Tag Archives: alternative

New Janus Mutual Fund Uses Tail Risk Analysis

Summary JAGDX is a global allocation fund (70/30) which uses tail risk analysis to mitigate risk. The Fund inception was in June 2015, and it has gotten off to a rocky start. But it may be worthwhile to track this fund to see how they manage a full market cycle. Overall Objective and Strategy The primary objective of the Janus Adaptive Global Allocation Fund (MUTF: JAGDX ) is to provide investors total return by dynamically allocating its assets across a portfolio of global equity and fixed income investments, including the use of derivatives. The fund attempts to actively adapt to market conditions based on forward looking views on extreme market conditions (both positive or negative) with the goal of minimizing the risk of significant loss in a major downturn while still participating in the growth potential of capital markets. On average, the fund provides 70% exposure to global equities and 30% exposure to global bonds (70/30 allocation). But the fund has the flexibility to shift this allocation and may invest up to 100% of its assets in either asset class depending on market conditions. Because of this, JAGDX will likely have above average portfolio turnover compared to other funds. The portfolio managers use two complimentary processes: a “top down” macro analysis and a “bottom-up” risk reward analysis. These processes use proprietary models which seek to identify indicators of market stress or potential upside. These models include an options-implied analysis that monitors day-to-day movements in options prices for indicators of risk and reward between asset classes, sectors and regions. Top-Down Macro Analysis: Focuses on how the Fund assets will be distributed between global equity and fixed income. They use a proprietary options implied information model, among other tools, to monitor expected tail gains and losses across the equity and fixed income sectors and adjust as necessary to mitigate downside risk exposure. Bottom-Up Risk Reward Analysis: Designed to identify underlying security exposures in order to maximize exposure to securities which will realize tail gains while minimizing exposure to securities expected to provide tail losses. Within the Fund’s equity positions, the managers will adjust sector, currency and regional exposures away from market cap weightings based on their evaluation of expected tail loss and gain. Within the Fund’s fixed income positions, they will adjust the credit, duration and regional exposures using the same analysis. The fund managers measure both extreme positive and negative movements known as expected tail gain (ETG) and expected tail loss (ETL). Portfolio construction is driven by the ratio of ETG to ETL, while targeting a desired level of portfolio risk with the goal of maximizing future total return. For more information on expected tail loss, take a look at this Wikipedia page on Expected shortfall . (click to enlarge) Source: rieti.go.jp Fund Expenses The Fund offers several classes of shares. JAGDX is available without a 12b-1 charge, but only if you buy the fund directly from Janus. The expense ratios for some of the share classes are listed below: JAGDX (Class D Shares): 1.01% JVGIX (Class I Shares- Institutional): 0.82% ($1 million minimum) JVGTX (Class T Shares): 1.13% (available on brokerage platforms) JAGAX (Class A): 1.07% (front-end load 5.75%) JAVCX (Class C Shares): 1.82% (deferred load 1%) Minimum Investment JAGDX has a minimum initial investment of $2,500. Past Performance JAGDX is classified by Morningstar in the “World Allocation” or IH category. The fund had unfortunate timing when it was first issued on June 23, 2015. As of the end of the third quarter it had dropped by 9%, although it has recovered a bit since then. It is still very early, but so far the Fund is lagging its peers. 1-Month 3-Month JAGDX +1.18% -4.16% Category(IH) +1.37% -3.89% Percentile Rank 61% 66% Source: Morningstar Mutual Fund Ratings The fund is too new to have a Lipper or Morningstar rating. Fund Management The fund is managed by two individuals: Enrique Chang: Chief Investment Officer, Equities and Asset Allocation. Joined Janus in September 2013, and has previously worked for American Century and Munder Capital Management. Holds a BS in Mathematics from Fairleigh Dickinson and a master’s degree in finance/quantitative analysis and statistics and operations research from NYU. Ashwin Alankar, PhD: Global Head of Asset Allocation & Risk Management. Joined Janus in August, 2014 and has previously worked for AllianceBernstein and Platinum Grove Asset management. Holds a BS in chemical engineering and mathematics and a master of science degree in chemical engineering from MIT. He also holds a PhD in finance from the University of California at Berkley Haas School of Business. Comments Tail risk hedging is designed to enhance return potential by: Helping to mitigate losses when a market storm hits. Provide liquidity in a crisis, allowing you to buy assets at distressed prices when others are forced to sell. Allow investors to take greater risks elsewhere in their portfolios. But as with any market timing strategy, there is always the possibility of market “whipsaws,” where markets trade up and down in a sideways pattern for extended periods and tail risk hedging may become an extra expense instead of a benefit. JAGDX has gotten off to a rocky start, but they have an interesting approach to risk management, and I will be tracking the fund to see how they do over a full market cycle. So far, they have attracted about $50 million in assets, so it is still uncertain whether the fund will be a long term success.

