />
<br />
Next, insurers assumed that the interest rates at which they would be able to invest the premiums they would receive over the course of a few decades would be relatively stable in future years. Some attempted to hedge this risk, especially if they had a large book of LTC insurance. However, hedging is expensive, often causes accounting headaches, and the market for very long duration interest rate hedges is relatively small compared to some of the blocks of business the bigger players had. Many of the insurers just "went naked" and hoped for the best on interest rates. None of the actuaries had a financial crisis and several years of quantitative easing featured prominently in their models, unfortunately. All those premiums they were expecting to invest at 6% and higher rates in high grade corporate bonds and treasuries were now being invested (for years) at 3%. To make it worse, some insurers chose to deliberately invest in much shorter term bonds gambling that rates would spike back up and that they would not have to lock in low rates for the long term. This has proved to be a poor bet. Still more insurers left the industry and just about everyone left in the market (plus those that ceased selling new policies) started hammering their blocks with double digit percentage rate increases.<br />
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The jury is still out to some extent on the third of the three major risks, namely the timing, duration, and size of claims made by insureds as they entered nursing homes. Most of the policies in existence are too new for many to have gotten to the point of making a claim. Of the insurers that have more than a handful of claims, experience compared to pricing is mixed. The insurers who got into this market as an accommodation to their customers (i.e. reluctantly) seem to be doing OK. The insurers who spent too much time listening to the marketing department ("Bob, we need to loosen underwriting and offer a generous new benefit to gain market share") have had cause to regret doing so. We will see whether insurers get the claims they priced for in coming years.<br />
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So now you have an inkling as to why this mess has happened, but the LTC insurers' problems are theirs and the resulting premium increase is your problem to deal with. What do you do when you get the dreaded premium increase? First, use this as an opportunity to re-evaluate your LTC insurance needs in the context of your overall financial plan. It has probably been 5 to 10 years (or more) since you bought the policy. Do you still need this insurance, or has your net worth increased to the point where you could feasibly self-insure? Are the premiums so low even after the increase that they are easily affordable for the foreseeable future? Second, you should make sure that this insurer is one you want to continue doing business with. The LTC insurance business has not been kind to insurers and those with a big presence in this market have generally seen their financial strength degrade and their ratings drop. LTC insurance is by nature a very long term contract and the risk that an insurer falls down on its end of the deal is a lot higher over the course of a few decades than it is over a year or two. Third, it would be a good idea to get new quotes on LTC insurance policies from other insurers to compare them with the newly increased premium you are asked to pay. In most cases even the jacked-up premiums for old policies will be well below what insurers are charging for new policies (which should help illustrate how badly insurers underpriced the old policies). If you have a lifetime coverage or even a 5 year benefit period on your existing policy and wish to keep it, a new policy will not be an option as insurers have almost entirely ceased selling those types of policies.<br />
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If you have determined that you still need a LTC insurance policy, the insurer remains acceptable, and the price is better than what you can get on the open market, clearly you will be keeping the policy and paying up. Usually when insurers raise LTC insurance premiums they give policyholders the option of keeping their existing benefits at the higher price or reducing benefits in exchange for a smaller or possibly no increase. Whether or not accepting the reduced benefits is a good idea depends on your budget and how much LTC coverage you feel you need.<br />
<br />
Regardless of which choice you make, expect that you will see future premium increases in the future. Given the degree to which these policies are underpriced, many blocks of business likely need to have their premiums increased 50 to 200% in order to be actuarially sound. In order to raise premiums on LTC insurance policyholders, insurers have to go through a state regulatory process and usually receive permission (and they have to do so in each and every state where they have policyholders they wish to charge more). Most state insurance regulators do not want the bad press and complaints they may face by allowing enormous premium increases all at once. As a result, insurers who may need a 75% average increase will ask for 35%, get permission for a 30% increase, and be told or expect to come back for the rest in a few years. So its likely that premium increases will be like cockroaches: where you see one, there are probably more lurking. Make sure you can afford at least one more premium increase if you decide to keep your policy.<br />
<br />
Its unfortunate that insurers badly underpriced LTC insurance policies over the past 15-plus years. That said, the industry has learned some painful lessons and changed the product to one that is hopefully more sustainable in the future. I believe that anyone buying a new policy should do so with the understanding that premiums could go up and a premium of 50 to 100% above whatever you are quoted should fit in your budget before you sign on the dotted line, just in case.<br />
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As always, this is meant for your edification and amusement, not for your financial advice or financial planning. Consult your advisors, do your own research, take your own risks, make your own insurance decisions.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-87307594859399785802014-01-31T08:52:00.000-07:002014-01-31T08:52:19.951-07:00Published on Seeking Alpha: Underperforming Olin Corporation Needs To Be Acquired "Olin Corp. (<a href="http://seekingalpha.com/symbol/oln" title="Olin Corporation">OLN</a>) reported fourth quarter 2013 earnings on Monday meeting analysts' estimates and tallying up record annual EBITDA of $424 million. While this is a notable achievement, management indicated first quarter EPS well below the consensus forecast and EBITDA for 2014 at best equal to 2013's performance. Meanwhile the company continues to laud itself for its increasing cash balance (up $143 million during 2013 to $308 million at the end of the year), continuing its 20 cent per share quarterly dividend (which has not been raised since 1999), and repurchasing 1.5 million shares during the course of 2013 (1.9% of shares outstanding for perhaps $40 million or 10% of EBITDA). Based on Monday's closing price, the company trades at EV/EBITDA of approximately 6 times and has done so for some time. Despite their multimillion dollar compensation, management together with the board owns a trivial amount of the company giving them little incentive to do much beside collect their pay and options grants. Olin is ripe for an activist to shake things up or a buyer to emerge to unlock the company's value."<br />
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The above is an excerpt from my recently published article on Seeking Alpha. To read the whole thing, go here: <a href="http://seekingalpha.com/article/1980331-underperforming-olin-corporation-needs-to-be-acquired?source=yahoo">http://seekingalpha.com/article/1980331-underperforming-olin-corporation-needs-to-be-acquired?source=yahoo</a><br />
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<em>Author's note: Now that I am no longer subject to the numerous restrictions related to my prior employment, I have started trying new things professionally. I submitted an article to Seeking Alpha which they selected for publishing as a "Small-Cap Insight." I intend to split content in the future between this blog and Seeking Alpha, assuming they like my stuff enough to publish it.</em><br />
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<em>As always, the linked article is for your entertainment only rather than investment advice. Consult your advisors, do your own due diligence, take your own risks, and be careful with your money. I am just some over-educated boob on the inter-tubes: what do I know?</em>The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-53608293405316601102014-01-27T01:00:00.000-07:002014-01-27T01:00:11.649-07:00The Not So Tender Offer: What To Do When Your Bond Is Called Early<em><strong><span style="font-size: large;">And Why You Should Almost Always Accept The Offer</span></strong></em><br />
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As I mentioned in a recent post about the high yield bond market (<a href="http://lifeinvestmentseverything.blogspot.com/2014/01/high-yield-market-looking-overvalued.html">http://lifeinvestmentseverything.blogspot.com/2014/01/high-yield-market-looking-overvalued.html</a>), junk bond issuers have been taking advantage of the lower rates and easy terms available to them in the new issue market. When existing junk bonds are refinanced, sometimes the issuer will simply exercise the call option embedded in the bonds (usually at a fixed price that starts at par plus 6 months of coupons and declining as the bond nears maturity). However, often junk issuers wish to refinance their bonds before the call date has arrived or their lawyers are worried about the possibility of a technicality in the existing bond covenants that may prevent them from issuing new bonds to refinance the old ones. When this happens junk issuers will initiate what is known as a "tender offer" to get the owners of the existing bonds to go along with their intended refinancing. Unfortunately, there appears to be some confusion on the part of retail bond owners about the best course of action when confronted by a tender offer. This post is about what to do if you own a bond that is the subject of such an offer.<br />
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First, what exactly is a tender offer? No, this is not something communicated by a lady of negotiable affection. Here is sample language from a Navios Acquisition (NNA) bond tender offer conduct in 2013:<br />
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The Offer is scheduled to expire at 12:00 midnight, <location idsrc="xmltag.org" value="LU/us.ny.nyc">New York City</location> time, on <chron>November 26, 2013</chron>, unless extended or earlier terminated by the Co-Issuers (the "Expiration Time"). Tendered 2017 Notes may be withdrawn at any time at or prior to <chron>5:00 p.m.</chron>, <location idsrc="xmltag.org" value="LU/us.ny.nyc">New York City</location> time, on <chron>November 12, 2013</chron>, unless extended or earlier terminated by the Co-Issuers (the "Consent Time"). Other than as required by applicable law, tendered 2017 Notes may not be withdrawn after the Consent Time. Holders tendering their 2017 Notes at or prior to the Consent Time will be required to consent to certain proposed amendments to the indenture governing the 2017 Notes. <br />
Holders who validly tender (and do not validly withdraw) their 2017 Notes at or prior to the Consent Time will be eligible to receive total consideration of <money>$1,048.94</money> per <money>$1,000</money> principal amount of 2017 Notes, which includes a cash consent payment of <money>$30.00</money> per <money>$1,000</money> principal amount of 2017 Notes tendered (the "Consent Payment"). The Offer contemplates an initial payment date, so that holders whose 2017 Notes are validly tendered at or prior to the Consent Time and accepted for purchase should expect to receive payment as early as <chron>November 13, 2013</chron>.<br />
Holders who validly tender their 2017 Notes after the Consent Time but at or prior to the Expiration Time will not be eligible to receive the Consent Payment, but will be eligible to receive the tender offer consideration of <money>$1,018.94</money> per <money>$1,000</money> principal amount of 2017 Notes tendered."</blockquote>
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A tender offer is a formal offer made to buy a security (in this case a bond) from any and all holders. The buyer sets the terms, including deadlines, prices to be paid and sometimes other conditions (such as the maximum amount to be bought or the requirement that the new bond issue be successful to refinance the old one). In the case of public bonds (what retail investors would be holding), tender offers must be filed with the SEC and are viewable in all their detail on the SEC's EDGAR filing website. When junk bond issuers make a tender offer, the terms of the offer usually include two deadlines (early and final) and a redemption price that includes what is known as a "consent payment" (more about the consent payment later). Typically, there will be an early deadline and a final deadline to tender your bonds and bondholders meeting the early deadline will get a higher price (generally at least 3% of par or more over the final deadline price; NNA offered a 3% early tender premium). At any time, the issuer reserves the right to walk away from the tender offer, although this is rarely done unless the new bonds to be issued to refinance the old ones do not go off as planned. With the difference in prices offered to redeem the bonds between the early and final deadline for tendering, bondholders are highly incented to tender their bonds by the early deadline. If you are planning on tendering your bonds (which is usually the right choice), make sure you tender in time for the early deadline in order to maximize the redemption amount you receive.<br />
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So the mechanics as I have described them are relatively straightforward. You might be thinking that you like the bond you own, the issuer is strong enough to issue new bonds, and you want to hang onto the bond and enjoy the income rather than participate in the tender. In most cases, this is not a great idea for a number of reasons. First, many tender offers are done when the bonds are already callable or will become callable soon. Even if you do not participate in the tender offer, the bonds will be called soon anyway. If the tender will give you a higher exit price than the call would, it makes no sense not to take what is offered in the tender.<br />
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Second, the tender offer includes a "consent payment" as part of the early deadline bond payment for a reason. Properly underwritten junk bonds generally contain a long list of covenants which restrict issuers from doing a number of things and require them to do other things, all intended to protect the bondholders from the issuer "betting it all on red" with the borrowed money. However, the bond indenture almost always includes a provision that allows the issuer to do away with all the covenants if they can get 2/3 of the outstanding bonds and half of the bondholders to agree to do so. The consent payment in the early tender is the mechanism by which the issuer gets the bondholders to agree to remove the covenants in the old bond issue. Here is language from the recent NNA tender offer:<br />
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" <org idsrc="xmltag.org" value="NYSE:NNA">Navios Maritime Acquisition Corporation</org> ("Navios Acquisition") (NYSE: NNA) announced today that Navios Acquisition and its wholly-owned subsidiary, <org>Navios Acquisition Finance (US) Inc.</org> ("Navios Acquisition Finance" and, together with Navios Acquisition, the "Co-Issuers") have commenced a cash tender offer (the "Tender Offer") for any and all of their outstanding 8 5/8% First Priority Ship Mortgage Notes due 2017 (the "2017 Notes") and a consent solicitation to eliminate or modify most of the restrictive covenants and certain events of default, and release the liens for the benefit of the holders on the assets that secure the 2017 Notes, and make other changes to provisions contained in the indenture governing the 2017 Notes (the "Consent Solicitation" and, together with the Tender Offer, the "Offer")."</blockquote>
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As you can see, NNA sought bondholder consent to not only do away with the covenants, but also to release liens on the collateral securing the bonds (a fleet of ships).<br />
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If the tender offer is successful, any bondholders who do not participate and do not have their bonds called typically are left holding bonds which are totally devoid of covenant protection and which are usually effectively subordinated to the new bond issue that funded the tender offer (in the case of the NNA tender, you also would have gone from first lien mortgage bonds to unsecured bonds). You do NOT want to own such paper, as in the event of a bankruptcy or restructuring you are likely to fare poorly. As a result, it is generally wise to accept the tender offer rather than attempt to hold out and keep your bonds.<br />
