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The V20 Portfolio Week #12: The Value Of Doing Nothing

Summary The V20 Portfolio increased by 5% while the S&P 500 rose 3%. Doing “nothing” has value. Dex Media and Conn’s should release material news in January. Things are looking up as we wrap up the year. The recent rally sent the S&P 500 into positive territory for the year, and the V20 Portfolio benefited as well. Although the market closed early this week, the V20 Portfolio posted a respectable gain of 5% versus S&P’s gain of 3%. There were no major news for any of our holdings and there were no major movers. Quite a boring (but profitable) week I would say. At times like this, I feel that it’s important to review the V20 Portfolio’s philosophy. Doing Nothing In 2015, the V20 Portfolio only entered into seven positions and only completely exited one (Perion Network (NASDAQ: PERI )). To some, this may seem lazy. “What? The Traveling Investor only studied seven stocks and called it a year?” Rest assured that a lot more work was being done behind the scene, much of which I’ve shared with the Seeking Alpha community, such as my Low P/E series or Diamond, Rock, Or Coal series . However, that is not the point. What I’m really trying to say is that there is value in doing “nothing.” When you know that your portfolio contains the best stocks (out of the ones you’ve studied), what’s the benefit of replacing one? There is none. While I’ve looked at hundreds and hundreds of stocks, none of them made the cut to supplant any of our current holdings (including cash). Of course, the reason why it is difficult is the result of V20 Portfolio’s high return objective. It is quite easy to identify a stable company that can return 3% annually, but it’s quite another story to spot a company that can return 20% with reasonable certainty over the long-term. Near-Term Outlook I’ll talk about some near-term catalysts that could impact the V20 Portfolio in the near-term and I’ll save the discussion of 2016 for next week. Dex Media (NASDAQ: DXM ) is nearing its third deadline. After two extensions of the forbearance period, we should receive another update by January 4th, 2016. There is no doubt that any news, both good and bad, will introduce significant volatility to the stock. However, from the portfolio’s perspective, the volatility is restricted to the upside. As of December 24th, 2015, the position only accounted for 0.5% of the total portfolio. Conn’s (NASDAQ: CONN ) will be releasing December 2015 sales data in January. Recently there has been some weakness the retail sector due to poor industry data. U.S. retail sales were below forecasts for the last three reporting periods (September to November). While Conn’s has continued to churn our very good numbers (November comps were up 8%), it is clear that the market is still betting against it given the way the stock has been performing (down almost 50% from its high in July). While I do not think that comps growth can stay elevated at 8% forever (and I don’t think any retailer is capable of such a feat), I do believe that Conn’s will not experience a sales meltdown that many investors have been fearing since it started to tighten its credit policy, and December sales data could be data that can revert investors’ current pessimism. Note: I spend a great deal of time researching every company in the V20 Portfolio (~40% YTD). If you are looking for some ideas that could complement your own portfolio, you can click the “follow” button and be updated with my latest insights. Premium subscribers will get full access to the V20 Portfolio. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Junk Bond CEFs Yielding 9% And Poised To Benefit From Rising Interest Rates (Part 1)

Summary In the high yield bond carnage, there is a group of funds that has gone oversold despite their insulation from rising interest rates. These funds do not borrow money to invest, so rising interest rates will not negatively impact their net investment income (NII). There remains risk to these funds’ NAV from further declines in the bond market, but dividends are safe for all but one fund. Junk bond markets have gone through a panic and are now in a lull, although many expect more turbulence with future interest rate hikes hurting both the value of issued debts and the borrowing costs of levered closed-end funds. There is a small group of non-levered CEFs that invest in junk bonds but do not use leverage, thereby insulating themselves from higher borrowing costs that will narrow spreads and impact their net investment income in much the way that earnings are hindered by mREITs and BDCs who depend on a spread between low borrowing costs and high investment income from debts. (click to enlarge) Source: Google Finance, SEC Edgar Instead, these funds focus on the high yield market and pass on net investment income to shareholders