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Another EXG-ETW Pairs Opportunity Presents Itself

Summary Mean reversion in CEFs can be exploited for small gains in portfolio performance. A previous article successfully capitalized on a premium/discount discrepancy between EXG and ETW. The current article identifies another potential opportunity to buy EXG (and sell ETW). Around one year ago, I wrote an article entitled ” Should You Sell ETW And Buy EXG? ” that described a pairs trading opportunity for these two funds. The Tax-Managed Global Buy-Write Opportunities Fund (NYSE: ETW ) and the Tax-Managed Global Diversified Equity Income Fund (NYSE: EXG ) are both global option income close-ended funds (CEFs) from Eaton Vance (NYSE: EV ). The main difference between the two CEFs is that ETW has around 100% option coverage while EXG has around 50% option coverage, with ETW therefore being the more defensive of the two funds. Both funds seek to achieve “current income with capital appreciation through investment in global common stock and through utilizing a covered call and options strategy.” See my previous article for further comparison regarding those two funds. The thesis of the pairs trade was based on the fact that ETW’s discount had narrowed to -3.31% (1-year premium/discount: -7.71%), while EXG’s discount remained high at -8.45% (1-year premium/discount: -8.33%). As was seen in a follow-up article ” Closing The EXG-ETW Pairs Trade “, the discount for ETW had widened from -3.31% to -3.93% while the discount for EXG had narrowed from -8.45% to -5.60%, leading to a gain of ~3% in 6 weeks (~23% annualized). While ~3% over six weeks doesn’t seem much, keep in mind that i) this works out to be ~23% annualized , and ii) this was a “dollar-neutral” trade , in that I merely sold my existing holdings of ETW and used the proceeds to buy EXG, while keeping the total dollar value of the investment constant. Had I held onto the trade for a bit longer, the EXG:ETW pair could have returned even more, up to ~12%. (click to enlarge) The mean reversion of CEF premium/discounts is something that has been documented in the literature (e.g. Patro et al. ). At the same time, a pairs trading strategy reduces risk by making dollar-neutral trades. Indeed, the similarity of EXG and ETW has made the EXG:ETW ratio trade within a tight range of ~10% for the past five years, as can be seen from the graph below. Highs in the graph represent good times to sell EXG and buy ETW, while lows in the graph represent good times to buy EXG and sell ETW. (click to enlarge) Current opportunity The chart above shows that the EXG:ETW ratio has again sank to the lower bound of the trading range. Why has this happened? As can be seen from the chart below, despite tracking each other closely for around ten months since October of last year, there has been a sudden dislocation of the price of the two funds over the past two months. EXG data by YCharts Most of this price disconnect is due to differential premium/discount behavior of the two funds. Over the past 3 months, EXG’s NAV total return was -4.74%, while its price total return was -10.44% (source: CEFConnect ). On the other hand, ETW’s NAV total return was -4.12%, while its price total return was “only” -5.42%. Another way of stating this data is that EXG’s discount has expanded more than ETW’s. EXG has a current discount of -11.08% (1-year average: -6.24%) while ETW has a current discount of -6.70% (1-year average: -5.03%). This means that EXG is more attractive from a valuation standpoint compared to ETW. Note that world stocks (via the iShares MSCI ACWI (All Country World Index) Index ETF ( ACWI)) suffered a 3-month total return of -8.55%, meaning that both EXG and ETW outperformed their benchmark, as would be expected for option-income funds during stock market downturns. The 1-year premium/discount history of EXG is shown below (CEFConnect). We can see that its current discount is at its widest point for the past one year. (click to enlarge) The 1-year premium/discount history of ETW is shown below (CEFConnect). Based on the above analysis, a pairs trading strategy would entail selling ETW and buying EXG. Given that both funds have very similar 5-year average discount values (-9.45% for EXG and -8.90% for ETW), a reversion of EXG’s current discount of -11.08% and ETW’s current discount of -6.70% would allow investors to profit from the trade. Risks In my previous article, I wrote: More defensive funds (the ones with higher option coverages) are getting more expensive relative to the less defensive funds…What could one take away from this? One might infer that market participants are worried about an impending market correction, and are bidding up more defensive option income funds. It appears that the same phenomenon may be happening right now. As ETW has 100% option coverage, it is more defensive than EXG at 50% option coverage. Indeed, in 2011, ETW eked out a positive NAV total return performance of +0.98%, while EXG declined by -3.33%. By