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Why might you choose to spurn an issuer's tender offer? There are relatively few cases where you would want to do so. One possible case is when the issuer might have to offer a bigger premium than its initial tender offer. This situation is rare and since you can withdraw your bonds from the tender up to the deadline in most cases, you might as well tender in time for the early deadline. Second is if the bonds are only partially tendered for. For example, if an issuer has $600MM outstanding in a particular issue and tenders for $300MM you might well choose to keep your bonds. Chesapeake Energy (CHK) has conducted multiple partial tenders over the years as it seeks to manage its debt load. If you choose to keep your bonds, read the tender offer carefully to ensure that the issuer is not seeking to remove covenants and other protections from your bonds.<br />
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As always, this is not meant to be investment advice. Consult your advisors, do your own due diligence, take your own risks. I am just some dude pontificating on the internet.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-89852599870871340662014-01-22T22:52:00.001-07:002014-01-22T22:52:35.796-07:00High Yield Market Looking Overvalued And Underprotected<div class="separator" style="clear: both; text-align: center;">
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The high yield (AKA junk) bond market is a funny thing. Everyone who invests in this asset class knows they are buying IOUs from higher risk issuers who offer extra interest and extra restrictions on what the issuer can do in order to compensate the investors for the higher risk. Sometimes investors are more concerned with the extra risk involved and sometimes they are more interested in the extra interest offered. But relatively few junk investors seem to look beyond the rating and the yield, and almost all seem to have very short memories. The junk market appears to me to be approaching an extreme and I would caution anyone tempted to chase yield in this market to be very careful.<br />
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As I observed shortly after starting this blog (<a href="http://lifeinvestmentseverything.blogspot.com/2012/01/dumpster-diving-in-junk-bond-market.html">http://lifeinvestmentseverything.blogspot.com/2012/01/dumpster-diving-in-junk-bond-market.html</a>), the junk market is prone to excesses. In part due to the relatively small size of the junk market compared to institutional balance sheets, when there is trouble in the junk market money flows out very quickly and amid a dearth of buyers bond prices tend to crash and spreads get very high, very quickly (see: 2008-2009). Conversely, when money is flowing into junk bond funds and institutional buyers are chasing yield with abandon the exact opposite happens: bond prices start rising and spreads get vanishingly small relative to the risk involved in owning these bonds. I believe that the junk bond market is increasingly in bubble territory and danger is rising even as investors are getting ever lower spreads in reward.<br />
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As you can see below, high yield spreads are well below the 5% level (3.86% as of the most recent print) and beginning to approach the lows last seen during the height of the credit bubble in 2007.<br />
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If the party continues, past history suggests that spreads could decline (briefly) below 3% so while the junk market is in the danger zone it may not have reached the furthest excesses possible.<br />
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In case you don't find simple spread levels convincing, there are some other indicators of trouble in the new issue market. Since the vast majority of high yield bond are callable by the issuers at a fixed price (par plus a premium that usually starts at half a year's coupons and declines as the maturity date approaches) and the issuers are usually run or advised by people who know very well when to take advantage of what the junk market has to offer, junk issuers aggressively call bonds, refinance, and issue additional debt when spreads are tight and terms are easy. Guess what junk issuers are doing in today's market? In addition to the second consecutive year in which high yield bond issuance exceeded $300 billion, 2013 was a near record year for the issuance of PIK/toggle notes. PIK/toggle notes are junk bonds that give the issuer the option of paying coupons in additional bonds instead of cash, meaning that the outstanding amount of debt actually grows after the bonds are issued. Why might issuers choose to pay coupons "in kind" (PIK = pay in kind) rather than in cash? It is hard to come up with plausible reasons aside from an inability to actually pay cash coupons. Think of these bonds as Option ARMs for risky, highly leveraged corporate borrowers.<br />
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Covenant protection for investors on newly issued junk bonds has also cratered in 2013. While you can see this by comparing the covenant package of just about any newly issued junk bond with the bond it refinanced, an even easier way is to watch the Moody's High Yield Covenant Quality Index. This is a simple numeric indicator of the average quality of covenants in new high yield deals ranging from 1 (best quality) to 5 (no protection to speak of). The index has spent the bulk of 2013 between 4 and 5, meaning that covenant protection for bond buyers is near historically weak levels.<br />
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So what does this mean for junk investors? If you own junk bond funds, re-evaluate your allocation to junk. While you might think that the fund owns older, higher quality bonds, just about every junk bond fund is having its bonds called and replaced by new bonds with lower coupons and far weaker covenants. If you own individual bonds, expect to have any older bonds called away. It is up to you whether to continue buying junk bonds, but be aware that what is available in the market today has very low spreads and higher risk than at any time in the last seven years. At the very least, it is probably wise to consider buying higher average credit quality (BB/Ba rated) junk and stay away from the riskiest, most highly levered issuers. If you own generic "multi-sector" funds or "go anywhere" funds, look carefully at how much junk they own and consider whether this level of risk is acceptable given your goals and risk tolerance.<br />
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It is frustrating to have to stay away from an asset class that has a number of attractive attributes (higher income, limited duration/interest rate risk, built in exit strategy via maturity or calls), but the nature of this market requires discipline in order for a prudent investor to be successful over the long haul. The silver lining is that we can say one thing with absolute certainty: at some point the junk market will blow up again and investors who did not get hurt by the inevitable implosion will be well-positioned to once again buy junk at very attractive spreads and likely the chance to make significant capital gains.<br />
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As always, this is my own musings rather than investment or legal advice. Do your own due diligence, consult your advisors, take your own risks. I am just some stranger on the internet babbling away and might very well be dead wrong about all of this.<br />
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The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-23080937879397892372014-01-16T20:52:00.003-07:002014-01-16T20:52:54.550-07:00A New ChapterA couple years ago I started this blog partly as an experiment and partly as a way to formalize and expand on my investing notions by putting them into print. A few of you were good enough to read my ramblings and even comment on them, for which I am grateful (spammers aside). However, I was greatly hampered by a need to maintain anonymity and I felt the need to avoid a number of topics due to the nature of my employer. As of today, I am no longer subject to those constraints. I can come out of the shadows and comment on whatever I like. I will also have the time to cover some new topics, perhaps surface some new investment ideas, and revisit some old post topics that are worthy of further discussion. I intend to submit some work to Seeking Alpha as well and plan to experiment with both exclusive and non-exclusive listings on that venue.<br />
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First, a bit about me. I have been an active investor since 1998. I am a CFA charterholder and hold an MBA from NYU-Stern. Over the last 20 years I have been a bank and insurance company regulator, a hedge fund securities analyst, a ratings agency analyst and a consultant. Going forward I intend to pursue such business and investment opportunities as may present themselves while amusing myself and hopefully my readers.<br />
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I look forward to digging up new opportunities to share with my readers and offer up whatever meager knowledge I have accumulated for your education and amusement.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com1tag:blogger.com,1999:blog-9213538927378012885.post-47822298310546667222013-01-29T23:30:00.000-07:002013-01-29T23:30:03.672-07:00Cutting Off The Tail, Part 3<strong><em><span style="font-size: large;">In Case Of Emergency, Break Glass</span></em></strong><br />
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Having covered insurance, measurement and management of risk tolerance, and other topics in the last two parts of this series (here <a href="http://lifeinvestmentseverything.blogspot.com/2013/01/cutting-off-tail-part-1.html">http://lifeinvestmentseverything.blogspot.com/2013/01/cutting-off-tail-part-1.html</a> and here <a href="http://lifeinvestmentseverything.blogspot.com/2013/01/cutting-off-tail-part-2.html">http://lifeinvestmentseverything.blogspot.com/2013/01/cutting-off-tail-part-2.html</a>), I will now turn to a subject area that I hesitate to cover lest I be considered a kook or nutball survivalist. However since the topic at hand is hedging the worst outcomes so that you can sail through life in a more carefree manner I think I would be doing my readers a disservice if I did not at least mention ideas on how to mitigate the very worst situations. Accordingly, I will offer some thoughts on how to cost effectively prepare for natural and other disasters that might disrupt daily life as we know it and possibly put you and your family at risk.<br />
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First, what disasters am I thinking of when I suggest some preparations? No, I am not anticipating a zombie invasion or an invasion by a foreign power. The kind of disaster I am thinking of is a major storm, wildfire, tornado, etc. that would probably disrupt utilities, make travel difficult or impossible, and result in locally empty supermarket shelves. In most cases, you will be on your own for 3 to 7 days as government or other assistance is likely to take at least a few days to coordinate and whatever the cause of the disaster may impede access to where you are. In the case of major hurricanes (Sandy, Katrina, etc.), even the National Guard was not able to have a major presence in the affected area for several days and in the meantime food, water, heat, etc. were in very short supply for the people in the affected area. I think it is reasonable for everyone to prepare for disasters of this magnitude. Obviously there are other disasters that could require self sufficiency for a longer period of time, but most people are not likely to find value in trying to hedge away very unlikely downside scenarios. My intention is to offer relatively easy, relatively low cost forms of insurance against reasonably likely bad things happening, not suggesting you build a $2 million bunker in the wilderness defended by armed monkeys.<br />
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What is required in a disaster to ensure safety? Simply put, food, water, light, climate control, and security. Food should be a pretty obvious need and can be accomplished as easily as keeping a week's worth of non-perishable food on hand at all times. Buy some extra of what you already eat and keep it on hand, rotating your stock and always using the oldest stuff first. You may have to make some provision to be able to cook what you have on hand if your utilities are not on. Your stove may not be working, your hot water heater may be out of commission, and with no electrical service most of your appliances will not function. As a result, it would be a good idea to have on hand a backpacking stove, barbecue grill with an extra burner (for boiling/cooking), or some other means of cooking a meal and heating water without the use of your normal appliances. In a pinch, you could always cook over a fireplace or in an improvised fire pit in your yard, but you had better have ample fuel, a healthy tolerance for smoke, and possibly tolerant neighbors.<br />
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Water is the next must-have (what my Latin teacher in high school would have called a sine qua non). If you have to, you can make it for a week or more without food. Without safe water to drink, you would be challenegd to make it 48 hours. Make sure that if you have no utilities (electric, water service, etc.) you still have on hand a minimum of a gallon per day for at least 3 days for each person and dog in your household. You might be pretty smelly after a few days, but you would at least have enough to drink. Storing water can be accomplished a number of ways, but by far the easiest way would be to just buy gallon jugs of water at the supermarket and stick them in a basement or closet. I live in a dry climate and would be in trouble quickly without water coming out of the tap, so I have one of these drums in my basement <a href="http://www.costco.com/Shelf-Reliance%c2%ae-Deluxe-BPA-Free-55-gallon-Barrel-Water-Storage-System.product.11766218.html">http://www.costco.com/Shelf-Reliance%c2%ae-Deluxe-BPA-Free-55-gallon-Barrel-Water-Storage-System.product.11766218.html</a> More than likely, you don't need to go to as much trouble and expense, but it was an easy way to have a bunch of safe drinking water on hand. In a pinch, you could tap your water heater's tank for water, but if the drinking water supply is contaminated (common in major floods and storms) you would have to be able to treat it to make it safe (boiling, etc.).<br />
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The next need in a disaster is light. Things will seem a lot less scary if bad things happen if you can have a bit of light after dark. Flashlights, LED lanterns and the like are the easiest, most failsafe and cheapest way to go. If you wish to go a bit further there are wisely sold LED flashlights and lanterns which can be recharged via a hand crank (we have one for camping). Its a bit of a pain, but you don't have to worry about batteries being dead when you need some light.<br />
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Climate control may sound like a silly thing to need in a disaster, but don't knock it. If you live in a climate with extreme heat, you will very much value some way to stay cool. This can be as simple as a basement where the temperatures remain moderate in the summer or as elaborate as a gigantic whole-house backup generator that can run your central AC. Perhaps more importantly, you will want to have a way to heat your home in cold weather in the event of a disaster. A major storm is bad enough, but if it is compounded by water pipes that burst due to freezing, you have an even bigger mess. A fireplace or woodstove is an ideal solution if you keep enough fuel on hand to run it a few days. If you don't have a fireplace, a space heater or catalytic heater may be a good thing to keep around, but pay very close attention to product warnings about oxygen consumption, potential carbon monoxide poisoning, and fire danger.<br />
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Finally, in a disaster you will have to worry about security. Its a sad truth that after a major disaster things get messy for a while and opportunists and bad actors come out of the woodwork in the form of looters, thieves and assorted criminals. Looting was widespread in the aftermath of hurricane Sandy, even in fairly affluent areas. That being the case, you should have appropriately robust doors, door frames and locks on your home to secure it. If you live in a house, keep shrubbery trimmed to avoid providing hiding places for miscreants. If you ever wanted a dog, this is a good excuse. Even small dogs will generally serve as effective noisemakers, alerting you of potential trouble and suggesting to the miscreants that they try their luck elsewhere. Finally, you may wish to consider having some means of self defense on hand. If your state an local laws permit and you have the desire to do so, you may wish to take the Vice President's advice and acquire a shotgun for home defense. If your views on life or your local laws preclude you from doing so, a can of pepper spray would probably a good idea.<br />
