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VEU: Now Might Be A Good Time To Add Foreign Equity Exposure To Your Retirement Portfolio

Summary Investing for retirement can be as simple or as complex as you want to make it. One well diversified global ETF with a low expense ratio is a good start. Given the relative under-performance of foreign equities over the last five years, now might be a good time to add exposure to foreign equities to your retirement portfolio. This article reviews VEU, an ETF that can be added effectively to the core portion of most investors’ portfolios to increase exposure to foreign equities. Simply Investing – Philosophy Whether you are just starting to invest for yourself or your kids or are taking back control of your investments from an investment advisor, keep investing simple, consistent, diversified and low cost and you will significantly increase your chance of success. One well diversified global ETF with a low expense ratio is all that is required for many people starting to invest in equities, and an ETF that meets these criteria is the Vanguard Total World Stock ETF (NYSEARCA: VT ). As an investor’s experience, time dedicated to investing activities and desired risk, increases, investors can add ETFs to the core of their portfolio to gain exposure to new areas or increase exposure to areas that the investor believes will outperform. The next step for many investors is to allocate a percentage of their portfolio to “edge” positions, which offer additional risk and opportunity. Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ) This article reviews VEU, an ETF that can be added effectively to the core portion of many investors’ portfolios to increase exposure to foreign equities. VEU – Regional allocation and investment synopsis Source: Vanguard (allocation as of 10/31/2015) VEU seeks to track the performance of the FTSE All-World ex US Index. It has holdings in approximately 2,500 stocks with broad exposure across developed and emerging non-US equity markets around the world. VEU’s broad global diversification helps to minimize volatility that any one region may experience. As can be seen above, VEU’s heaviest weighting is in European stocks. Investors looking to increase their exposure to foreign stocks should consider whether they want a heavy concentration of European stocks in their foreign stock ETF, when adding this ETF to their portfolio. VEU performance compared to the S&P 500 (click to enlarge) Source: Yahoo Finance (11/29/2015) As the chart above shows, the S&P 500 has significantly outperformed VEU over the last five years. There are a number of reasons for this including the relative strength of the US economy and the US dollar compared to foreign economies and currencies. While the out-performance of the US market may continue for some time, after such an extreme period of under-performance by foreign stocks, now might be a good time to start building or add to a core position in foreign stocks in anticipation that this under-performance will, at some point, at least partially reverse itself. VEU -Equity characteristics Source: Vanguard (as of 10/31/2015) As the table above indicates, VEU is very well diversified, holding 2,508 stocks. The median market cap is quite large at $28.5 billion. VEU’s current price/earnings ratio at 17.4 is high compared to historical levels for global markets. The high current price/earnings ratio is not unique to VEU. The price/earnings ratios for US markets and many global markets are currently higher than historical norms. These high price/earnings ratios are likely due to the low returns that alternative investments, such as fixed income, currently offer. Investing for retirement should be done on a consistent basis. A simple investment plan, makes consistent investment that much more likely to happen. The relatively high current price/earnings ratio of stocks suggests that if you have a large amount of capital to invest today, it is advisable to dollar cost average this investment into the market over a period of time. VEU – Top 10 holdings Source: Vanguard (as of 10/31/2015) VEU’s top ten holdings are dominated by European companies, with eight out of the ten holdings European. As previously indicated, European stocks make up 47% of VEU’s holdings, so they are somewhat over-represented in this list of VEU’s top ten holdings, but these top ten holdings make up only 8.9% of total net assets. VEU – Expense ratio and dividend yield VEU’s expense ratio is 0.14%, this is well below the average expense ratio of similar funds at 1.16%. Given the relatively high price of the market today, it is likely that future returns may be lower than those recently experienced. In this environment, it is important that the core of your portfolio is allocated to funds with low expense ratios like VEU. The forward looking dividend yield is 2.95% based on the last four quarters distributions. Conclusion Your chance of long term investment success increases significantly by keeping your investing simple, consistent and well diversified. Most investors can benefit by building a core position in a well diversified global ETF with a low expense ratio like the Vanguard Total World Stock ETF. After establishing an initial core position in a global ETF, then additional low cost, well diversified ETFs can be added to the core portion of your portfolio to gain exposure to areas under-represented or which the investor believes will out-perform. With the relative under-performance of foreign stocks compared to the US market over the last five years, now might be a good time to increase your exposure to foreign stocks by to adding a low cost, well-diversified foreign stock fund like VEU to the core portion of your portfolio.

