Tag Archives: author

Protecting Yourself Against The Next Bond Liquidity Crunch

By DailyAlts Staff Anyone who lived through it knows that liquidity evaporated during the 2008-09 financial crisis. In response, the U.S. federal governments imposed a series of rules and regulations designed to make financial markets safer, but instead, they’ve contributed to even more illiquidity. What can investors do about it? That’s the question explored in Alliance Bernstein’s September 2015 white paper Playing with Fire: The Bond Liquidity Crunch and What To Do About It . Trading Turnover is Down The bond market has long been considered a safe haven during times of financial stress. Historically, well-capitalized banks have stood at the ready, willing to buy bonds – particularly investment-grade and government issues – when no other buyers were interested. But due to regulatory changes, banks are hamstrung from providing this service, and as a result, turnover in both investment-grade and high-yield bonds has plummeted since the financial crisis. Increased Correlation It’s not that demand is down: New bonds are being issued in record numbers, and investors are willing to buy. The problem is that during so-called “fire-sale” selloffs – when stocks, bonds, and commodities suffer sharp declines – bond-market liquidity is drying up, and thus sellers under duress must contend with wide bid/ask spreads and lower selling prices than they bargained for. And, as a result of the policies of the Federal Reserve and other central banks, these broad selloffs are becoming more and more common. The Impact of Central Banks In the wake of the financial crisis, when liquidity dried up, central banks began forcing down interest rates by buying government bonds and other assets, thereby expanding the money supply and flooding the markets with liquidity. Their bond buys pushed interest rates down and forced yield-minded investors into riskier assets. In addition to the U.S. Federal Reserve, the U.K.’s Bank of England, the EU’s European Central Bank, the Bank of Japan, and the People’s Bank of China have all massively expanded their balance sheets since 2009. Crowded Trades With lower rates on government bonds, stocks and other riskier assets become more attractive by comparison. While 0% interest rates may have made sense as an “emergency” policy measure, nearly ten years later, rates are still pegged near zero, but it appears things are likely to begin normalizing later this year, or in early 2016. It’s widely acknowledged that the Fed and other central banks have boosted bonds and other asset prices, so the reversal of their policies is likely to have the same effect – indeed, even the Fed’s threat of scaling back its “quantitative easing” bond-buying program in 2013 led to a “fire-sale” dubbed the Taper Tantrum. The risk in 2015 and into 2016 is that yield-starved investors have crowded into too many of the same trades, and that without banks standing on guard to buy during the next “fire-sale” selloff, there may be no takers (at reasonable prices), and thus a severe liquidity crunch. What to Do About It? So what can investors do about it? AllianceBernstein’s Head of Fixed Income Douglas Peebles and Head of Global Credit Ashish Shah, authors of the white paper, provide the following list: Diversify using a broad multi-sector strategy; Be a contrarian and avoid the crowd; Keep cash handy – and don’t neglect derivatives; Do your credit homework – and expand your investment horizon; and Consider select investments in private credit. Investors should vet asset managers as part of their “credit homework.” Peebles and Shah recommend asking managers questions to gauge their acumen, such as “To what do you attribute the decline in liquidity?” and “How has your process changed as liquidity has dried up?” In closing, the authors ask investors to remember: While the financial crisis did considerable damage to markets and investors, those who kept their cool – and who didn’t rely too much on liquidity – made a lot of money. For more information, download a pdf copy of the white paper .