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Hopefully nobody needs any of the above things, ever. Unfortunately, we know that disasters can and do happen on a regular basis and a small amount of preparation makes for a cheap insurance policy. For more information on disaster preparedness, visit the Red Cross' website at <a href="http://www.redcross.org/prepare/disaster">http://www.redcross.org/prepare/disaster</a> Having prepared for the worst, you can then go on and live life with less worry.<br />
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As usual, the above is not intended as investment advice, spiritual advice, or anything other than my observations about life. Consult your advisors, do your own due diligence, and be careful. Objects in mirror may be closer than they appear.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com1tag:blogger.com,1999:blog-9213538927378012885.post-45975849144417405442013-01-29T17:14:00.002-07:002013-01-29T17:14:21.696-07:00CHK: Out With The Old...<strong><em><span style="font-size: large;">Aubrey McClendon's Exit May Pave The Way For A Sale</span></em></strong><br />
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After running into a cashflow shortfall and years of ethical failings, Chesapeake Energy attracted the attention of activist investors last year and the problems plaguing the company began to be resolved (see <a href="http://lifeinvestmentseverything.blogspot.com/2012/05/chk-little-help-from-your-friends.html">http://lifeinvestmentseverything.blogspot.com/2012/05/chk-little-help-from-your-friends.html</a> among other past posts). Today after the close of the market the company announced that its founding CEO Aubrey McClendon will be stepping down. To be fair to Mr. McClendon, he and former partner Tom Ward (now at SandRidge Energy and also attracting activist attention) built a monster exploration and production company out of nothing. However, the long track record of poor corporate governance and the aggressive manner in which a big oil and gas company came to be run have held back the market valuation of CHK. Now that the firm has bid adieu to Mr. McClendon it would appear that there is room to change how the company is run and the valuation it receives.<br />
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I think there are three plausible outcomes for the company. First and simplest is a sale to a larger firm. There are a number of large oil majors which would find CHK's collection of drilling assets to be extremely attractive and they all have the financial wherewithal to complete the deal. Since the company's balance sheet has been backed away from the proverbial cliff, a sale could presumably be done in a non-distressed manner.<br />
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Second, the firm could simply get a new CEO more accustomed to running a firm like this in a more conservative "harvest" strategy and emerge as a credible, long term oil and gas player. Such a CEO could come from the executive ranks of an oil major and over time allow the firm to attract a higher valuation. Something similar happened to the firm now known as EOG. EOG was originally named "Enron Oil & Gas" and for obvious reasons was considerably beaten down by the market. A change of management and name plus the passage of time and EOG is now viewed as a credible oil and gas play that does not trade at a hefty discount to peers.<br />
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The third possibility is that the long-running Board investigation into Mr. McClendon's entanglements with CHK uncovered something particularly bad. If it is significant enough to affect the firm, the future might not be so bright for CHK investors. Since there appears to be no such disclosure as of this evening I am inclined to discount this possibility, but it is still possible. The stock is up some 10% after hours, so others seem to be optimistic.<br />
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In any event, it has been entertaining to watch CHK over the years and present times are no exception. I suspect that anyone who bought shares over the last year will find the outcome of the Aubrey McClendon saga to be profitable.<br />
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As always, do your own due diligence, consult your advisors and be careful. You can lose money on this stuff. Not intended as investment advice.<br />
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Disclosure: I am long CHK equity and call options.<br />
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The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-75706505407083917422013-01-28T00:02:00.000-07:002013-01-28T07:32:44.215-07:00WIW: Another Dollar Selling For 90 Cents<strong><em><span style="font-size: large;">Finding Fixed Income Value In A Closed End Fund</span></em></strong><br />
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<a href="http://www.goodwillaz.org/wp-content/themes/goodwill/images/90_cents.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://www.goodwillaz.org/wp-content/themes/goodwill/images/90_cents.png" /></a></div>
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In recent months, it has become increasingly difficult to find reasonably priced buying opportunities, especially in the realm of fixed income. Even the closed end fund (CEF) world has been bid up as there are very few funds that meet my investing criteria (market cap of at least $500MM, no excessive leverage or management fee, and at least a 10% discount to net asset value). In fact, more often than not when I screen CEFs there are no funds that meet my hurdles. However, there appears to be one very attractive bargain still available in fixed income CEFs, the Western Asset/Claymore Inflation-Linked Opportunities & Income Fund (WIW).<br />
<a name='more'></a><br />
WIW is rare in the current market environment. It is a non-exotic fixed income fund with no leverage and a big 11+% discount to net asset value. This fund is fairly liquid, with significant trading volume and a market cap in excess of $900 million. With a management fee of .60%, the fund is not being greatly overcharged by its manager (a distressingly common problem in the CEF world). As I detail in a prior post, WIW meets all of my screening criteria for finding a clear value in CEFs (see <a href="http://lifeinvestmentseverything.blogspot.com/2012/01/how-to-buy-dollar-for-90-cents.html">http://lifeinvestmentseverything.blogspot.com/2012/01/how-to-buy-dollar-for-90-cents.html</a>).<br />
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So what does this fund actually hold? As you can see below, the fund has over 75% of its assets in US TIPS and another 8.4% in non-US inflation linked bonds (largely developed economy bonds). The remaining 15% of the portfolio is a smattering of high yield, investment grade corporates emerging markets bonds, and other miscellaneous bonds.<br />
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<table border="0" cellpadding="0" cellspacing="0" style="width: 100%px;"><tbody>
<tr><td class="fundLeft"><div class="fund-modules" style="width: 620px;">
<h1 class="cef">
Portfolio Concentration</h1>
as of 10/31/12 <br />
Source: Guggenheim Investments <br />
<table class="fund-table-data" style="width: 100%;"><tbody>
<tr><td style="width: 200px;"><table cellpadding="0" cellspacing="0" style="width: 100%;"><tbody>
<tr><th width="73%">Asset Class</th><th width="27%">%</th></tr>
<tr><td>US TIPS</td><td class="right" nowrap="nowrap">77.36 %</td></tr>
<tr><td>Non US TIPS</td><td class="right" nowrap="nowrap">8.40 %</td></tr>
<tr><td>High Yield Corp</td><td class="right" nowrap="nowrap">4.85 %</td></tr>
<tr><td>Investment Grade Corp</td><td class="right" nowrap="nowrap">3.84 %</td></tr>
<tr><td>Emerging Markets</td><td class="right" nowrap="nowrap">2.98 %</td></tr>
<tr><td>Mortgage Backed Securities</td><td class="right" nowrap="nowrap">0.72 %</td></tr>
<tr><td>Other</td><td class="right" nowrap="nowrap">1.85 %</td></tr>
</tbody></table>
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192, 192)" istracker="1359144699307" visibility="visible"></path></path></g><g class="highcharts-legend" transform="translate(230 73)" zindex="7"><g clip-path="url("#highcharts-1")" zindex="1"><g><g class="highcharts-legend-item" transform="translate(8 3)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">US TIPS</tspan></text><rect fill="#53284f" height="12" rx="2" ry="2" stroke-width="0" stroke="#53284f" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-legend-item" transform="translate(8 21.44)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">Non US TIPS</tspan></text><rect fill="#565a5c" height="12" rx="2" ry="2" stroke-width="0" stroke="#565a5c" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-legend-item" transform="translate(8 39.88)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">High Yield Corp</tspan></text><rect fill="#5c7f92" height="12" rx="2" ry="2" stroke-width="0" stroke="#5c7f92" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-legend-item" transform="translate(8 58.32)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">Investment Grade Corp</tspan></text><rect fill="#999999" height="12" rx="2" ry="2" stroke-width="0" stroke="#999999" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-legend-item" transform="translate(8 76.76)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">Emerging Markets</tspan></text><rect fill="#003359" height="12" rx="2" ry="2" stroke-width="0" stroke="#003359" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-legend-item" transform="translate(8 95.2)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">Mortgage Backed Securities</tspan></text><rect fill="#94aa7e" height="12" rx="2" ry="2" stroke-width="0" stroke="#94aa7e" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-legend-item" transform="translate(8 113.64)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">Other</tspan></text><rect fill="#6a7f10" height="12" rx="2" ry="2" stroke-width="0" stroke="#6a7f10" width="16" x="0" y="4" zindex="3"></rect></g></g></g></g><g class="highcharts-tooltip" style="padding: 0px; white-space: nowrap;" transform="translate(47 131.405)" visibility="visible" zindex="8"><rect fill-opacity="0.85" fill="none" height="41.248" isshadow="true" rx="5" ry="5" stroke-opacity="0.05" stroke-width="5" stroke="black" transform="translate(1 1)" width="202" x="0" y="0"><rect fill-opacity="0.85" fill="none" height="41.248" isshadow="true" rx="5" ry="5" stroke-opacity="0.1" stroke-width="3" stroke="black" transform="translate(1 1)" width="202" x="0" y="0"><rect fill-opacity="0.85" fill="none" height="41.248" isshadow="true" rx="5" ry="5" stroke-opacity="0.15" stroke-width="1" stroke="black" transform="translate(1 1)" width="202" x="0" y="0"><rect anchorx="115.452931641414" anchory="53.4048461914063" fill-opacity="0.85" fill="rgb(255, 255, 255)" height="41.248" rx="5" ry="5" stroke-width="2" stroke="#53284f" width="202" x="0" y="0"><text style="color: #333333; fill: #333333; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" x="5" y="18" zindex="1"><tspan style="font-size: 10px;" x="5">US TIPS</tspan><tspan dy="15" x="5">Portfolio Concentration</tspan><tspan dx="3">: </tspan><tspan dx="3" style="font-weight: bold;">77.36%</tspan></text></rect></rect></rect></rect></g><g class="highcharts-tracker" zindex="9"></g></g></rect></svg></div>
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Happily, credit quality is quite high as illustrated below. 88% of the fund's assets are rated AAA/Aaa and only 6% of total assets are rated less than investment grade. As a result, the risks the fund is taking are dominated by things other than credit risk. As investors are not being compensated well for taking credit risk (junk spreads are at multi-year lows presently), a lack of significant credit risk is a good thing for this fund.<br />
<br />
<h1 class="cef">
Credit Quality</h1>
as of 10/31/12<br />
Source: Guggenheim Investments <br />
<table class="fund-table-data" style="width: 100%;"><tbody>
<tr><td style="width: 200px;"><table cellpadding="0" cellspacing="0" style="width: 100%;"><tbody>
<tr><th width="73%">Credit Ratings</th><th width="27%">%</th></tr>
<tr><td>AAA/Aaa</td><td class="right" nowrap="nowrap">88.03 %</td></tr>
<tr><td>AA/Aa</td><td class="right" nowrap="nowrap">0.71 %</td></tr>
<tr><td>A</td><td class="right" nowrap="nowrap">1.33 %</td></tr>
<tr><td>BBB/Baa</td><td class="right" nowrap="nowrap">3.84 %</td></tr>
<tr><td>BB/Ba</td><td class="right" nowrap="nowrap">4.33 %</td></tr>
<tr><td>B</td><td class="right" nowrap="nowrap">1.50 %</td></tr>
<tr><td>Below B</td><td class="right" nowrap="nowrap">0.19 %</td></tr>
<tr><td>Not Rated</td><td class="right" nowrap="nowrap">0.07 %</td></tr>
</tbody></table>
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A 0 0 0 0 0 125 125 Z" fill="#8b8178" stroke-linejoin="round" stroke-width="1" stroke="#ffffff"><path d="M 124.589 31.2509 A 93.75 93.75 0 0 1 124.963 31.25 L 125 125 A 0 0 0 0 0 125 125 Z" fill-opacity="0.0001" fill="rgb(192, 192, 192)" istracker="1359144699332" visibility="visible"></path></path></g><g class="highcharts-legend" transform="translate(230 54)" zindex="7"><g clip-path="url("#highcharts-4")" zindex="1"><g><g class="highcharts-legend-item" transform="translate(8 3)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">AAA/</tspan></text></g></g></g></g></g></rect></svg></div>
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Aaa<rect fill="#53284f" height="12" rx="2" ry="2" stroke-width="0" stroke="#53284f" width="16" x="0" y="4" zindex="3"><g class="highcharts-legend-item" transform="translate(8 21.44)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">AA/Aa</tspan></text><rect fill="#565a5c" height="12" rx="2" ry="2" stroke-width="0" stroke="#565a5c" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-legend-item" transform="translate(8 39.88)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">A</tspan></text><rect fill="#5c7f92" height="12" rx="2" ry="2" stroke-width="0" stroke="#5c7f92" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-legend-item" transform="translate(8 58.32)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">BBB/Baa</tspan></text><rect fill="#999999" height="12" rx="2" ry="2" stroke-width="0" stroke="#999999" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-legend-item" transform="translate(8 76.76)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">BB/Ba</tspan></text><rect fill="#003359" height="12" rx="2" ry="2" stroke-width="0" stroke="#003359" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-legend-item" transform="translate(8 95.2)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">B</tspan></text><rect fill="#94aa7e" height="12" rx="2" ry="2" stroke-width="0" stroke="#94aa7e" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-legend-item" transform="translate(8 113.64)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">Below B</tspan></text><rect fill="#6a7f10" height="12" rx="2" ry="2" stroke-width="0" stroke="#6a7f10" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-legend-item" transform="translate(8 132.08)" zindex="1"><text style="color: #3e576f; cursor: pointer; fill: #3e576f; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" text-anchor="start" x="21" y="15" zindex="2"><tspan x="21">Not Rated</tspan></text><rect fill="#8b8178" height="12" rx="2" ry="2" stroke-width="0" stroke="#8b8178" width="16" x="0" y="4" zindex="3"></rect></g><g class="highcharts-tooltip" style="padding: 0px; white-space: nowrap;" transform="translate(102 142.832)" visibility="visible" zindex="8"><rect fill-opacity="0.85" fill="none" height="41.248" isshadow="true" rx="5" ry="5" stroke-opacity="0.05" stroke-width="5" stroke="black" transform="translate(1 1)" width="147" x="0" y="0"><rect fill-opacity="0.85" fill="none" height="41.248" isshadow="true" rx="5" ry="5" stroke-opacity="0.1" stroke-width="3" stroke="black" transform="translate(1 1)" width="147" x="0" y="0"><rect fill-opacity="0.85" fill="none" height="41.248" isshadow="true" rx="5" ry="5" stroke-opacity="0.15" stroke-width="1" stroke="black" transform="translate(1 1)" width="147" x="0" y="0"><rect anchorx="45.3092008332063" anchory="52.779296875" fill-opacity="0.85" fill="rgb(255, 255, 255)" height="41.248" rx="5" ry="5" stroke-width="2" stroke="#53284f" width="147" x="0" y="0"><text style="color: #333333; fill: #333333; font-family: "Lucida Grande", "Lucida Sans Unicode", Verdana, Arial, Helvetica, sans-serif; font-size: 12px;" x="5" y="18" zindex="1"><tspan style="font-size: 10px;" x="5">AAA/Aaa</tspan><tspan dy="15" x="5">Credit Quality</tspan><tspan dx="3">: </tspan><tspan dx="3" style="font-weight: bold;">88.03%</tspan></text></rect></rect></rect></rect></g><g class="highcharts-tracker" zindex="9"></g></rect> So what are the chief risks here? First and foremost, the fund sports a duration of a hefty 9.06 years which is well above that of the Barclays Aggregate Bond Index of 4.62 years. This indicates substantial interest rate risk, although since the fund is largely comprised of TIPS this risk is keyed to movements in real interest rates rather than nominal rates (real rates equate to a nominal rate by adding the real rate to the inflation rate as expressed by the Consumer Price Index (CPI)). Given the fund's average duration of 9.06 years, a 1% increase in real rates should yield a loss of about 9% of NAV. Since 10 year TIPS real rates are currently about -.60% (yes, minus .6%), the possibility of an adverse rate move is significant. Second, the manager of the fund attempts to hedge the fund against major risk events using derivatives. While I think that in general a periodic hedging strategy is probably a good idea because it should tamp down volatility, a risk of WIW is that the manager gets the hedging strategy wrong or fails to hedge against an event that turns out to be unexpectedly deleterious to the fund. Finally, WIW has the risk of all CEFs which is that the discount to NAV could widen even further than it already has.<br />