comparison, ACWI fell -7.60%. Thus, a risk of this pairs strategy is that if a market correction were to occur, ETW will likely fall less than EXG. Still, the high current discount of EXG does provide a margin of safety whatever happens. Top holdings The top holdings of EXG and ETW as of 7/31/2015 are shown below (source: CEFConnect). EXG Google Inc (NASDAQ: GOOG ) $109.01M 3.49% Ev Cash Reserves Fund 0.12 06 Aug 2015 $67.98M 2.18% Nike, Inc. B (NYSE: NKE ) $64.89M 2.08% Apple, Inc. (NASDAQ: AAPL ) $64.18M 2.06% Exxon Mobil Corporation (NYSE: XOM ) $58.57M 1.88% Home Depot, Inc. (NYSE: HD ) $56.87M 1.82% Roche Holding AG ( OTCQX:RHHBY ) $53.33M 1.71% Walt Disney Co (NYSE: DIS ) $52.62M 1.69% Prudential Financial (NYSE: PRU ) $51.89M 1.66% Medtronic, Inc. (NYSE: MDT ) $51.25M 1.64% Nippon Telegraph and Telephone Corp. (NYSE: NTT ) $50.25M 1.61% ETW Apple, Inc. $62.02M 4.61% Microsoft Corporation (NASDAQ: MSFT ) $36.47M 2.71% Amazon.com Inc (NASDAQ: AMZN ) $25.20M 1.87% Nestle SA ( OTCPK:NSRGY ) $24.41M 1.81% Novartis AG (NYSE: NVS ) $22.71M 1.69% Roche Holding AG $21.95M 1.63% Google Inc $20.61M 1.53% Gilead Sciences Inc (NASDAQ: GILD ) $20.32M 1.51% Fast Retailing Co., Ltd. ( OTCPK:FRCOY ) $19.59M 1.46% Google, Inc. Class A (NASDAQ: GOOGL ) $18.76M 1.39% Comcast Corp A (NASDAQ: CMCSA ) $17.91M 1.33% Summary I really like both EXG and ETW as option-income funds. Over both past 3-year and 5-year periods, both funds have achieved comparable total return performances with ACWI, but with lower volatility, resulting in higher Sharpe ratios compared to the benchmark ETF. Investors who own both EXG and ETW can consider further “juicing up” their portfolio returns by taking advantage of mean reversion in premium/discount values of the two CEFs. The current discount of -11.08% for EXG is more attractive than ETW’s at -6.70%, which suggests that investors could swap existing holdings of EXG for ETW. However, one risk of this strategy is that in a prolonged market correction, ETW will perform better than EXG, being the more defensive of the two funds.

Why I’m Reiterating Income Investors Buy Consolidated Edison Instead Of Southern Company

Summary Southern Company’s 4.8% dividend yield beats many of its sector peers. But that is mostly because of Southern’s declining stock price in 2015. Fundamentally, Southern is struggling. Its revenue and core earnings are declining, due to major cost overruns at its Kemper project. Meanwhile, ConEd allows investors to sleep well at night, which should be the main concern when buying utility stocks. As a result, I continue to favor ConEd over Southern. Income investors are likely drawn to Southern Company (NYSE: SO ) and its 4.8% dividend yield. But Southern has given investors a number of headaches over the past year related to its massive Kemper project. Repeated completion delays and cost overruns have negatively affected Southern’s earnings over the past year. This has caused Southern to underperform many of its peers like Consolidated Edison, Inc. (NYSE: ED ) so far this year. Even though Southern Company’s dividend yield beats ConEd’s, I think ConEd is the better utility stock to buy. ConEd’s 4% dividend yield slightly trails Southern’s yield, but that is only because Southern’s stock price has declined this year. Investors should think about total return, and not just dividend yield, when evaluating an investment opportunity. ConEd has much smoother earnings growth, while Southern’s earnings are unusually volatile, especially for a utility. For these reasons, I recommend income investors consider ConEd instead of Southern. Trouble Lurks On the surface, there doesn’t seem to be anything wrong with Southern. Earnings per share grew 1% last quarter , and 15% in the first six months of 2015, year over year. That looks quite strong at first glance. But there are a number of caveats that make Southern’s true underlying earnings much less impressive than they appear. First and foremost, Southern is benefiting from a very easy comparison. Last year’s quarterly results were heavily weighed down by huge charges against earnings, due to the Kemper project. This has made Southern’s 2015 earnings results show solid growth, but that is only because last year’s numbers were so badly depressed. If you strip out the excess charges throughout 2014, Southern’s adjusted earnings are actually down 4.4% through the first six months of 2015. Therefore, investors looking at the headline reported numbers only may get a distorted image of Southern. The fact that excess cost overruns at Kemper have moderated somewhat this year is not exactly cause for celebration. Southern’s operating revenue declined 6.5% over the first six months of 2015, year over year, which is a disturbing indicator of the company’s shaky underlying fundamentals. This is why Southern’s stock price is down 8% year-to-date. Plus, the forward-looking picture is cloudy at best. Southern now anticipates the Kemper project will not be placed into service until after April of 2016. This will result in $15 million in additional total costs. Moreover, the company expects to incur $25 million-$30 million in additional costs each month for deferring the start-up beyond March, and another $20 million per month in financing and operating costs. If that weren’t bad enough, because the project will be delayed beyond April 19, Southern would be required to return $234 million to the IRS, which is what the company had received in prior tax credits for the project. In its press release, Southern vowed that its customers will not foot the bill for the added costs. Since there are no free lunches, someone has to foot the bill, and that someone will be Southern and its shareholders. As a result, while things are “less bad” this year than last year, it appears there is more trouble in store for future quarters. Reiterating My Preference For Consolidated Edison Income investors may see Southern’s higher dividend yield and stop there. But dividend growth is a consideration as well, and if Southern’s revenue and core earnings continue to decline, the company may not be able to maintain dividend growth that meets inflation. Southern has paid a dividend for 271 consecutive quarters, dating back to 1948. For its part, ConEd is no dividend slouch. It has increased its dividend for 41 years in a row. This makes ConEd a Dividend Aristocrat, while Southern is not. More importantly, Southern is struggling to grow revenue and earnings consistently, and Kemper is only exacerbating the problem. Meanwhile, ConEd gives investors stable revenue and earnings growth, as the company has not had nearly as many operating issues as Southern. For example, ConEd grew EPS by 3% last year, and is off to another good start to the current year. ConEd’s core earnings per share are up 11% through the first six months of 2015, year over year. Going forward, investors should continue to enjoy stable earnings growth. The company expects full-year earnings to reach $3.90 per share-$4.05 per share. At the midpoint of its forecast, that would represent 6.5% earnings growth from 2014, which would be a very solid earnings growth rate for a utility. I last wrote about my preference for ConEd over Southern in this article , dated June 15. Since the day that article was published, ConEd has outperformed Southern by 10 percentage points. Given Southern’s inability to get things right at Kemper, and ConEd’s solid growth, I expect ConEd’s outperformance to continue. Disclaimer : This article represents the opinion of the author, who is not a licensed financial advisor. This article is intended for informational and educational purposes only, and should not be construed as investment advice to any particular individual. Readers should perform their own due diligence before making any investment decisions.

India- An Attractive Destination For Long-Term Growth

Summary India is poised for a robust economic recovery on the backdrop of strong fundamentals. Slowdown in China created ripple effects across emerging markets, but India looks like an attractive alternative. Narendra Modi government’s efforts on making India a manufacturing hub to catalyze economic recovery. For those who have been tracking the equity markets, last month has been quite a rollercoaster ride. The global sentiments remained weak with negative news flowing from China with respect to their economy. The Chinese economy grew by 7.4% in 2014, which is the slowest in 24 years. In an attempt to boost its exports and revive the economy, China announced a devaluation of its currency. This triggered panic selloff across markets. Emerging markets got the maximum impact. In an attempt to prevent the falling stock prices, the People’s Bank of China reduced its interest rates twice during the last couple of months. But, this failed to entice global investors and panic prevailed. The story in India looks quite different from its peers. The country is in a much stronger wicket compared to its peers. While the US Fed is mulling over increasing its interest rates, the Reserve Bank Of India (RBI) surprised the markets on 29th September with a 50 basis points (bps) cut in the repo rate. The rationale for the same is as follows. ( RBI’s Policy Statement ) Retail inflation has eased significantly to 3.66% in August 2015 as against 7.73% in the same month previous year. ( India’s Inflation ) The monsoon deficit in India has been around 14% this year. However, the central government has taken resolute steps towards managing food supply. Economic recovery has been slower than expected. This rate cut, combined with the 75 bps rate cut done during this year by the central bank is expected to bring down the cost of borrowing. This can encourage fresh borrowing and can propel capital expansion. For companies that already have significant debt on their books, their interest cost is expected to come down, thereby increasing profit margins. On the backdrop of a slowing Chinese economy, global commodity prices have been low. While this may be a negative for countries exporting commodities, it