Dynegy: Too Early To Buy

Summary Dynegy shares have been cut in half in 2015 as investors run for the exits. While metrics are improving, the company still doesn’t generate significant operational cash flow. Additionally, I have concerns over whether cash flow problems have impacted the company’s ability to properly maintain its assets. It’s still to early to buy. If you really want a piece of this company, buy the preferred shares instead. Dynegy (NYSE: DYN ) is a holding company that owns a large portfolio of power generation assets throughout the United States, with a heavy concentration of these assets located in the Northeast and Midwest. The company operates regulated utility operations while also competing in the wholesale electric business, where it provides electricity to utilities, power marketers, and industrial customers. Unlike traditional regulated utilities that are the sole source of power for their customers, the wholesale market pits many players against each other in the name of driving down costs. Dynegy operates approximately 26GW of generation assets, with the vast majority of production evenly split between modern combined cycle natural gas plants and legacy coal plants. In acquiring and developing these assets, the company has had both an interesting and volatile past. Dynegy emerged from bankruptcy in 2012 with a little help from the renowned Carl Icahn , only to make a $6.25B acquisition (12.4GW) of coal and gas-fired assets from Duke Energy (NYSE: DUK ) and Energy Capital Partners just a few short years later in 2014. While the debt load may appear large given the company’s size and recent bankruptcy, the acquisition was viewed favorably by most ratings agencies in regards to improving earnings by acquiring some retail regulated business. However, this debt didn’t come cheap – weighted average interest rate of the debt was 7.18%, quite high given our current position in the interest rate cycle. Operating Results (click to enlarge) As one of the largest merchant energy providers using natural gas, you might expect operating results to have been a little bit more favorable than this post-bankruptcy. There are some sparks of improvement for investors to grab on to, such as improving gross margins. The retail Duke Energy/Energy Capital Partner assets have improved the company’s margin profile, and spark spread improvements due to collapsing natural gas prices have also boosted margins. SG&A expenses have also grown quite slowly, indicative of the scale that is present in many utilities. Bigger is generally better in this sector. Like the income statement, cash flow generation hasn’t been much better. Dynegy generated negative operational cash flow in 2013 and 2012, and was only generated marginal cash flow in 2014. 2015 is set to be a better year, but the company still struggles to generate enough cash to sustain itself. Through this point in 2015, the company has barely spent any money at all on capital expenditures ($500M over three and a half years). Even after taking into account the change in the business from the acquisition, this still seems woefully low. Great Plains Energy (NYSE: GXP ), another company with heavy coal exposure and nearly identical enterprise value, has averaged $600-800M in annual capital expenditures. I’m not sure I buy into just $130M in capex to support the company’s 16 power plants in 2014. This company is a long way away from supporting itself from a cash flow perspective, never mind instituting a dividend that can be healthily supported. I do like the company’s natural gas operations. Citing industry trends, management itself notes that it expects ~50GW of coal power plants to be phased out of markets that Dynegy competes in due to a variety of factors, such as falling natural gas prices, increased capital expenditure requirements, and burdensome regulatory costs. However, I can’t help but feel this leads to a negative in and of itself as well. This bullishness on natural gas generation seems to run contrary to the assets picked up from the Duke Energy deal, as a sizeable (roughly 40%) portion of those assets were coal-fired. Duke Energy has been reluctant and slow to shift generation away from coal, and while these were non-core assets for Duke Energy (the company has decided to focus on its East Coast operations), Duke Energy management wouldn’t have taken a poor deal just to dispose of these assets. Conclusion Dynegy is too early in the turnaround stage for me to recommend it, and it is too early to go bottom fishing, despite the stock getting halved in price in 2015. While I’m not going to call it a short (I would have six months ago), the company is still years away from being what investors want in a utility: consistent cash flows, a healthy dividend, and a fair valuation. The preferred issue is probably the better play here if you’re deeply interested in the company. The preferred currently yields 8.49%, and is convertible into 2.58 shares of Dynegy if you choose to later on. At $59.22/preferred share at this point, if this thing ever does recover, you’ll be sitting pretty and will have been paid a healthy dividend to boot while you wait.