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The case for WIW is relatively simple. I would like to maintain an allocation to TIPS in my portfolio to complement the modest amount of I bonds I am able to buy ($10,000 per year per social security number). The problem with TIPS is that they appear rather generously priced and sport negative real yields (compared with I bonds which have a real yield of 0%). Because WIW is trading at a significant discount to NAV, it effectively enables an investor to buy 10 year TIPS (with some extraneous stuff in the non-TIPS 15% of the fund's portfolio) at a real yield of about positive .5%. Positive .5% real yields are not exactly going to blow the doors off for anyone, but they are far more attractive than 0% (I bonds) and -.6% (10 year TIPS). The fund yields about 3% (paid monthly) and the large discount to NAV will likely narrow at some point (could be days, months or years), offering the possibility of a capital gain over and above whatever the underlying assets do.<br />
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I think WIW is one of the best values in the fixed income CEF universe at present. Given the fund's relatively modest volatility, it also offers an opportunity to add some less volatile assets to one's portfolio.<br />
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As always, the above is not intended as investment advice. Do your own due diligence, consult your advisers and be careful. You can lose money on this stuff. Not guaranteed by anyone.<br />
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Disclosure: I am currently long WIW and may purchase more without warning or updating this post.<br />
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The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-5920351472020481902013-01-24T15:52:00.000-07:002013-01-24T15:52:27.169-07:00You Put Your Peanut Butter In My Chocolate!<strong><em><span style="font-size: large;">In Brief: Chesapeake-Methanex Gas Supply Deal Portends More To Come</span></em></strong><br />
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Today Chesapeake Energy (CHK) and Methanex (MEOH) announced a long term gas supply deal: <a href="http://methanex.mwnewsroom.com/press-releases/methanex-corporation-and-chesapeake-energy-corpora-tsx-mx-201301240848830001">http://methanex.mwnewsroom.com/press-releases/methanex-corporation-and-chesapeake-energy-corpora-tsx-mx-201301240848830001</a> The terms of the deal are that over a period of 10 years CHK will supply enough natural gas to a MEOH plant in Louisiana to produce 1 million tons of methanol annually. It takes approximately 22 MCF of natural gas to make 1 ton of methanol (<a href="http://www.methanol.org/Energy/Resources/Alternative-Fuel/Energy-Tribune-MI-Lynn-July-2009.aspx">http://www.methanol.org/Energy/Resources/Alternative-Fuel/Energy-Tribune-MI-Lynn-July-2009.aspx</a> - 100 CF makes 1 gallon of methanol and there are 333 gallons of methanol in a ton), so this deal equates to about 33 BCF a year. As CHK has forecast 2013 production of 1,030 to 1,070 BCF of natural gas, this deal accounts for about 3% of 2013 natural gas production. While that may not seem like much, this deal also has a very attractive form of upside for CHK in that the price it will receive for its gas will be partially based upon the market price for methanol. Since methanol is priced at the margin based on its energy content as a substitute for oil and refined products, CHK is effectively capturing some of the price premium oil commands above natural gas of equivalent energy content. Financial details have not been released (and they are unlikely to ever become public), but if this allows CHK to sell natural gas at a 1/15th or 1/20th multiple of the price of oil instead of the current 1/27th multiple ($3.50 natural gas/$95 oil) the company gains substantial upside to the current depressed level of natural gas prices. MEOH benefits from this agreement because its feedstock costs for methanol are based on the price it receives for the finished product and so has a substantial amount of protection for its margins even if methanol prices move a long way up or down from their present level (methanol prices are volatile).<br />
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This appears to be a win-win deal for both companies. Given the current glut of natural gas in the US, I expect to see more deals structured between gas producers and large end-users that improve the long term economics of both parties' businesses. An additional benefit for the natural gas producers is that if enough of these deals are consummated (especially for new natural gas-using plant capacity), the excess supply depressing natural gas prices at present should gradually decline to yield a tighter market with more attractive spot prices for gas. If this model is attractive enough, it could even be an indication that we might see a major end user (chemical company, utility, etc.) buy a natural gas producer.<br />
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As always, the above is not intended as investment advice. Consult your advisors, do your own due diligence, and be careful. You can lose money on this stuff.<br />
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Disclosure: I have long equity positions in CHK and MEOH and I am long calls on CHK.<br />
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The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-2292240320982022032013-01-24T15:23:00.000-07:002013-01-24T15:23:07.292-07:00Cutting Off The Tail, Part 2<strong><em><span style="font-size: large;">Assessing Your Risk Tolerance Compared With The Risks You Run</span></em></strong><br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxJMObs2nBBf_n5mM00WV0h8snOlCS6O8CYMaFeI-1IyTb_pfX60BYG1nQmAYpVSh22Pm59t5yMtcmG8vGNWdNshm4awcKXLyFNft_0bRHrWd3FhpEErMZl38N6kOkQRMEH5KoO0u_GxA/s1600/stockmarket-cartoon.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="345" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxJMObs2nBBf_n5mM00WV0h8snOlCS6O8CYMaFeI-1IyTb_pfX60BYG1nQmAYpVSh22Pm59t5yMtcmG8vGNWdNshm4awcKXLyFNft_0bRHrWd3FhpEErMZl38N6kOkQRMEH5KoO0u_GxA/s400/stockmarket-cartoon.png" width="400" /></a></div>
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In my last post (<a href="http://lifeinvestmentseverything.blogspot.com/2013/01/cutting-off-tail-part-1.html">http://lifeinvestmentseverything.blogspot.com/2013/01/cutting-off-tail-part-1.html</a>) I offered some thoughts on how to use various forms of insurance to mitigate some large downside risks that most investors face in real life. Aside from insurable risks which tend to be characterized by low probability and high severity, every investor is confronted by risks which are much more likely and can have severities ranging from minor to extreme: portfolio risk. Much ink has been spilled over the years on how to measure your risk tolerance and as far as I can tell it remains more of an art than a science. In this post I will offer some thoughts on how to assess your risk tolerance and adjust your portfolio so that you only take risks you can live with.<br />
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<a name='more'></a>So how do you know how much risk you can live with? This is a much tougher question than it might seem. I have seen numerous ways touted to help assess risk tolerance and they all fail to account for the emotional component of investor reactions when things are either looking really positive or in the pit of Hell. This isn't necessarily a failure of the various questionnaires and other methods that are used. Instead, it illustrates the difficulties identified by behavioral finance research of integrating emotional and non-rational aspects of human behavior with cold, calculating financial planning. Inevitably, people become too exuberant and risk-tolerant when things are good and too risk shy when things are bad (or have been in the recent past). So the same investor might give distinctly different answers to a risk tolerance assessment survey depending on what course the markets have taken n the recent past. So while I think there is some value (they make you start thinking about risk) to many of the commonly used risk tolerance assessments, until they integrate the emotional aspect of risk tolerance and/or compensate for it they will remain substantially flawed.<br />
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I don't have any magical way to fix the fundamental flaw that the risk tolerance questionnaires have. Instead, I would suggest assessing risk tolerance another way. Risk is usually defined as the risk that you will see the value of your investments decline for some period of time. Given the tendency of most markets to have periods of time when they drop (sometimes precipitously) generally followed by a recovery, self-correcting price fluctuations may not be a great measure of risk for long term investors. Instead, I think there are two forms of risk that should be contemplated and managed to the extent possible. First, investors should be on guard for the risk that a specific investment or even an entire market may decline and never recover. Clearly, an individual equity bears this risk, with the risk increasing as the underlying company risk of default increases. However, there are also entire markets that are at risk of effectively never recovering. A handy example is the Nasdaq index, which peaked at over 5,000 in the dot-com era and a dozen odd years later is still well short of that figure despite solid recent performance. The risk of an investment or market never recovering is that you have a permanent loss of capital (as opposed to a temporary one which reverts to a gain if you are patient for a few months to a few years).<br />
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Aside from obvious situations like a stock issued by a firm with shaky finances, it can be challenging to identify situations where an entire market may be at risk of permanent losses. However, valuation is usually a good guide so when you see record valuations it is probably time to start being cautious. The risk of permanent losses from individual securities can be mitigated by diversification. How should one diversify this risk effectively? A very simple and highly effective way of doing so is to set limits on how large individual exposures can be within your portfolio. For example, I generally adhere to a self imposed rule of having no more than 5% of my portfolio in a specific security at the time I initiate a position and no more than 10% at current market values (leaving room for appreciation). So on a $1 million portfolio that would restrict cash used to buy a position to $50,000 and if the position appreciated to over $100,000 at market value I would be forced to begin selling down the position to stay with my 10% limit. An appropriate limit might be different for each person, and I would suggest scaling the percentage limits based on how quickly you believe your portfolio would rebound from a total loss. Clearly a portfolio composed of broadly diversified index funds would largely avoid the risk of a permanent capital loss and many investors chose to do so.<br />
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The second and more important risk is the risk of your portfolio failing to meet your goals. Most investors have specific financial goals in mind, either for their portfolio as a whole or for segments of it (a college fund for your children, for example). In the long run, the biggest risk investors face is failing to meet their goals. Which matters more: seeing your portfolio drop 25% in a year and taking two years to recover the losses, or not having enough money to pay for the kids' college tuition or fund retirement? Yet most risk measures and sensitivities are focused on the risk of short term portfolio drawdowns rather than the risk of failing to meet your goals. I suggest that a good way to think about your risk tolerance with regard to the risk of failing to meet your goals is to consider the specific goals you have and the likely consequences of not meeting them. For example, if your goal is to save enough to retire at age 55 and you miss that goal, most likely the consequence will be that you have to work for additional years to have enough saved for retirement. How unhappy are you with that outcome? If you enjoy your career and believe you will continue to do so, you might not be that upset to miss your goal and therefore be quite risk tolerant. On the other hand, if you are counting he days until you no longer need to have a job, you might be fairly risk intolerant.<br />
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Fortunately, it is fairly obvious how to reduce the risk of not meeting your goals. First, if you are not on track to meet your goal or wish to increase your chances of comfortably meeting it, you can contribute more to your portfolio out of your present income. This is the simplest, most certain way to reduce your risk and it is entirely under your control. Of course, this strategy has certain risks, most notably that you are giving up additional opportunities for consumption today in the hopes that you will be around to use the savings later. "Tomorrow is promised to no man." A second way to reduce the risk of failing to meet your goals is by adjusting your portfolio mix. You might think that this is a suggestion to buy more bonds or hold more cash. It is not. Instead, the adjustments that reduce your risk depend upon how close you are to meeting your goal. The farther away you are, the more willing you should be to take additional volatility risk if it comes with additional potential returns. So an investor who is saving for retirement and has a goal of retiring in 20 years should be much more willing to see their portfolio drop temporarily if it means that they are likely to be rewarded for enduring the volatility. On the other hand, the same investor who is a mere 5 years from retirement has less time to wait out such fluctuations and should seek to reduce portfolio volatility so long as they are still reasonably likely to earn a large enough return to meet their goals.<br />
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As a final thought, the above is by no means exhaustive and there are other risks that may be unique to your situation. There are also lots of investors who are not cut out to endure high volatility even if it means pushing back their goals by a period of years. If you know you will not be able to sit tight (or buy more) as the the markets go into one of their regular swoons, either find a way to automate things and don't look too often (401ks and similar programs are an excellent way to do so), reevaluate your goals to make them more realistic in the face of having to accept lower returns for volatility you can live with, or save more of your income to offset your reduced returns over time. Unfortunately, there is no free lunch here, just a set of trade-offs to consider.<br />
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As always, the above is not intended as investment advice. Consult your advisors, do your own due diligence, take your own risks and be careful. There are no certainties in life except death, taxes and the fact that you will lose money on your investments from time to time.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-9464033376618764862013-01-22T14:42:00.000-07:002013-01-22T14:42:06.489-07:00Cutting Off The Tail, Part 1<br />
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<span style="font-family: Calibri;"><span style="font-size: large;"><strong><em>How To Ensure That You Are Protected If The Worst Happens<o:p></o:p></em></strong></span></span></div>
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<span style="font-family: inherit;">The US has backed away from the so-called “fiscal cliff,”
equity markets have rebounded (with the S&P500 recently at levels last seen
in 2007), volatility in the markets have declined, and junk credit spreads are
going back down to foolhardy levels.<span style="mso-spacerun: yes;"> </span>The
US housing market appears to be rising again, and the European debt crisis
seems to have died down to the level of an occasional whimper.<span style="mso-spacerun: yes;"> </span>Not that there aren’t a few clouds on the
horizon, but for now the environment appears to be reasonably calm and at least
moderately positive.<span style="mso-spacerun: yes;"> </span>Considering the
events of the last several years, an oasis of calm is a good time to double
check your preparations for calamity, financial and otherwise.<span style="mso-spacerun: yes;"> </span>In this and the next couple of posts, I will
lay out some common sense preparations everyone should make while things are
relatively good so that you don’t have to worry about the worst case scenarios
(as much) when the next period of instability inevitably comes about.<span style="mso-spacerun: yes;"> </span>As an additional bonus, having ensured that
the worst possible outcome shave been mitigated you will be free to take on
more investment and/or professional risk if you choose to do so.<span style="mso-spacerun: yes;"> </span>Fundamental to personal financial belt-and-suspenders
preparation is sufficient insurance coverage.<span style="mso-spacerun: yes;">