without borrowing to boost returns. Despite that, these funds’ distribution yields are familiar to investors of levered CEFs, ranging from 4.5% to 12.28%. These funds are: the MFS Special Value Trust (NYSE: MFV ), the Putnam High Income Securities Fund (NYSE: PCF ), the Western Asset High Income Opportunity Fund (NYSE: HIO ), the Western Asset High Yield Fund (NYSE: HYI ), and the Western Asset Managed High Income Fund (NYSE: MHY ). Despite their lower risk profile, these funds have suffered declines similar to levered CEFs, with double-digit declines in the past year across the board, and most losses incurred in the last six months: (click to enlarge) Source: Google Finance With the exception of MFV, these funds were relatively strong performers and were outperforming many levered CEFs thanks to their lower risk profile until the summer. Then as yields rose sharply for high yield debt and default rates continued to rise, these funds joined the junk sell-off to reach their 52-week lows. Source: Moody’s The increase in yields is in part a result of higher defaults and credit downgrades across the market, and has also caused NAVs for these funds to fall alongside all other junk bond funds. This dynamic means that these funds’ current discount to NAV is in fact close to its highest discount in the last year, despite being near 52-week lows: (click to enlarge) Source: CEFA’s Universe Data Is the Risk There? There remains a risk that, if yields rise and bond values fall, the NAV of these funds will decline. However, there is not a commensurate risk of NII declines for two reasons. Firstly, higher borrowing costs are a non-issue for these funds. For funds that are 40% levered or more, higher borrowing costs could damage their ability to make a profit from borrowing to buy junk bonds. What’s more, funds that will need to de-lever because of fears of declining NAVs will be forced to sell off when values are plummeting, causing a similar dynamic that resulted in the shuttering of bond funds like Third Avenue’s . This is a non-issue for these non-levered CEFs. Without borrowing costs or redemptions an issue, they do not need to sell issues unless their NII-to-distribution coverage falls below 100%, which is currently not the case in any of these funds except for MFV. (I will discuss NII coverage of these funds in a future article). With the exception of MFV, this is a rare group of funds which investors can purchase without fears of declining NAVs resulting in distribution cuts. With a sustainable yield of around 9%, these funds are worth considering as an option for immediate and reliable income. Avoid MFV The only fund of this group that is under-earning its distributions is MFV. This is in part due to a recent change in its investment strategy that allows it to focus more on equities in addition to debt: The fund currently has an investment policy that MFS normally will invest the fund’s assets primarily in debt instruments. Effective on December 9, 2015, that policy will be changed to provide that MFS normally invests a majority of the fund’s assets in debt instruments. The change allows the portfolio management team greater flexibility to increase the fund’s exposure to equity securities. There are no other changes to the way the fund is being managed. The good news about this shift is that it will allow the fund to avoid the turbulence of the high yield market with greater flexibility to diversify into equities. The bad news is that this will negatively impact the fund’s immediate income and make it more dependent on capital gains-and active trading-to maintain payouts. Currently, the fund has devoted a third of its assets into equities, limiting its income producing opportunity: (click to enlarge) At the same time, the fund’s equity allocations are slightly skewed towards financial services companies; an ironic decision, considering these companies will benefit the most from rising interest rates: (click to enlarge) It is unclear why the fund’s management has decided on this shift and chosen what very may well be near the bottom of the junk bond market to do so; a decision to shift towards equities earlier in 2015 would have demonstrated much more foresight. So Which to Choose? In part 2 of this series I will discuss the credit quality and income durability of the other funds, but suffice to say for now each currently has NII in excess of its distributions, with coverage ranging from 107% to 128%: (click to enlarge) The relatively low yield on PCF, combined with its high distribution coverage, means that it is unlikely to cut dividends in the short term as it did in 2012, 2013, and 2014, but it also makes the fund’s income stream relatively low compared to HIO HYI, and MHY. In the cases of these funds, distribution coverage is currently solid, making any of these a worthwhile addition to a diversified high yield income portfolio.