UGI Corporation: Little Bit Of This, Little Bit Of That

Summary UGI Corporation has its hands in many pots, with businesses all around the world. Peeling back the onion reveals that management has maintained control of operations. With manageable debt, high profitability, and below average valuation multiples, investors could pick much worse in the utility sector. UGI Corporation (NYSE: UGI ) is a holding company that operates a variety of businesses involved in the transportation and distribution of energy products. The company has been on an acquisition spree, spending over $2B over the past five years acquiring a vast swath of business lines. Shareholders have rewarded the exuberant spending with outsized returns over the broader utility index. Are more returns set to come or has the company lost direction? What Does UGI Corporation Do? As mentioned, the company owns a substantial interest in a variety of businesses: General Partner of AmeriGas Partners (NYSE: APU ), prior research by me found here International liquid petroleum gas businesses Midstream & Marketing operations (energy services and electric generation businesses) An electric generation segment (ownership interests of approximately 250MW of power generation) A gas utility business (serving nearly a million customers in Pennsylvania and Maryland) Phew. Simple this company is not. The above five operating segments actually simplify a variety of businesses that really don’t deserve to be comingled (revenue from co-ownership of power plants and pipeline building are intertwined in the Midstream & Marketing segment as an example). The AmeriGas’ ownership interest constituted just under half of 2014 revenue and profit, so the importance of this interest to operating results cannot be understated. AmeriGas is a propane distributor, with operations across the vast majority of the United States. Through its distribution network, AmeriGas provides propane to customers who have no real alternative for heating and cooking in their homes and businesses. 2014 was a stellar year for propane due to a colder than average year that drove operating margins due to scarcity of supply – 12.7% operating margins compared to 5.8% operating margins in 2012. Investors should be careful and consider that 2014 should not be a base case scenario for AmeriGas and is rather unlikely to be repeated. 2015 has been shaping up to be an average year in regards to operating results. This weakness year/year is part of the reason why earnings per share are set to fall in fiscal 2015 compared to fiscal 2014 for UGI Corporation. I’d highly recommend reading my prior article on AmeriGas for a deeper understanding, but as an overview, there are quite a few headwinds facing AmeriGas going forward. UGI highlights the main risk in its form 10-K: “Retail propane industry volumes have been declining for several years and no or modest growth in total demand is foreseen in the next several years. Therefore, the Partnership’s ability to grow within the industry is dependent on its ability to acquire other retail distributors and to achieve internal growth, which includes expansion of the Propane Exchange program and the National Accounts program (through which the Partnership encourages multi-location propane users to enter into a supply agreement with it rather than with many suppliers), as well as the success of its sales and marketing programs designed to attract and retain customers.” Retail propane is AmeriGas’ core business and has been declining slowly. This is due to a variety of factors, such as the expansion of natural gas further into rural territories (on a BTU/price basis, propane cannot compete and that is unlikely to change) and shrinking demand from customers due to milder temperatures and customer energy conservation. AmeriGas’ management believes that a propane exchange program (i.e., swapping out bottles for your grill) might help plug the slow leak of lost customers, which I find a stretch. Neither does consolidating the industry more, which isn’t going to stem the demand problem. The UGI International segment is another large contributor to revenue. The division sells LPG products throughout portions of Europe such as France, Belgium, the Netherlands, Austria, etc. Like AmeriGas, these sales are primarily