is a huge positive for India as it is an importer and consumer of commodities. India imports close to 80% of its oil requirements. Crude oil prices have fallen sharply over the last one year, and this will have a huge positive impact on the current account of India. It is evident that an economic recovery is underway. The RBI has also stated this clearly in its monetary policy review on 29th September 2015. It has been 15 months since the Narendra Modi government has taken charge and the fundamentals look robust. The Make in India Campaign – With the government encouraging foreign companies to set up their factories in India, this campaign will definitely boost manufacturing, construction, power, infrastructure, technology and logistics sectors. The government is striving hard to make it easier to do business in India. This can definitely attract more foreign funds to the country. While earnings growth was subdued in the previous quarter, it is expected to be robust. With the domestic demand picking up and global economy recovering (healthier data from US and Europe), earnings are expected to improve over the next 3 to 5 years. Softer commodity prices is a huge positive as it will result in improving margins and increased profitability. China has been witnessing increase in the cost of labour and real estate. In comparison, India looks like an attractive alternative for companies to move into. Considering these factors, Indian equities definitely look attractive as an investment destination. In this light, an evaluation of The India Fund, Inc (NYSE: IFN ) is given below. Fund Investment Objective: The fund’s investment objective is long-term capital appreciation, which it seeks to achieve by investing primarily in the equity securities of Indian companies. Investment Philosophy: Bottom-up stock selection Proprietary research driven Based on fundamental analysis Factsheet Download Performance: As on 31st August 2015 The fund has a well-established track record of over 20 years. As it is evident from the past performance, the NAV has beaten the MSCI India Index over the short-term and the long-term. This superior performance can be attributed to a) Superior stock selection of the fund; and b) Fund manager’s ability to manage sector-wise weightings effectively. Top 10 Holdings: As on 31st August 2015 Sector Allocation: As on 31st August 2015 The portfolio consists of fundamentally strong companies that would be benefited as the economic recovery happens in India. The top 10 holdings constitute 58% of the portfolio. The portfolio is diversified across 9 sectors and has a balance between both cyclical and defensive companies. The fund has highest weighting to financial services. With the central bank cutting the repo rate by 50 bps and the outlook for interest rates moving southwards in the next 12 to 18 months, financial services are expected to play a key role in economic recovery of the country. Information Technology and Consumer Staples have a weighting of around 17.5% each to the portfolio. Information Technology plays an important role in the exports of the country. With the US Dollar strengthening against the INR, these companies can be benefited due to increased US Dollar revenues. The Consumer Staples companies in the portfolio, especially ITC, Hindustan Unilever and Godrej Consumer Products have very low debt, well-established brands and a strong hold in the Indian consumer market. The other key sectors that are expected to contribute to the fund’s performance are Healthcare and Industrials. Healthcare has a weighting of 10.1%. Growth is expected to come from both the domestic markets and exports. Industrials have a weighting of 5.3%. This sector will be benefited significantly as the Make in India campaign becomes a reality and as manufacturing activity improves. The cash level in the portfolio is just 1%. As it is a closed-ended fund, it need not maintain high cash levels to fund redemption requests as they are not allowed. As on 1st October 2015, the closing price of the fund was $24.27 while the NAV of the fund was $27.54. It is currently trading at a discount of 11.87%. IFN data by YCharts Forward Looking Estimates The RBI, in its latest monetary policy review has projected a GDP growth of 7.4% for the year 2015-16. The International Monetary Fund (NYSE: IMF ) too has projected a GDP growth of 7.5% for the same period. This is higher than its estimate of China’s GDP growth which is 6.8%. With an inflation projection of around 5%, the portfolio companies are expected to deliver a robust 13-15% growth in earnings over the next 3 to 5 years. The fund also has a healthy track record of generating superior returns than the benchmark. Considering the robust macro-economic factors in India and with limited number of India-dedicated funds listed in the US, The India Fund, Inc fund looks attractive for long-term wealth creation. Fund Management Team: Asian Equity Team based in Singapore Net Assets: $824.1 million Expense Ratio: 1.47% Shares Outstanding: 29,541,212