Diving Into The Herzfeld Caribbean Basin Fund

Summary CUBA is a closed-end fund focusing investment in the Caribbean. CUBA is currently trading at a 20% premium to its NAV. News in Caribbean has been large driver of fund since it’s inception, that could be changing. A few months ago I wrote an article attempting to recommend ways to profit from the newly rekindled U.S. and Cuban relationship. In this article, I recommend, among other options, the Herzfeld Caribbean Basin Fund (NASDAQ: CUBA ). After receiving a few messages and comments speaking on the haziness of this fund and the caution that should be exercised with it, I was prompted to further research and analyze the fund. In this article, I will divulge my unbiased findings on the fund. Overview CUBA is a closed-end fund that focuses on investment in companies that have potential to recognize large revenue increase from the economic development of Caribbean countries, including, but not limited to, Cuba, Dominican Republic, Costa Rica, and many others. By using a long-term investment strategy, the fund attempts to position itself in such a way to profit from not only tourism in the Caribbean, but also from projects and investments to improve infrastructure, trade, and the standard of living in the region. As the fund’s homepage states, the ultimate goal and investment strategy is long-term capital appreciation, driving fund manager, Thomas J. Herzfeld, to make investments in companies that are not only risk averse, but also poised to grow alongside the region. Findings The elephant in the room with this fund, and the most obvious concern from the comments on my aforementioned article received, is the fund trading at around a 20% premium to its net asset value. This is a red flag for investors, and has been a concern for the past 9 months. Investors do not want to pay a price 20% higher than the value of the assets, before fees, for a fund with a seemingly risky premise. Trading at a premium is a relatively young trend in the larger picture, starting in late 2014 after almost 5 years of discounted trading in relation to its NAV. It is important to analyze the factors that may be causing the sudden jump in price of this closed-end fund. The predominant explanation is investor excitement around Cuba. The trend towards Cuban relations is an unpredictable and exciting one, and investing in something so unknown can be a daunting decision for even experienced investors. This makes a fund that has been involved in the Caribbean for many years an attractive option. The continued news about Cuba has sparked the interest of many investors and the Herzfeld Caribbean Basin Fund is riding a wave of excitement that could very well be the largest contributing factor to the premium it is currently trading at. This is what fund founder and manager Thomas Herzfeld had to say about the topic in an interview with Barron’s. “Yes, it hit $15 a share, and the net asset value was about $7 or $8. That’s in keeping with its history. Whenever there is good news on Cuba, it reacts like that.” The last transition from a discount to a premium price point that the fund made was in late 2014, putting it right on track with the date that movement toward restored diplomatic relations between Cuba and the U.S. was making news, confirming Mr. Herzfeld’s statement. The correct question to ask now is, is this price and growth sustainable? As it is evident that the price of the fund largely depends on Cuba, it would appear that after news dies down the fund will fade with it. On the contrary, if the news gives way to palpable improvement in the market, especially in Cuba, the fund is poised to profit from growth in that nation and all across the Caribbean. The fund has existed solely in a time period when good or bad news was the most influential driver of price. The realization of actual action and efforts to improve relations with Cuba have put a new era of tangible growth from real economic improvement into the realm of possibility for the Herzfeld Caribbean Basin Fund. If this is the case, then it is only a matter of time before the NAV catches up with price as companies reap profits and success while the Caribbean becomes an emerging market and hub for economic and infrastructural development. In addition to the inflated price, investors also pay the management fees for investing in a fund, adding an additional expense to cut into final profits. In the financial reports from the fund, it can be seen that virtually all investments, 99.36%, are common stocks. The fund has no direct investment in the Caribbean, but that being said, the diversity in its portfolio is worth mentioning. The largest portion of the portfolio, 16.75% belongs to leisure stocks, including cruise lines such as Carnival Corp (NYSE: CCL ) and Royal Cruise Lines (NYSE: RCL ), both poised to reap profits from growth in the Caribbean, especially Cuba. The next largest segment belongs to airlines at 15.17%, with investment in airline companies that serve the Caribbean and stand to profit from prosperity in the region. Another important and potentially profitable fund investment focus is in infrastructure. Herzfeld and his team have portioned 11.64% of holdings to construction and materials companies including MasTec (NYSE: MTZ ) and Vulcan Materials (NYSE: VMC ), both companies are based in the southern United States and both are standing ready to supply Cuba with the infrastructure it needs to grow as a country. This could lead to the recognition of profits for the fund and the advancement of the Cuban economy. Investment in these companies not only finds profit from their role in bolstering Cuban infrastructure and economy, but also shows promise in helping other holdings that will feed off of an improved Cuba. Fees to own CUBA are 3.64%, which begs the question, is it worth paying a premium to the NAV and fees for a portfolio of mostly common stocks, of which I could simply own myself? The simple answer, by investing in this fund, one is investing in not only the sum of its holdings, but convenience of immediate diversification and exposure to an exciting market, paired with the expertise of management that has knows the region and has been in business there for years. Manager of CUBA, Thomas J. Herzfeld is a closed-end fund and Caribbean veteran, having written a number of articles and books on the topic, paired with living in Miami for 40 plus years, it was hard for him to not become a Caribbean expert, primarily Cuban. This expertise in both has only been sharpened since he started the Herzfeld Caribbean Basin Fund in 1993. Conclusion The primary concern when analyzing this fund is its relative volatility compared to its price. When the fund trades at a premium to its NAV, it is due mainly to outside factors influencing investor excitement about an intriguing market. It is advisable to proceed with discretion with any investment, but given the volatile nature of CUBA, one should truly analyze the cause and effect nature of the Caribbean and Cuban market exists in and the subsequent cause and effect nature of this market on share prices of not just the fund as a whole, but the companies it holds. It is well within the realm of possibility to see steady and reliable growth in the Caribbean and ensuing growth and performance from CUBA. That said, we could be staring down another situation of investor excitement sending share prices and hopes into the stratosphere only to come crashing down when the reality of the situation does not live up to the high expectations set for it. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Dollar Sensitivity: The New Style And Size Debate