to residential and small businesses that use the gas for heating and cooking. Unfortunately, LPG prices are much higher in Europe than in the United States. This has made electricity, which is immensely more expensive on a BTU basis than LPGs in the United States, a viable competitor to European LPG for heating and cooking in Europe, especially in France. So just like in the United States, customer demand is on a slow, marginal decline barring cold weather spikes: “The LPG markets in France and the Benelux countries are mature, with modest declines in total demand due to competition with other fuels and other energy sources… due to the nuclear power plants, as well as the regulation of electricity prices by the French government, electricity prices in France are generally less expensive than LPG. As a result, electricity has increasingly become a more significant competitor to LPG in France than in other countries where we operate. In addition, government policies and incentives that favor alternative energy sources can result in customers migrating to energy sources other than LPG in both France and the Benelux countries.” As a bright spot, the gas utility segment bears promise. I’m a fan of gas utilities; the environmental risk is much lower but allowed rates of return are generally similar to electric utilities. Gas utilities also have a steady stream of capital expenditures (replacement of pipe) that are easy to pass along to consumers, on which gas utilities are entitled to their fair rate of return. Additionally, being located in Pennsylvania, UGI’s gas utility business is located near many heavy industries such as metal and paper manufacturers. This allows better diversification of revenue away from the residential consumer that some utilities do not benefit from. From a sourcing perspective, being next to Marcellus and Utica shale formations provides a readily available and cheap source of natural gas to sell along to consumers. Being able to provide cheap natural gas prices for local consumers means higher relative demand compared to other areas of the United States. Midstream & Marketing is a growing but convoluted segment. Bundled up in operational results here are the operating results from natural gas liquefaction, LPG storage, energy peaking business (selling stored gas to utilities during times of high demand), pipeline construction, and partial ownership in coal, natural gas, and solar power plants (250MW worth). This makes our jobs as investors incredibly difficult as it becomes tedious to analyze and project future earnings potential. In general, however, this segment is like the others in that it benefits from cold weather spikes in the Northeast, such as during 2014. Peaking businesses can be highly profitable but can also sit on stored LPGs for some time waiting for the opportunity to sell. Cash Flow With all these businesses, how has operational cash flow performed? You might be as surprised as I was to see a fairly healthy cash flow statement. Operational cash flow has been growing and capital expenditures light (which makes sense given the asset-light nature of the retail LPG businesses). Because of strong operational cash flow, UGI would have actually been generating net cash balances excluding its acquisitions, a rarity for companies operating in the utility industries that have been running through cash in a cheap debt, low interest rate environment. At 3x net debt/EBITDA, UGI has much less leverage than most utility peers. Conclusion Trading at a ttm EV/EBITDA of less than 8x, shares appear cheap from that valuation perspective. The variety of businesses here appear to still be well run despite the amalgamation of holdings that management has collected over the past few years. While the company still relies heavily on propane/butane sales, worldwide geographical diversity does limit some of the risk. While I don’t think operating income can expand much from here outside of boosts from cold weather events, management still has plenty of room to bump the dividend to reward shareholders without getting themselves into cash flow problems. If you’re interested in AmeriGas, this might be a safe way to get exposure to the company while getting some worldwide exposure and regulated utility business diversification as well.