A Rate Hike Will Threaten This Bond Fund’s Reach For Yield

Summary HYT has moved towards higher duration issues to maintain distributions, making it more heavily exposed to a rate hike than other high yield funds. HYT’s dividend history and its current failure to earn income to cover distributions indicate a rate cut in 2016. Nonetheless, there is an opportunity to purchase HYT when the market discounts its underperformance too heavily — although that time has not come quite yet. BlackRock Corporate High Yield Fund (NYSE: HYT ) is a thinly traded and often overlooked closed-end fund that seeks consistent high income to shareholders through active capital allocation in the high yield taxable bond and debt derivative universe, with a smattering of equity on the side. To its credit, the fund has a solid track record of paying special dividends that have driven its total yield above 8% for most of its history since inception. This must be counterbalanced by a consistent decline in dividends and a fall in NAV that make it suspect for the income-seeking investor. Currently, the fund deserves attention because a recent dividend cut for HYT and turmoil in the high-yield market as a whole have generated interest in just about any high-yielding CEF. But there is cause for caution. The Dividend History Unfortunately, regular dividends have been consistently falling for this fund for a long time: (click to enlarge) In 2015, shareholders faced a 7.3% dividend cut after similar cuts came to the fund in 2012, 2013, and 2014. Dividends have fallen 41% since the fund’s inception, and the fund’s market price has fallen by a third. The Capital Losses Some CEF investors like to catch funds that trade at a discount to NAV using the logic of value investors: get dollars when they’re on sale for 80 cents. In addition to the falling dividends HYT pays out, there is another reason why this strategy will not work with HYT. The fund’s overall capital losses are not abating. According to the fund’s most recent annual and semi-annual reports , the fund has lost 7.4% of its value from June to September. Over a one-year period to September, the fund lost 3.14% of its NAV. Since then, the fund has lost another 0.6% of its NAV. Greater Exposure to Rising Rates We can largely attribute these losses to a cratering in the high yield market, which has also caused a distressing decline in the NAV of high yield funds such as Pimco High Yield Fund (NYSE: PHK ) and caused me to sell my holdings in that fund (I discuss this decision here ). In the case of PHK, management seems to be preparing for this fall in junk debt values by shifting the portfolio towards shorter duration holdings at higher yields. In theory, this will free up capital for new issues at higher rates if the Federal Reserve raises rates in December or early next year. In the case of HYT, this is not management’s strategy. In September, HYT had 75% of its holdings with maturities ranging between 3-10 years, with over half having maturities between 5 and 10 years. In June, 68% of its holdings were in the 3-10-year maturity window, with 44% in the 5-10-year maturing range. This means there is now a higher risk of HYT losing more of its NAV if the Federal Reserve raises interest rates and rates for high yield debt goes up as well. Even if the Fed doesn’t raise rates, if the market worries about higher default rates due to declining profitability on the stronger dollar, or because of cheap oil, or any other of the myriad reasons that have driven a fall in the high yield market in 2015, HYT is more exposed than PHK and other actively managed high yield funds. The CLO Bet HYT is also making another small bet by moving into CLO investments. In its last annual report, HYT disclosed approximately $24.5 million in CLO investments, which is over half of its $49.5 million invested in asset-backed securities. On the plus side, CLOs remain only 2% of HYT’s total portfolio. There is potential for credit spreads to narrow if the Federal Reserve does raise interest rates and causes other interest rates, such as LIBOR, to follow suit, but this will have significantly less impact on HYT than on other high yield funds, both in the CEF and BDC universe, which have invested more aggressively in CLOs to boost returns. A good example of a much higher risk high yield fund that has seen weak NAV growth and high market value declines based on CLO exposure is Prospect Capital (NASDAQ: PSEC ). Their high CLO holdings are discussed in this prescient article by BDC Buzz. PSEC has fallen 12.7%, excluding dividends, since BDC Buzz’s article (although it was by no means his first warning on the dangers in that company). For HYT, this means its CLO holdings are relatively conservative. On the surface, this sounds good; but they are in fact so conservative that it is difficult to determine the purpose of holding such a small portion of the portfolio in these volatile assets. Additionally, many of those CLOs are in small and middle-market companies or BDCs that service the small and middle-market companies, again compounding HYT’s exposure to companies that are more likely to suffer higher default rates. For example, as of its September report, HYT held $2.1 million in asset-backed securities whose counterparty is Ares CLO Ltd. and another $877,000 to WhiteHorse subsidiaries of H.I.G. Capital, a diversified private equity investment firm. Matching Income to Distributions Since CLOs pay a higher yield than market-issued bonds, these are part of the fund’s overall strategy to make income match distributions. Unfortunately, the fund is still falling slightly short of its payout. Since March, the fund has paid $1.21 million of its distributions as a return of capital and its dividend coverage has remained below 85% for five months. Its current ROC is a small fraction of the overall value of the fund and is by no means a cause for alarm at the present time. However, it does indicate the strong likelihood of another dividend cut in 2016 as we have seen over the past few years, meaning investors should calculate their expected income from this fund not based on its current yield but on its likely future yield. Also, because of the long duration of the fund’s holdings, its ability to churn into higher yielding new issues will be limited, making it even less likely to enjoy a higher rate of income on its holdings if yields on corporate debt rise next year. Discount to NAV When deciding whether to purchase HYT or not, investors should also consider the fund’s discount or premium to NAV and how this is likely to trend in the future. Except for a brief spell in 2012, the fund has always traded at a discount, and its current discount is the steepest it has been since 2008. (click to enlarge) The fund’s current 13.47% discount is slightly above the 52-week average of 12.37%, although the last year’s tumultuous and volatile high yield bond market may make the last year’s average a less reliable indicator of timing a purchase in this fund than in the past. While investors looking for mean reversion may be tempted to buy as its discount seems curiously low, the above considerations about portfolio duration, ROC, and poor positioning for rising rates should make investors pause before jumping in. Conclusion HYT is not positioning itself for a rising interest rate environment and has seen a steep discount to NAV priced in as a result. Additionally, the fund’s consistent dividend cuts mean that it cannot be purchased as a source of reliable income. However, it can be purchased when the market undervalues its income potential. A careful analysis of the fund’s shift of its bond holdings by duration and a closer understanding of its allocations to CLOs and its exposure to smaller companies is necessary before making a purchase on this name.