By Jeremy Schwartz When making investment decisions, many are familiar with making allocation decisions between large and small caps or between growth and value stocks. These decisions to over- or under-weight different segments of the market are what drive relative returns, and depending on your allocation mix, the returns can be quite different. Recently, as a result of the divergence in central bank policies, investors have also had to take views on currency risk, with clear winners and losers. Increasingly, we have seen investors shift away from currency risk in the developed international markets-specifically Europe and Japan-and focus just on the equities through currency-hedged indexes. But what about the currency impact on domestic equities? Currency Factor in U.S. Equities Currency moves are not just important to foreign markets. In the U.S., we have also seen U.S. dollar strength impact stocks that are exposed to sales in foreign markets. It is widely known that a significant percentage of the revenues of U.S. companies in the S&P 500 Index comes from abroad. If the U.S. dollar continues to strengthen, this is likely to provide continued headwind for the companies with meaningful revenue from and business exposure in foreign markets. By contrast, if the U.S. dollar reverses, these firms should benefit. WisdomTree designed two new U.S. equity factor Indexes to help position investors according to their view of the U.S. dollar’s direction. WisdomTree Strong Dollar U.S. Equity Index (WTUSSD) – includes only firms that derive more than 80% of their revenues from the United States. These companies tend to be less impacted by a strong-dollar environment-they aren’t focused on selling their goods and services abroad, and their import costs decrease with the dollar’s rising purchasing power. The Index also tilts weight more heavily toward stocks whose returns have a higher correlation to the returns of the U.S. dollar. WisdomTree Weak Dollar U.S. Equity Index (WTUSWD) – includes only firms that derive at least 40% of their revenues from exports. These firms tend to be more impacted by a strong-dollar environment, as they are focused on selling their goods and services abroad. Similarly, during a weak-dollar period, we’d expect these firms to become more competitive in selling their goods abroad. The Index also tilts weight to stocks whose returns are more negatively correlated (or have a lower correlation) to the returns of the U.S. dollar. Below we compare the since-inception performance of the WisdomTree Dollar Indexes, as well as popular size and style indexes, to get a sense of divergence between factors. Index Performance (click to enlarge) For definitions of indexes in the chart, visit our glossary . Dollar Indexes Divergence: we find the 3.98% divergence between WTUSSD and WTUSWD interesting, especially considering the short-term performance period. Despite that and the fact that analyzing just performance is not a robust statistical analysis, it seems there have been clear winners and losers, with WTUSSD coming out ahead. It is also interesting that the discrepancy is larger than the 2.92% difference between the S&P 500 Growth and S&P 500 Value, leading us to believe that the WisdomTree Dollar Indexes are offering differentiated exposures. Performance Differences between Size Indexes: have been the smallest (at 0.23%) of the indexes shown above. The difference is interesting to us because we often hear that small caps should be impacted less by a strengthening dollar because their revenues are typically more domestically focused. We estimate the weighted average revenue from outside the U.S. at 19% and 38% for the S&P Small Cap 600 and the S&P 500 indexes, respectively. Again, the period is short and there could be other factors driving the returns, but it is something we will continue to monitor. Can the Separation Continue? One of the most important macroeconomic forces impacting the markets have been currency changes motivated by diverging monetary policies. If you believe the U.S. dollar will continue to strengthen over the coming years, as is WisdomTree’s baseline view, this could provide the backdrop for continued divergence among U.S. equities. The degree or speed of the divergence is hard to predict, but we think it will be important to continue monitoring the performance differences for this new factor and look to provide commentary around any continued divergence. Important Risks Related to this Article Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations. Jeremy Schwartz, Director of Research As WisdomTree’s Director of Research, Jeremy Schwartz offers timely ideas and timeless wisdom on a bi-monthly basis. Prior to joining WisdomTree, Jeremy was Professor Jeremy Siegel’s head research assistant and helped with the research and writing of Stocks for the Long Run and The Future for Investors. He is also the co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” and the Wall Street Journal article “The Great American Bond Bubble.”