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<span style="font-family: inherit;"><a name='more'></a></span><br />
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<span style="font-family: inherit;">A basic principle of rational insurance buying is that you
should only insure items or events that you cannot afford to weather yourself
without undue financial risk.<span style="mso-spacerun: yes;"> </span>So
carrying collision coverage on a $2,000 beater car that you have had for a
dozen years is a waste of most people’s money (as they can presumably replace
the car out of pocket relatively easily), while forgoing homeowner’s insurance
on a $400,000 house is likely to be a poor decision as well for the opposite
reason (most people cannot afford to rebuild the house out of pocket with
financial hardship).<span style="mso-spacerun: yes;"> </span>The insurance
premium may look cheap on some risks you should not insure, but rest assured:
insurers are quite efficient at pricing risk and they will generally price your
premium sufficient to cover the expected losses, plus their overhead costs,
plus some profit.<span style="mso-spacerun: yes;"> </span>As a result, if you
are insuring risks you can afford to eat in the event of a loss, you are merely
padding an insurer’s profits at your expense.<o:p></o:p></span></div>
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<span style="font-family: inherit;">So what insurance should the risk-managing investor
maintain?<span style="mso-spacerun: yes;"> </span>There are three clear-cut
forms of coverage every investor should maintain, and two others that may be
appropriate depending upon one’s circumstances. <span style="mso-spacerun: yes;"> </span>First and foremost, every investor should
have adequate liability insurance, such as an “umbrella” or excess liability
policy.<span style="mso-spacerun: yes;"> </span>Unfortunately, every individual
with non-trivial net worth is a potential target in a lawsuit and there are oh,
so many ways to become the target of one.<span style="mso-spacerun: yes;">
</span>Fortunately, umbrella policies with liability coverage limits of $1
million or more (in excess of any underlying coverage of your home or car) are
readily available at relatively low cost (a few hundred dollars per year).<span style="mso-spacerun: yes;"> </span>While a million dollar plus settlement is
unlikely for any of us, having such coverage in place means you will not be
financially devastated by such an outcome and that you will have the insurance
company’s lawyers fighting tooth and nail to avoid having to pay an outsized
claim.<span style="mso-spacerun: yes;"> </span>I believe that such coverage is
an absolute necessity and failing to carry such a policy is taking a foolhardy
risk that can be inexpensively insured away.<o:p></o:p></span></div>
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<span style="font-family: inherit;">The second necessary type of coverage is homeowners’ and
auto insurance.<span style="mso-spacerun: yes;"> </span>While there is an
important element of property damage coverage (especially with homeowners’
coverage), both of these policies are needed for investors because they offer
liability coverage and will generally be required by your insurer in order to
qualify for an umbrella liability policy as discussed above.<span style="mso-spacerun: yes;"> </span>Collision and comprehensive coverage for a
vehicle may or may not be worth carrying depending on the value of the vehicle
compared with your net worth and risk tolerance.<span style="mso-spacerun: yes;"> </span>For example, an investor with a $100,000 net
worth who owns a $20,000 car would probably wish to maintain property coverage
on the vehicle because a total loss would equate to a loss of 20% of his or her
net worth.<span style="mso-spacerun: yes;"> </span>In contrast, an investor with
a $2 million net worth owning the same car might rationally choose not to carry
property coverage on the vehicle because a total loss would represent a 1% loss
of net worth (equivalent to a sloppy day in the financial markets).<span style="mso-spacerun: yes;"> </span>In contrast, maintaining sufficient
homeowners’ property coverage (and possibly flood insurance if you are in a
flood plain) is probably appropriate for everyone as most investors would not
want to sustain a financial loss equal to the reconstruction costs of their home.<o:p></o:p></span></div>
<o:p><span style="font-family: inherit;"> </span></o:p><br />
<span style="font-family: inherit; line-height: 115%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">The third type of insurance every investor
should maintain is some form of health insurance. This may be provided by an employer or purchased on your own, but given the huge unpredictability of healthcare costs in the US it would be foolhardy to forgo healthcare insurance. That said, if you have a choice on the details of your policy it probably would be wise to have a "high deductible" plan which offers substantially lower premiums in exchange for a deductible of as much as $10,000 annually. One should only insure losses which you cannot relatively easily "eat" without significant financial repercussions. If a $5,000 portfolio loss would not be material to your net worth, why should a $5,000 healthcare expense that is less than your deductible be different?</span><br />
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Finally, there are two kinds of insurance which may be important risk management tools for investors: disability income and life insurance. In large part, the need for both of these forms of insurance hinge on the answer to the same question, namely if you are no longer earning an income (due to disability or death) would you and your family be in serious financial difficulty? If the answer is yes, you should have both disability income and life insurance coverage. Disability coverage may be offered through your employer or be bought in the open market. Life insurance is usually best purchased away from an employer plan unless you have health risks that would make you difficult to insure as an individual. For most people buying life insurance in the open market level term insurance with a rate fixed for 10 to 30 years is the best product to buy due to its simplicity, transparency and relatively low cost. While there are a few situations where a permanent life policy (universal life, whole life, etc.) would be appropriate, the vast majority of life insurance buyers would be better served buying term life insurance.<br />
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While I have attempted to lay out the most important forms of insurance coverage, this list is by no means exhaustive. If you feel the need for some sort of coverage and you cannot afford the losses this insurance would cover, by all means buy the coverage. However, before you buy insurance make sure you understand what the policy covers (and does not over), look very carefully at any new product pitched to you, and revisit whether you really need to part with those premium dollars.<br />
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In the next two parts of this little series of "covering your assets" posts, I will address how to check up on your portfolio compared to your risk tolerance, and how to mitigate some of the non-financial risks we all face.<br />
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As always, the above is not intended as financial or investment advice. Consult your advisors, do your own due diligence and be careful. I am just some dud typing away on the interwebs so why would you take my advice?The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-16011868982732019262013-01-18T14:12:00.000-07:002013-01-18T14:12:54.767-07:00Safe Money Rate Alert!<strong><em><span style="font-size: large;">Pentagon Federal Credit Union Offering An Attractive Set OF CD Rates</span></em></strong><br />
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In the present low rate environment, it helps to keep an eye wide open for good deals to offset the generally lousy returns available on safe instruments. Previous posts have identified the most reasonable places to put "safe" money these days, and one of them is certificates of deposit (CDs). There is a big range in rates and terms between different depository institutions so it pays to shop around. At the moment, the institution that appears to be offering the best terms is Pentagon Federal Credit Union (Pen Fed), available at <a href="http://www.penfed.org/">www.penfed.org</a>. Pen Fed has a long history of offering above market yields on CDs and is one of the 5 largest credit unions in the US (and anyone can join by purchasing a 1 year membership to the National Military Family Association). Pen Fed is currently offering CDs with APYs ranging from 1.25% for a 1 year term to 2% for a 7 year term. These rates are far above what treasuries offer (less than 1% yield for 5 year money) and the 3 year rate is about the same as a 10 year treasuy. Better yet, if rates spike Pen Fed offers fixed early surrender penalties of 6 months' worth of interest for terms up to 4 years and 12 months of interest for 5 and 7 year terms. The math says that a 4 year CD yielding 1.85% APY would have an early surrender penalty of less than 1%, effectively granting the buyer of this CD a very cheap put option in the event of a rate spike.<br />
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To be clear, 2% and under yields will not blow the doors off for anyone. However, in a very low rate environment where competing CDs and treasuries offer a fraction of the interest Pen Fed is generously dispensing, this looks like rates worth grabbing. Be sure to stay below the deposit insurance maximums, or course.<br />
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Disclaimer: As always, due your own due diligence. Although it seems unlikely, you can probably lose money even buying a CD. Read the fine print and be careful. I have no affiliation with Pen Fed other than being a customer for a number of years.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com3tag:blogger.com,1999:blog-9213538927378012885.post-33027103926660823192012-09-19T15:47:00.001-06:002012-09-19T15:47:28.456-06:00Short Attention Span Theater<span style="font-size: large;"><strong><em>The Credit Markets Are Starting To Get Stupid (Again)</em></strong></span><br />
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Way back in January I discussed in some detail when investors would want to be in or out of the junk bond market (see <a href="http://lifeinvestmentseverything.blogspot.com/2012/01/dumpster-diving-in-junk-bond-market.html">http://lifeinvestmentseverything.blogspot.com/2012/01/dumpster-diving-in-junk-bond-market.html</a> ). One of the most important things any investor in this market can do is know when NOT to be invested in junk, since owning junk at the wrong time can destroy quite a lot of value in a relatively short time period. The hallmarks of a junk bond market that is starting to get overly frothy include excessively tight spreads over treasuries, high volumes of new bonds being issued, and increasingly lax structures that strip much of the protection afforded to investors by covenants and other features of these securities. You might be inclined to think that after the horrendous debacle of 2009 the credit markets would exercise some discipline for a long time. There is increasing evidence that you would be wrong to think that.<br />
<a name='more'></a><br />
First, junk spreads have slid significantly in recent weeks. The BofA Merrill Lynch US High Yield Master II Option-Adjusted Spread index now shows junk bond spreads hovering just above 5% above treasuries of similar maturity. This isn't at all time lows of less than 3%, but it is low enough that anyone thinking about buying junk for yield should think twice about doing so. Given the substantial increase in risk, all of a sudden would-be junk investors are being compensated at relatively low levels. Sub 5% spreads mark the point at which I personally am not eager to buy any junk and when I start thinking about selling.<br />
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Second, issuance volumes have been high over the course of the summer and they have increased their pace in September thus far. Across the spectrum of credit from the cleanest investment grade names to Caa/CCC-rated junk, new bonds are being pounded out every day. Even issuers whose debt is not callable are rushing to refinance now that the market is accomodating. For example, B-rated American Axle (AXL) recently successfully refinanced its 2014 bonds by issuing new long term bonds and conducting a tender offer for its non-callable existing bonds. When issuers that have been junk rated for a long time start rushing to refinance, it isn't because they just feel like doing so. Generally these types of issuers are long term observers of the junk market and understand very well that the market only gets this loose for a limited time.<br />
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Finally, terms and conditions have begun to get extremely aggressive in new junk issuance. Covenants and other measures are important protections for investors in junk bonds, as they force an issuer to deal with problems sooner rather than later and usually keep the management of a troubled company from "putting it all on red" and try to gamble their way out of a mess using the bondholders'/lenders' capital. Unfortunately, when the junk bond market gets frothy issuers are sometimes able to dispense with many or even all of these restrictions. As a prime example, AdvancePierre Foods is said to have been in the market today with a new syndicated loan which is of the "covenant lite" variety. This debt apparently was priced at 4.75% over LIBOR with a 1.25% LIBOR floor (all in yield of 6%) that matures in 4 and 3/8 years. This $825MM issuance has little or no covenant protections for the investors buying the loan, so the management of this privately-held leveraged buyout company can do pretty much what they want as long as they make the contractually scheduled payments on this loan. The proceeds paid off existing loans, but they also funded a dividend to the owner of the company. So a B-rated issuer was able to sell close to $1Bn in loans that have almost no protections for the investors and they were allowed to pay out a chunk of the lenders' money to the equity investors. For all of this lattitude they will pay a 6% yield. This is a pretty aggressive structure, and if we see more issuance like this and possibly some spillover from the leveraged loan market to the junk bond market, it will be a very clear sign that investors should resist the temptation of yield and get out of the junk market.<br />
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Investors should watch developments in the credit markets carefully in coming weeks. More aggressive behavior will be a clear sell signal, especially if spreads continue to drop.<br />
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Lest this just be about doom and gloom, I would offer you a silver lining from increasing stupidity in the junk market. The last time the credit markets got dumb, the equity market benefitted. Specifically, credit was so readily available and cheap that lots of mergers and acquisitions that would never have otherwise been possible got done. Accordingly, after a number of transactions where either other companies in the same industry or leveraged buyout funds took over targets at a significant premium to market values, the market begain pricing in higher valuations for a number of sectors. This had a stimulative effect on equity valuations and if you happened to be an investor in one of the "loved" sectors or in one or more takeover targets, you got a strong tailwind on your equity portfolio.<br />
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As always, the above is not intended to be investment advice. Consult your advisors, be careful, do your own due diligence.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-9034732335487042162012-08-27T02:36:00.000-06:002012-08-27T02:36:00.155-06:00Trade Recap: JQC Has Followed The Script<strong><em><span style="font-size: large;">I Love It When A Plan Comes Together</span></em></strong><br />
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Back at the beginning of February, I highlighted what appeared to be an attractive medium risk trading opportunity stemming from the repositioning of a closed end fund with ticker JQC (see <a href="http://lifeinvestmentseverything.blogspot.com/2012/02/jqc-profiting-from-metamorphosis.html">http://lifeinvestmentseverything.blogspot.com/2012/02/jqc-profiting-from-metamorphosis.html</a>). Aided by a scramble for yield all over the globe, my expectations for the trade have largely panned out over the past 6 months. This post will detail what has happened with JQC and try to answer the eternal question that stems from successful trades: now what?<br />