ITC Holdings: Growth Comes At A Price

Summary Transmissions business carries less risk and higher allowed returns than other utilities. Dividend is slated to grow at a 10-15% annual pace through 2018 by management. ITC Holdings is highly leveraged and burns through cash – a change to allowed returns could be disastrous. ITC Holdings (NYSE: ITC ) is the largest electricity transmission company in the United States, operating out of the Midwest. Current operations sprawl out from the center of the country, impacting dozens of states. Unlike your typical regulated electric utility that directly produces energy to provide electricity to customers, ITC focuses fully on grid infrastructure. Electric transmission assets have been historically under-maintained, resulting in significant transmission constraints and stress on ageing equipment. To combat this, the regulatory environment has shifted to companies like ITC to fix these issues while receiving a stable, regulated rate of return. Given ITC’s estimates of $160-240B in additional necessary upgrades to infrastructure by 2030, substantial opportunity exists for utilities to earn a fair return on invested capital upgrading these assets. This business model has been a long-term outperformer. Looking back ten years, shares have trounced utility peers but have begun to underperform recently. Is this a healthy needed sell-off or an opportunity for investors to buy in before the next leg up in share price? Not Your Grandfather’s Utility Your typical state-regulated, power-producing utility has a tough time. Rates it can charge are set at fixed rates in between rate cases it makes with state regulators, hopefully with various riders in place that allow recovery of necessary capital expenditures or changes in commodity prices. In nearly every case, electric utilities experience “regulatory lag” – a gap between capital spending and eventual recovery. Disallowances are always a risk. Further exasperating utility management, a utility might make an investment assuming a return on equity that never materializes or an incredibly long amortization period that stretches out the timeline of recovery. Political gamesmanship between the utility, regulators, and the public that bears the costs is always present. ITC Holdings is instead governed by FERC, the Federal Energy Regulatory Commission. Working with the Feds directly avoids a large portion of the games played in the rate-making process. Regulatory lag isn’t as much of a problem as FERC rate-setting is forward-looking with annual adjustments. Further benefitting ITC is the much higher allowed returns on transmission infrastructure. Most publicly-traded utilities have seen their allowed return on equities plummet over the past decade to approximately 10%, give or take a half percentage either way. Allowed returns for transmission companies like ITC is in the 12% range depending on region. In a nutshell, this makes ITC a much more profitable business than most utility peers, with profit and operating margins that energy producers like Duke Energy (NYSE: DUK ) could only dream of. In spite of risk to drops in allowed return on equity (FERC dropped allowed return on equity on New England assets to 11.7%, setting off warning bells across transmission utilities), the company should enjoy meaningful returns above and beyond standard utilities for some time. Further cementing ITC’s advantages over electric utilities, transmission assets are simple. By and large, they are simply pole and wire assets with supporting infrastructure. The environmental and regulatory risk simply isn’t as present as it is for power-generating utilities. There is no nuclear waste requiring disposal or possible coal ash basin breaches to worry about. Operating Earnings The growth story is obvious here; you won’t find many other companies in the utilities segment growing at over 12% compound annual growth rate. Annual revenue growth is expected to continue at this pace over the next five years as ITC continues to take on projects. Operations and maintenance expenses have actually stayed relatively flat, indicative that maintenance costs are minimal for new transmission infrastructure once updated. Consistently better than 50% operating margins are stellar and more indicative of a company like Apple (NASDAQ: AAPL ) than a regulated utility. Getting a piece of these strong results doesn’t come cheap, because at more than 13x ttm EV/EBITDA, shares trade at a 30% premium to the broader utility industry. Serial Debtor Issue? If anything should concern investors, it is the rapid rise of the company’s debt. The company has breached $4B in debt compared to just $2.5B in 2010. Net debt/EBITDA of slightly over 5x has held steady as ITC’s earnings have grown as well, but this is a substantial amount of leverage as the company pours significant money into capital expenditures. Credit ratings are stable investment grade, but all ratings agencies note the risks in this heavy spending. A deterioration in the company’s regulatory or operating environment (increased regulatory lag, lowered allowed return on equity by regulators, litigation, rising interest rates) could stunt ITC’s cash flow which would hamstring further investment. Any company that perpetually issues hundreds of millions in debt year after year, especially one as small as ITC Holdings, should make investors pause and consider possible implications. Conclusion The small current dividend yield of 2.26% shouldn’t scare away investors. Per management’s 2014-2018 guidance, 10-15% annual dividend increases are to be expected. If management executes and hits the high end of this dividend growth target (as it did in 2015), your yield-on-cost would be 3.43% at the end of 2018, which would be a respectable number that you may not get by buying a slow-growing 3% yielder today. Additionally, ITC’s share repurchase program is rather unique in the utility industry, one that is most often plagued by dilutive equity issuance every few years that is never offset by buyback programs. However, the company’s high degree of leverage, price premium to other utilities, risk of more competition for projects, and uncertainty regarding future allowed returns on electric transmission infrastructure weigh heavily on my ability to issue a buy recommendation.