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As I mentioned way back in February, JQC was about to switch from being an oddball mixture of 70% preferred stock and 30% common equity to becoming mostly a bank loan fund. A new management team was installed and the asset switch was done. JQC also switched from a quarterly dividend to a monthly one while maintaining the same overall yield. Instead of being an orphan strategy which did not appeal to many investors, the fund is now a bank loan/high yield fund which offers a generous payout while taking credit risk and largely avoiding interest rate risk. JQC is in good company, as there are a number of other bank loan funds which by and large trade at little or no discount to NAV (some are at a premium) and generally find a warm reception from investors because the entire world seems to be chasing the kind of yields that these funds offer. At the time I first mentioned the fund, JQC was trading at a discount to NAV of between 9 and 10% compared to a peer average of about 3%. As you can see from the table below JQC is still trading at a modest discount to its peers, but the gap has become much smaller:<br />
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</tr>
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<td class="xl63" height="20" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 15pt;"><span style="font-family: Calibri;">JQC</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">-2.78%</span></td>
</tr>
<tr height="20" style="height: 15pt;">
<td class="xl63" height="20" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 15pt;"><span style="font-family: Calibri;">BLW</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">3.87%</span></td>
</tr>
<tr height="20" style="height: 15pt;">
<td class="xl63" height="20" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 15pt;"><span style="font-family: Calibri;">EFT</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">5.98%</span></td>
</tr>
<tr height="20" style="height: 15pt;">
<td class="xl63" height="20" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 15pt;"><span style="font-family: Calibri;">EVV</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">1.02%</span></td>
</tr>
<tr height="20" style="height: 15pt;">
<td class="xl63" height="20" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 15pt;"><span style="font-family: Calibri;">EFR</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">5.84%</span></td>
</tr>
<tr height="20" style="height: 15pt;">
<td class="xl63" height="20" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 15pt;"><span style="font-family: Calibri;">PPR</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">0.00%</span></td>
</tr>
<tr height="20" style="height: 15pt;">
<td class="xl63" height="20" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 15pt;"><span style="font-family: Calibri;">VTA</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">-2.62%</span></td>
</tr>
<tr height="20" style="height: 15pt;">
<td class="xl63" height="20" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 15pt;"><span style="font-family: Calibri;">VVR</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">0.40%</span></td>
</tr>
<tr height="20" style="height: 15pt;">
<td class="xl63" height="20" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 15pt;"><span style="font-family: Calibri;">JFR</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">1.67%</span></td>
</tr>
<tr height="20" style="height: 15pt;">
<td class="xl63" height="20" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 15pt;"><span style="font-family: Calibri;">ERC</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">-4.14%</span></td>
</tr>
<tr height="20" style="height: 15pt;">
<td class="xl63" height="20" style="background-color: transparent; border-color: black windowtext windowtext; border-style: none solid solid; border-width: 0px 0.5pt 0.5pt; height: 15pt;"><span style="font-family: Calibri;">Peer Average</span></td>
<td align="right" class="xl64" style="background-color: transparent; border-color: black windowtext windowtext black; border-style: none solid solid none; border-width: 0px 0.5pt 0.5pt 0px;"><span style="font-family: Calibri;">1.34%</span></td>
</tr>
</tbody></colgroup></table>
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So JQC's performance has benefited from a discount to NAV which fell about 7% while the peer group went from a 3% discount to a 1% premium, or a 4% tailwind overall. Aided by a favorable environment for high yield bonds and bank loans, NAVs for JQC and its peers generally ticked upward modestly over the past 6 months as well. Finally, all of these funds offer a generous yield and JQC shareholders collected $.5335 in payouts since February 1, 2012 for an additional yield of 6.1% (unannualized). All of this adds up to a total return in a bit over 6 months of 13.7%. I will leave annualization of that return as an exercise for the reader, but it appears to be in the region of a 25% annualized return. Not bad for a fixed income instrument and a lot better than the S&P 500's performance with far less volatility.<br />
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That was then, this is now. The question facing anyone who owns this fund is, what to do now? Clearly JQC is far less of a piece of low-hanging fruit than it was in the past, given that the discount to NAV has closed significantly and the discount to peers is smaller than it was. Since JQC still has the second largest discount in its peer group, there is probably still room for further tightening of the discount to NAV especially as the fund builds an increasingly long track record as a bank loan fund. But since we are only talking about 2 or 3 percentage points of potential extra return, any tightening of the NAV discount relative to peers will just be a "cherry on top" and not the kind of bonanza the past 6 months have offered. So in the future it is highly likely that returns from holding JQC will be lower than the blistering ~25% annualized returns we have seen. Investors who choose to continue holding this fund should temper their expectations.<br />
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Future returns will be composed of three pieces: the cash yield, changes in discount to NAV, and changes in the value of the underlying assets. JQC currently sports a cash yield of 8.5%, well above most alternatives. The yield may diminish if rates continue very low and the markets are favorable to high yield issuers refinancing, but it probably will not change much. With a discount to NAV of a bit under 3%, the discount could tighten as much as 3 to 5% based on peer discounts, but the discount could also potentially widen. The underlying assets of the fund are leveraged loans and high yield bonds. Typically upside is limited on these securities because issuers can call the loans and bonds at a premium equal to about 6 months' worth of interest, while downside can be 100% in the event of default. Defaults are at low levels currently and do not appear set to rise much, but upside is also probably limited to a further 2 to 5%. Adding all of these sources of potential return and risk together, returns on JQC over the next 6 months are likely to be 8.5% annualized (the cash yield) plus or minus 3 to 5%, assuming that the credit markets do not fall apart again. Your guess is as good as (or likely better than) mine as to whether the credit markets will fall apart, but it does not appear to be imminently on the horizon.<br />
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If you want exposure to junk credit or are reaching from yield, a position in JQC would seem to be a reasonable alternative. JQC yields more and has a higher discount to NAV compared to its peers and as one of the larger of such funds it should be significantly more liquid. Other alternatives might be one of the bank loan mutual funds out there (which unlike JQC and its CEF peers are usually not leveraged), a recently rolled out ETF that focuses on bank loans (BKLN), or junk bonds/a junk bond fund. On the other hand, if your attraction to JQC was due to its potential for outsized gains in a relatively short time period, it may be a good choice to collect your winnings and move on. It is highly unlikely that the next 6 months will be as lucrative as the last 6 months for JQC investors.<br />
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Since I am sitting on a larger than normal cash position already, I have decided to hold my stake in JQC for now. I happen to like the asset class (bank loans/junk), JQC still has a greater than peer discount to NAV, and I don't see a lot of more attractive alternatives. Notably, the discounts to NAV on virtually any kind of CEF that holds fixed income assets have plummeted over the course of 2012, presumably the result of the global hunt for yield. As such, I don't see obviously very attractive new CEFs to rotate into from JQC.<br />
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As always, the above is not intended as investment advice. Do your own due diligence, consult your advisors, take your own risks and be careful. You can (and probably will at some point) lose money on anything that isn't a bank account.<br />
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<br />The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-18208036767018892922012-08-22T19:24:00.002-06:002012-08-24T21:36:42.491-06:00Mission: Refinance Completed - The Post Mortem<span style="font-size: large;"><strong><em>Relatively Painless Experience</em></strong></span><br />
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<a href="http://www.fatherofone.com/wp-content/uploads/2012/05/easy-buttons800x800.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="400" src="http://www.fatherofone.com/wp-content/uploads/2012/05/easy-buttons800x800.jpg" width="400" /></a></div>
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As I mentioned in a prior post <a href="http://lifeinvestmentseverything.blogspot.com/2012/07/fun-with-housing-finance.html">http://lifeinvestmentseverything.blogspot.com/2012/07/fun-with-housing-finance.html</a> I have recently been going through a refinance on my home with <a href="http://www.boxhomeloans.com/">www.boxhomeloans.com</a> in order to swap an ARM for a 30 year fixed rate loan at what appear to be historically low interest rates. The mortgage process is still time consuming and requires attention, but it is far less paper intensive than in years past.<br />
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I have to give Box Home Loans credit for moving the process along and keeping me informed throughout the process. After uploading and signing almost everything electronically, the appraisal was completed shortly thereafter and with an appraised value of 10% in excess of my purchase price I was good to go. Some additional documentation was required a few weeks into the porocess, but once again I was able to do everything quickly and electronically. The closing happened (barely) within the lock period, and this took some logistical effort on Box' part because I was actually out of the state on business travel the week the closing was scheduled. Box found a notary where I was travelling and was able to have me sign and review all of the documents in time to have them overnighted to my wife so that she could sign them in time to avoid breaking the lock. Since rates have risen a bit since I locked my rate, I did not want to have to refloat and accept a higher rate.<br />
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All this rosy stuff aside, this only went as smooth as it did because of a few factors:<br />
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- I fit in the"box": my situation was well within the underwriting parameters for conforming Agency mortgage originations. If this had not been the case, either I would have had to take steps to fit in the box (by paying down the loan balance, paying off other debt, etc.), or I would have had to go through a much more expensive and troublesome process that may not have been worth pursuing since this was an opportunistic refinance.<br />
- I didn't need to close this loan in order to move. This was a refinance. If the loan process had broken down at some point and fallen through, all I would have been out was a few hundred dollars in expenses. If I were depending upon the closing of this loan to buy my new home (as was the case last summer when I moved in), this process would have required a lot more close attention and the stakes would have been a lot higher.<br />
- I was fortunate in that the value of my property rose. If the appraisal value had instead moved down over the last year I would have had to either partially pay down the loan to get the loan to value down to 80% or give up on the refinance.<br />
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If you have an existing mortgage and you can qualify for an Agency mortgage, watch rates closely. Nobody knows how long rates will stay as long as they are, but the process is fast and simple enough that you should be able to lock in an ultra-low rate without a lot of fuss.<br />
<br />The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com1tag:blogger.com,1999:blog-9213538927378012885.post-73674745788769829482012-08-09T12:28:00.001-06:002012-08-11T14:00:43.684-06:00Burning Up...<span style="font-size: large;"><strong><em>The Grains Markets May Offer A Speculative Opportunity</em></strong></span><br />
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A brief google search or a perusal of the financial news will tell you that the extreme drought conditions currently experienced by much of the US are wreaking havoc on 2012 crops, especially corn. More recently, some areas have received some rain, but it is likely too late to revive the scorched corn crop. Other crops are suffering as well. Other than potential increases in food, energy and other prices, what does this mean to the average investor?<br />
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Commodity markets have certain dynamics that make like very difficult for commodity producers, but present occasional opportunities for investors. Of most interest given the present conditions in the the agricultural sector is the tendency for commodity prices to overshoot on both the upside and the downside when supply and demand get out of balance. These overshoot events may be relatively brief, but they are often fairly predictable and can be lucrative speculative opportunities. Using upside overshoots as an example, typically what happens in these excessive price movements is a supply shortage confronts inflexible demand. Since the market rations a scarce commodity to those willing and able to pay the most for it, prices can spike far and fast, sometimes exacerbated by short-covering and momentum speculators chasing the trend.<br />
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So how can one spot an emerging potential outsized commodity price movement? There are certain necessary preconditions that can clearly be identified. First, there must be relatively inflexible demand for the commodity, at least in the short term. For example, heating fuel in the winter and food are commodities for which there is extremely inelastic demand in the short term. Consumers simply do not have many alternatives and are effectively forced to buy these commodities regardless of price. Second, there must be a supply shortage that cannot be easily or cheaply remedied by imports or alternative supplies. Natural gas in the continental US is a convenient example. In 2005 a great deal of natural gas production capacity and infrastructure in the gulf of Mexico was destroyed by a series of hurricanes. As the US does not have significant natural gas import infrastructure in place, there was literally no way to replace the shortage until the damage could be repaired. Finally, there must be little or no stockpiles available to tide the market over in times of shortage.<br />
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It appears that the grains market is potentially approaching an overshoot, especially the corn market. The three preconditions appear to be present. Demand can certainly change over time, but at least in the short term it is relatively inflexible. The most obvious sources of reduced demand are livestock feed and ethanol production. However, it will take time for the beef industry to materially reduce the herd during which time the cattle still have to be fed. The ethanol industry can shut down plants in favor of other gasoline oxygenates or the US government can grant an exemption for oxygenation, but these steps will require time (months, most likely). Supply has been badly impacted by the drought. I recently drove across the heart of the corn belt in the US Midwest and the crop destruction is simply astonishing. Dry land corn is largely a near total loss in many areas and even some of the irrigated crop does not look terribly healthy. Alternative supply would normally come from South America (especially Argentina), but South America's crop was also affected by a bad drought in 2012. Finally, corn stocks are at multi-year lows, estimated as low as a 2 month supply on hand. The corn market appears at risk of a large price spike if the news on supply or demand is slightly worse than expected.<br />
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What does this mean for us as investors? There are plenty of companies that will be winners and lowers due to movements in grain prices and it might be worth watching some of the losers for a potential buying opportunity. However, there is another opportunity that is probably best regarded as a speculation that should only be hazarded with high risk, high potential return capital that you are willing and able to lose. I typically try to keep 1% of my portfolio for speculative bets like this, but any allocation may be inappropriate for many investors so make sure that any such bets you make are appropriate for you and your risk tolerance. That said, there are commodity futures ETFs available that allow investors to take positions on corn, soy and wheat (tickers CORN, SOYB and WEAT, respectively). Of particular interest, there is also a market for options on CORN, with options quoted but not yet traded on SOYB. So if one wished, one could take a speculative position either by buying or selling a position in one of these ETFs or in options on CORN. In a market environment where prices appear to be potentially primed to significantly overshoot, a leveraged position in CORN via options could provide an outsized return on a relatively modest capital commitment.<br />
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To give an idea of the potential risk and reward of a speculative trade in CORN, if one bought options on CORN the potential risk is every dollar you pay for the options. By their nature, options can and often do expire worthless. Upside is highly magnified by the leverage inherent in options. For example, if you bought February $55 calls on CORN and the price of the commodity rose enough for the ETF to double from its present price to about $105, your $3.50 per share options could be worth $60 per share. Considering that wheat is currently at $9 and at one point in 2008 rose to over $25, a large price move in a tight stocks and poor supply situation is possible.<br />
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What could go wrong in such a trade? Simply, the underlying commodity could fail to move in the direction you expect in the timeframe you expect. If that happens a position in the ETF would lose money and an options position would be a total loss. The risk of loss is significant, as this is an outright speculation rather than an investment. So be very, very careful and you should be very risk tolerant indeed to consider playing this game. That said, if you are willing to take a gamble and can afford to lose every penny you stake on such a wager, the market seems poised for a potentially large price movement.<br />
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As always, consult your advisors, do your own due diligence, take your own risks and be careful. Trades as described above are extremely risky and you can lose every penny you put into them. Caveat emptor. The above is not intended as investment advice.<br />
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Disclosure: I am long CORN call options.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-87954631045414334682012-07-23T18:07:00.000-06:002012-07-23T18:07:05.475-06:00How To Chase Yield<strong><em><span style="font-size: large;">Managing Risk & Being Careful While Doing Something Fundamentally Foolish</span></em></strong><br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_2zVksZqFa8j_HPL4bFhQ0aUbzXtTiTHTvlRn5aJv-YYHQS_OYxJriuAKXvjDC41id8lIiqk3QchO4GPg6LBG_FFB4lbvNLKm8I0dtdVeC9iB7wnVgSd0mBPBrszU81JK9YcPYZbDuKE/s1600-r/logo_running_with_scissors.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="400" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_2zVksZqFa8j_HPL4bFhQ0aUbzXtTiTHTvlRn5aJv-YYHQS_OYxJriuAKXvjDC41id8lIiqk3QchO4GPg6LBG_FFB4lbvNLKm8I0dtdVeC9iB7wnVgSd0mBPBrszU81JK9YcPYZbDuKE/s1600-r/logo_running_with_scissors.jpg" width="360" /></a></div>
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As old CDs, treasuries and similar very low risk investments continue to mature, one can hear the groans from investors and savers everywhere at the prospect of extremely low rates being offered on new bonds and CDs. In many cases, investors and savers are finding that the rates offered are so low that they cannot accept such low rates and still meet their minimum return required. This problem does not appear to be going away any time soon as central banks all over the world continue to do their utmost to keep rates on safe instruments very, very low. Those who refuse to accept current rates offered on low risk bonds and CDs will continue to have the same quandary for the foreseeable future: what do you do with the money? Many will choose to throw caution to the wind and adopt a strategy that has been the source of untold sums of lost money, chasing yield. This is a dangerous environment in which to do so because lots of people are doing the same thing. As a handy indicator, junk bond funds have been attracting enormous amounts of cash even as yields stay low and Vanguard recently decided to close its junk bond mutual fund to new money after being flooded with cash. Yet many people will chase yield anyway since some are effectively forced to do so due to needing higher returns than they can get from safe instruments. If you choose to chase yield, how can one manage the risk that inevitably arises from this strategy? How does a sensible person add some yield in a judicious fashion?<br />
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First and foremost, anyone chasing yield should be very honest with themselves about risk. If you start chasing yield and moving away from the very safest investment options, you will be taking more risk and the chance that you will lose money (principal) will increase materially. Time for a gut check: are you willing to risk losing money to boost yields? Can you afford to lose a chunk of principal in the event that one or more of your investments does not perform well? How much are you willing and able to lose? These are critically important questions you should have clear, honest answers for. Too many people simply start buying whatever yields the number they have in mind without a thoughtful consideration of the risk they can stomach. This usually ends poorly.<br />
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Once you have determined how much risk you are willing to take (and the answer may well be zero), you next need to do a bit of navel-gazing about the returns you require. How much do you really need to earn? The answer probably has a lot to do with what the money is intended for. If you are living off of portfolio income, you probably have a clear idea of how much money you need to earn in order to cover your expenses. If you are saving for a specific goal (college fund, retirement, major purchase, etc.), you likely have an idea of what return you need to make in order to meet your goal. If you don't know how much you need to make to meet your goals, then it is time to break out a spreadsheet and spend some thoughtful time figuring out where you are, where you are headed and how you plan to get there. Whatever your return goal, make sure you use that number as a means to discipline yourself from reaching too far for yield. The higher the stated yield, the greater the risk. If you need 6%, don't get seduced into thinking 9% is that much better. Chances are you will be taking a vastly increased amount of risk that ultimately isn't necessary to meet your goals.<br />
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Next, you will have to decide where you want to chase yield and how far you wish to spread your bets. There are several types of investments that offer higher yields and you may wish to diversify a bit to try to reduce risk. The downside of diversification is that with every additional investment there is more to watch, keep track of, make decisions about, and make mistakes with. Still, spreading your yield chasing capital around to as many as 6 different types of cashflowing types of assets should be easy enough to keep track of.<br />
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So where will you get yield from? There are a number of "usual suspects" when investors chase yield and all of them have been getting bid up as more and more people throw money at anything with a generous yield (caveat emptor). Below is a description of some of the most common choices along with a brief description of the risks involved:<br />
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- Mortgage REITS: There are a number of these, with one of the largest and oldest being Annaly (ticker NLY). These investment vehicles typically offer eye-popping yields (in the teens) which have attracted many investors. They make money by using investors' capital to buy government backed (and other) mortgage backed securities and they typically use significant leverage (commonly borrowing 5 to 10 times their equity). This works fine as long as interest rates stay level or drift lower, but if they start rising again mortgage REITs will get hurt badly in short order.<br />
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- Junk Bonds: I have detailed the risks, rewards and how-tos of this asset class here <a href="http://lifeinvestmentseverything.blogspot.com/2012/01/dumpster-diving-in-junk-bond-market.html">http://lifeinvestmentseverything.blogspot.com/2012/01/dumpster-diving-in-junk-bond-market.html</a> in brief, junk gets you lots of credit risk, relatively little interest rate risk, and at the moment is offering 6 to 10% yields depending on the "junkiness" of what you buy.<br />
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- Bank Loan Funds: Bank loan funds resemble junk bond funds in many respects an in fact may include credit exposures to some of the same obligors. However, loans have even less interest rate risk than bonds and tend to fare somewhat better in the event that the creditor defaults owing to loans' higher position in the capital structure of most junky borrowers. The trade-off is that yields tend to be lower, generally in the 3 to 7% range.<br />
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- BDCs: Business development companies, or BDCs, are somewhat leveraged investment vehicles which lend money to and sometimes take equity stakes in smaller companies. They are publicly traded (see AINV, TWO, etc.) and usually have generous (10+%) stated yields. Unfortunately, it is difficult to ascertain the health of the underlying companies which the BDC has lent money to or bought part of, so the sustainability of these hefty payouts can be tough to judge. These vehicles generally have ample credit risk which is magnified by the use of leverage. BDCs tend to get badly hurt in economic downturns.<br />
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- Preferred Stocks: Preferred stocks are oddball securities that have features of both bonds and equities. They typically have a fixed payout/coupon, a stated par amount and are callable much like a bond, yet the payout is considered a dividend (and can be cut) and most preferreds trade on an exchange like any common equity. While preferreds usually offer yields north of 5%, they have a lot of interest rate risk and can be called away just as the yield they offers moves above market. Preferreds also have greater credit risk than senior unsecured bonds issued by the same obligor. A great source of data on preferred stocks is <a href="http://www.quantumonline.com/">http://www.quantumonline.com/</a><br />
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- Closed End Funds: Closed end funds include a wide variety of asset classes, ranging from equities to municipal bonds to more esoteric strategies such as covered call funds. I have detailed how to evaluate closed end funds in detail here <a href="http://lifeinvestmentseverything.blogspot.com/2012/01/how-to-buy-dollar-for-90-cents.html">http://lifeinvestmentseverything.blogspot.com/2012/01/how-to-buy-dollar-for-90-cents.html</a><br />
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- Commodity Futures Funds: Commodity futures funds (such as PCRDX) aren't really a traditional yield vehicle, but because they must pay out income and short term gains and sometimes do so at eye-popping stated yields people do buy them for yield. In general, I would suggest that commodity futures funds are a poor choice when seeking yield, although they have other merits (such as hedging inflation risk).<br />
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Finally, let me again underscore the fact that chasing yield is a dangerous thing to do and I don't recommend it, especially for conservative investors and savers. If you can at all afford to do so, stick with your chosen asset allocation and leave the "safe" money in the lowest risk places (CDs, treasuries, etc.). The above detail is provided for those who choose to take the significant risk that comes with chasing yield or cannot meet their goals with the yields offered on low risk vehicles and are forced to take these risks.<br />
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Please consult your advisor. The above is not intended as investment advice. These are all risky investments and you can (and probably will at some point) lose money with them. Be careful.<br />
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<br />The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-28571711726947051462012-07-08T17:18:00.000-06:002012-07-08T17:19:41.918-06:00Fun With Housing Finance<strong><em><span style="font-size: large;">The Mechanics of Refinancing In a Mortgage Market Gone Crazy</span></em></strong><br />
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As should be obvious to anyone watching the markets, mortgage rates have fallen to record lows once again. Turmoil in equity markets, sovereign debt fears and probably expectations about central bank actions have continued to drive interest rates lower on a wide variety of fixed income instruments including agency mortgage backed securities (MBS). For conforming mortgage loans, yields on MBS drive pricing and rates on loans. However, the mortgage market is a bit of a mess in the wake of the real estate crash and the dissolution of a large part of the mortgage origination machinery in the last several years. The silly-low rates being dangled in front of would-be borrowers come with a bunch of strings attached and if you do not meet the many requirements to qualify for the advertised rate you are likely to pay far more in rate/fees or simply be unable to borrow at all. Since the list of requirements moves around not infrequently, potential borrowers who are on the edge will have a tough time figuring out if they qualify until they actually commit time, money and hair-pulling to an application.<br />
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Late last week I locked a rate to refinance my current mortgage. I will now explore the whys, hows, and what has changed over time in the mortgage process. I am lucky enough to comfortably meet the current requirements for receiving the advertised rate, so my comments will largely be confined to the so-called "conforming" mortgage market.<br />
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Before I get into the details of what I am doing, it is worth discussing why I even have a mortgage on my residence. There are a number of people who have made it a priority to own their homes outright, with no mortgage of any kind outstanding. This usually requires either paying the loan off with a lump sum or aggressively paying the loan down faster than is required over a period of years. While being mortgage-free is certainly attractive, it requires trade-offs. Chief among these is that you would have to devote much of your income or assets to paying off the mortgage early which would not allow one to take advantage of the many investment opportunities that crop up from time to time. While your returns will be volatile compared to the steady required interest of a mortgage, choosing this path isn't always about returns. Having the flexibility to deploy your capital at a moment's notice is a valuable option and one that you do not have when you use that capital to retire your mortgage. All of this said, there are definitely two schools of thought as to whether you should try to be mortgage free or not, and there are clearly benefits to not having a mortgage (sleeping well at night, never having to worry about default, etc.).<br />
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So what am I doing? Currently I have a 3.5% 5/5 ARM I took out a year ago when I purchased my home. At the time I wanted a simple, low cost product from a lender (<a href="http://www.penfed.org/">www.penfed.org</a>) I had dealt with in the past and this loan fit the bill. Pen Fed ate all the closing costs and the rate was a full percentage point below a 30 year fixed mortgage at the time. The structure of the loan is that the rate is fixed for 5 years after which it refloats every 5 years and the rate cannot move more than 2% at each adjustment. This is different from a standard 5/1 ARM which allows the rate to move every year after the first 5 and the initial interest rate can change as much as 5% at the first adjustment. So the 5/5 has far less "payment shock" ("holy cow did the payment go up!") risk than the standard 5/1. That said, the possibility of getting hit with rate increases in the future has been a nagging worry in the back of my mind for some time, so I have been watching 30 year fixed mortgage rates to see if I would have an opportunity to eliminate this risk. I would have been willing to accept a slightly higher rate than what I already had, but on Friday the monthly US employment report came out looking pretty anemic and the market again shoved rates down hard. I was able to lock a 30 year fixed mortgage with a rate of 3.5% and a 1/4 point credit toward closing costs. Total closing costs net of the credit will be just over $1,000. I easily spend $3,000 annually on various forms of insurance (home, auto, umbrella, term life), so a one-time cost of a thousand dollars to wipe out all my interest rate risk seems acceptable to me. If I ever have the chance to refinance at a lower rate I will be happy to do so, but I suspect that I will not be given that opportunity.<br />
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Despite some changes, it is still hard to get a straight answer on costs from most lenders. Calling up several mortgage brokers and lenders and asking for rates and fees will probably only show you who is the best liar. So how do you monitor rates and jump when the time comes? First, you can watch MBS prices/yields and interpolate from that. A Bloomberg terminal would be your friend for that task, but those without access might find daily price moves in MBB (an ETF that holds agency MBS) helpful to watch. Another source of information (for rates and almost everything else) is the Mortgage Professor's site <a href="http://www.mtgprofessor.com/">http://www.mtgprofessor.com/</a> which offers numerous calculators, articles, and daily wholesale loan rates (your retail rate would be higher, but movements in the wholesale rates would be closely tracked by retail rates). Finally, some lenders have chosen to be transparent and commit to showing you as much as they can up front. I monitored rates and fees at <a href="http://www.boxhomeloans.com/">www.boxhomeloans.com</a> and chose to lock my rate with them. I cannot recommend them yet because I am early in the process of getting my refinance completed, but thus far they seem to be taking pains to make things as simple and straightforward as possible.<br />
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What has really amazed me is how the mortgage process has changed over the last 15 years. When I took out my first mortgage in 1998 it was a 15 year fixed from a local bank that I knew would end up keeping the loan in its portfolio (not selling it). All I knew going in was the rate, with closing costs pretty much a mystery. Everything had to be done with paper and fax machines, and the lender was obviously doing its own credit work because they asked a bunch of persnickety questions that came from a person who was actually thinking. Fast forward to today and everything is electronic. In 50 pages of agreements and disclosures that had to be signed or initialled, all but 5 pages were able to be electronically signed and the remaining pages I scanned and uploaded to the lender's website. The rest of the requested documents were either pdf bank statements or scanned physical documents I had on hand that I uploaded. I have no idea who the actual funding lender is and the loan will almost certainly be sold off as soon as possible. The underwriting is being done against agency standards and will probably be done within software provided by one of the agencies. I would be very surprised if I get any underwriter questions that do not originate from needing to check off a box provided by one of the agencies rather than from a human being thinking and doing real credit work.<br />
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As of yet, I am waiting for the lender to set up an appraisal and move along with the process. Since this is a refinance and not a purchase, my risk on this deal falling through is pretty limited ($31 for the credit reports and whatever the appraiser charges). Aside from lender incompetence, the major reason refinances fall apart these days is an inability to show enough equity in the property due to declining real estate values. I am fortunate enough to have bought a year ago in a market that has been on a grafdual upswing, so I don't expect to have LTV issues. But what if you do have trouble getting below an 80% LTV? If arguing with the appraiser does not work, you can either abandon the refi, bring cash to the table to bring the LTV down to 80%, or pursue a HARP refinance if you are eligible (see <a href="http://www.makinghomeaffordable.gov/pages/default.aspx">http://www.makinghomeaffordable.gov/pages/default.aspx</a>). HARP refinances are a lot of trouble and tend to be expensive, so if at all possible I would recommend simply paying down the mortgage balance in order to comply with the 80% LTV limit.<br />
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I plan to update the blog on how this refinance goes once the dust has settled. It will be interesting to see if my very plain vanilla situation goes as smoothly as it should. Lots of people are refinancing, so I expect the lenders to be strained to process everything in a timely fashion.<br />
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As always, do your own due diligence, be careful, consult youtr advisors and watch your wallet.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-91987024802088237972012-06-20T13:26:00.001-06:002012-06-21T22:08:48.001-06:00How To Buy Life Insurance<strong><em><span style="font-size: large;">Cutting Through The Sales Literature, Marketing And Misinformation</span></em></strong><br />
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Many people at some point in their lives come to the realization that if they were to unexpectedly die their families would be in serious financial difficulty. Often this realization happens when you start having children or take on a major financial commitment, such as a large mortgage. A natural response is to buy life insurance to protect themselves, but all too often people do not buy the right amount, don't buy the right kind, or don't buy it from the right provider. There isn't a great deal in the way of common sense guides out there and the insurance industry and the agents have a vested interest in pushing certain types of products to less-than-well-educated customers. In addition, the insurance industry seems to thrive on producing an endless array of complex products which often sound a lot better than they are. This will be an attempt to offer some basic guidelines of buying life insurance coverage.<br />
<a name='more'></a>The first question you should ask yourself is, "do I really need a life insurance policy?" While it is a bit morbid, consider what your family/survivors' financial picture would be if you were no longer on the right side of the grass. Do they depend heavily on your earnings to make it? Or does your spouse substantially out-earn you and could comfortably cover all the household expenses on their income alone? Do you have kids and are you expecting to support them through college? Do you have sufficient net worth such that the family would be able to meet expenses over time without your earnings? What you should try to do is estimate what the family's shortfall would be in terms of money if you croak. A good rule of thumb is that it takes about 25 times the amount (in face amount of life insurance coverage) of the monthly shortfall in income to replace the lost earnings stream. Don't forget offsets such as any life insurance coverage you may have through your employer (most places I have worked have automatically covered me for 1X my annual salary), Social Security survivor benefits (can be significant if you have children), any pension benefits you might have earned, or other offsets. Finally, once you think you have come up with a reasonable amount, add at least a 10% margin of error to the coverage amount you came up with. Life insurance is generally inexpensive for younger people compared to the potential downside of not having enough, so err on the side of safety.<br />
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Once you have a reasonable idea of how much coverage you need, the next step is to determine what type of policy is most appropriate for you, and you should do this before talking to an insurance agent or other salesperson. It would be nice to get lots of detail and information about different types of policies before you make a decision, but the decision is usually pretty simple and as soon as you contact an insurer or agent the <strike>snow job</strike> sales effort will begin. I will try to make it extremely simple: if you are under 40 and not quite high net worth ($5MM or better), it is very likely that a 20 year term life policy will be a good choice. Many permanent life insurance (e.g. whole life or universal life) policies are sold to people for whom it is not suitable or necessary, often under the pretext that these policies offer some sort of magical, tax sheltered investment opportunity within them. For the vast majority of people 40 or under and not very high net worth, this is (to put it bluntly) a lie. Stick with term. Most term policies include a "conversion" option which allows you to trade in your term policy for a permanent policy at a later date without going through underwriting again, so if your circumstances or preferences change down the road you can relatively painlessly switch. Why is term a better choice for the typical consumer? It provides mortality coverage at a far lower cost (when I bought my term policy, the cheapest permanent option was a universal life policy with a premium of 6 times the cost as the term policy) than a permanent policy and the "investment" portion of most permanent policies is a lousy investment in virtually all cases.<br />
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When might you need a permanent policy rather than a term policy? There are a few circumstances under which something more than a term policy might be appropriate. First, if you have very high taxable income you may find a highly specialized permanent policy to be an option to grow your money tax deferred. Far less than 1% of the US population fits this mold. Second, if you have a spouse or child who is permanently disabled or sick, you may want to consider permanent insurance which would help take care of them if you expire (an advisor or attorney who can set up one or more trusts may be a wise investment as well). Finally, if you have a large or complex estate or one with an illiquid significant asset, permanent life insurance may be an important part of an estate plan.<br />
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Now, on to how to buy a policy. If you are buying term and are in generally good health, the easiest way to buy is to go through the website of an independent broker (such as <a href="http://www.insure.com/">http://www.insure.com/</a>) or directly to the website of life insurers who sell direct to the public (such as USAA, TIAA-CREF, and many others). Plug in your stats, pick a face amount, and voila! You get a quote on the spot, which will be verified upon the completion of underwriting. Before you ask to have underwriting done on you and a policy issued, see below for some suggestions on making sure that the attractively priced policy is offered by an acceptable insurer. Once the policy is finalized, write a check and you are done. It is a good idea to revisit your coverage, needs and plans every 5 years or so.<br />
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If you are given a higher price once underwriting is complet, you are not in generally excellent health, or you are buying something other than a term policy, you will want to seek out an independent insurance agent or broker. Make sure that this is not an agent tied to one particular company! You want to deal with someone who is not beholden to any one insurer, understands which insurers are likely to offer the best rates for your particular situation, and will not push you too hard toward a more expensive, complex product that you do not need. If you are not comfortable with an agent or broker you speak with, walk away and find another one. The agent or broker will help you find the right policy at the best price. But before you ask for underwriting to be done, you will want to make sure that the insurer is of an acceptably high quality to be "married" to for the long term.<br />
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Once you do your shopping around and get quotes (either directly or through an agent/broker), you need to screen the insurers offering the most attractive quotes. The easiest way to do this is to find the insurer's website and look up their "about us" page. Generally speaking, you want an insurer with a claims-paying rating of at least Aa3 (Moody's)/AA- (Standard & Poor's)/A+ (AM Best). The larger the company at a given rating, the more stable they are likely to be over time. Finally, if you have a choice pick a mutual insurer over a shareholder-owned stock insurer. Why pick a mutual? Stock companies are beholden to shareholders who want to see high returns, generous dividend payouts, and are perfectly happy to see financial engineering done to achieve these goals. Policyholders are still important, but they have to compete with shareholders. In contrast, in the case of mutual insurers the policyholders actually own the insurer. There are no outside shareholders and mutual insurers tend to be more focused on maintaining financial stability over the long term (decades) rather than the next quarter's earnings report. A large, well-run mutual insurer is typically much harder to kill than a stock insurer of the same size. Insurers do not have the FDIC backing up policyholder claims (they only have state guaranty associations that are not backed by the states and have limited funds on hand), so insurer stability over the life of your policy is very important.<br />
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Finally, I would be remiss if I did not point out that anyone considering buying life insurance should also make sure they have adequate long term disability insurance coverage. Statistically, people under 50 are far more likely to have a disability insurance claim than a life insurance claim and disability can be just as devastating to a family's finances. Make sure you are covered. Many employers offer this coverage, so check your benefits package before you start shopping insurers.<br />
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As always, consult your advisors, do your own due diligence, and be careful. I am just some random stranger tapping away on the internet.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0tag:blogger.com,1999:blog-9213538927378012885.post-43144826770511672822012-06-14T17:30:00.000-06:002012-06-14T17:30:41.393-06:00An Experiment In Bottom Fishing<strong><em>Holding An Outsized Cash Position In Hopes Of Scooping The Market</em></strong><br />
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Like many long term investors, I generally try to stay fully invested as a general rule. Even at the best of times, cash typically drags down overall portfolio performance over the long term and most of us (myself included) are not great at guessing which way the market will leap next. However, the past 5 years have presented investors with an amazingly large number of buying opportunities and I often found that being fully invested at such times meant that I could not fully take advantage of such opportunities. I don't generally like keeping lazy cash around doing nothing, but I decided this spring to try hanging onto an abnormally high level of portfolio cash in expectation that a buying opportunity would materialize shortly.<br />
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<a name='more'></a>I did not start out planning to sit on cash. I sold my entire LOW position and about half of my MEOH position as the market rallied and these equities reached my target for full valuation. I then started looking around for junk bonds or equities to redeploy the cash, but everything seemed priced just a bit too high. So I retrenched. I decided that after being offered ridiculous buying opportunities over and over in the past few years, I would just sit tight with a portfolio allocation of about 10% cash until the next buying opportunity cropped up. I am not entirely comfortable with this strategy because any number of studies have shown that investors have done a great job of blowing themselves up by getting out at the wrong time and either never getting back in or doing so at the exact worst moment. However, I view this as an experiment and if I have not found an opportunity by the end of the year I will just deploy the cash into index funds or ETFs. <br />
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There are certain risks to this strategy, of course. The most prominent risk is that you might fall victim to "analysis paralysis." There is a temptation to stick with what you have and not pull the trigger when an opportunity crops up. So how do you know when a real buying opportunity has shown up? It is very frustrating to buy something and be offered the chance to do so again at an even lower price the next trading day. I have mental note to start buying if the Dow drops below 12,000. Sure it is an arbitrary number, but a drop of that magnitude from the spring highs signal's a traditional correction which is usually a good time to start buying.<br />
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Another important risk is that the market might not provide a real buying opportunity and just churn for a while and then cruise higher. That would leave me with a slug of lazy, underperforming cash on my hands and mean that I have missed out. While this is a risk, I believe I have reduced it in two ways. First, the cash position is only 10% of my portfolio so the damage I can do to myself is relatively limited. Second, I have set a time limit: end of 2012 I will have found an opportunity or abandoned the experiment.<br />
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As always, consult your advisors, do your own due diligence, and take your own risks. Market timing like this is probably foolish. Do as I say, not as I do.The Good Soldier Svejkhttp://www.blogger.com/profile/07013339749774124288noreply@blogger.com0