Tag Archives: etfs

Value Seen In Muni Bond Closed-End Funds

Guest Paul Mazzilli, Independent Fund Consultant and Senior Advisor for S-Network Global Indexes, shares his thoughts on the current attractiveness of municipal bond closed-end funds: Their ability to use leverage very effectively. Wide discounts: share price dislocation versus net asset values. The potential impact of the Puerto Rico debt crisis. TOM BUTCHER: I’m here with Paul Mazzilli, Senior Advisor to S-Network Global Indexes. ETF providers often seek to partner with innovative third-party index developers like S-Network. Using his extensive knowledge of the closed-end fund market, Paul was instrumental in the development of the S-Network Municipal Bond Closed-End Fund Index. Paul, why may municipal bond closed-end funds be attractive for investors right now? PAUL MAZZILLI: There are three attractive aspects of municipal closed-end funds, all of which are working together right now. The first, as a closed-end fund, they have a set investment, they’re run by professional managers, and since they don’t have assets coming in and out like an open-end mutual fund, they can buy less-liquid, higher-yielding securities like private placements, non-rated bonds, and they’re not forced to sell bonds when people are seeking out liquidity. The next is a unique aspect of municipal closed-end funds. They have the ability to leverage. When a closed-end fund leverages, it will borrow against its own assets and buy more bonds. Here is a simple example: For a $100 million closed-end fund, the most it’s allowed to borrow is one-third leverage. It can borrow $50 million and buy another $50 million of bonds. The $100 million in assets becomes $150 million invested. If the underlying bonds are yielding 4%, the leveraged fund would yield 6%, approximately, before any incremental costs. You get almost a 50% increase given this ability to leverage one third. The final thing is that after closed-end funds are issued, they trade as stocks in the marketplace. Based on demand and supply, they can trade rich to their value [at a premium], or they can trade cheap to their value [at a discount]. Right now, they’re selling historically cheap at about a 10% average discount. The 25-year average discount is approximately 2%. So when you’re selling at a 10% discount, if you’re buying a dollar of assets for $0.90, if you had an asset yielding 10%, you’re actually getting an 11.1% yield on the money you’re putting up. This fact that they’re trading at a discount is happening right now because investors are fearful of the Fed raising rates. They are fearful of the equity markets, they’ve been raising cash since they’ve traded stocks, they’re selling them, they’re not looking at the underlying value, and it’s created a real buying opportunity. The discount has one other final advantage: If bonds were to sell off, but you’re buying at a 10% discount and it goes to a 5% discount, you actually could have a capital gain, even though the underlying bonds sell off. BUTCHER: Is the prospect of debt restructuring in Puerto Rico going to have any impact on municipal bond closed-end funds? MAZZILLI: Very good question. I think there are two different aspects. First, what does Puerto Rico do to the general municipal bond market? It is a significant issuer. It could have some impact in terms of how bonds trade. I personally believe a lot of that is already reflected in the market. Second is, what does it do to our index of municipal closed-end funds [S-Network Municipal Bond Closed-End Fund Index, CEFMX]? Our index currently has a very low exposure of about 0.43% to Puerto Rico. And that comes from two reasons. One: municipal closed-end funds tend to buy higher-quality funds, which would exclude Puerto Rico right now, or in the past. Two, we buy only national municipal closed-end funds, or our index represents only national municipal closed-end funds. And the national funds buy very little Puerto Rico exposure because they have a lot of other ways to diversify. BUTCHER: Paul, thank you very much for joining me today. MAZZILLI: Thank you. Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Investors cannot invest directly in the Index. Returns for actual Fund investors may differ from what is shown because of differences in timing, the amount invested and fees and expenses. Index returns assume that dividends have been reinvested. S-Network Municipal Bond Closed-End Fund Index is a rules based index intended to serve as a benchmark for closed-end funds listed in the US that are principally engaged in asset management processes designed to produce federally tax-exempt annual yield.

Newest Additions To Our Friedrich Charts

In 1989 I was four years into working on building what would later be called Friedrich and back then I read a book called “The Money Masters” by John Train, which changed my life . In that book, one of the chapters was about the portfolio manager of Source Capital = Mr. George Michaelis, whom I consider one of the greatest investors in history. In the Appendix of that book, is part of the Source Capital annual report to investors for December 31, 1985. Here is what George wrote then. The ratio that you see in the first paragraph is actually one of the foundation stones of Friedrich and plays a major part in my creation of the final algorithm. The reason that ratio is so powerful is because it allows one to determine a company’s actual rate of growth on Main Street by incorporating its return on equity along with the company’s dividend payout policy, which both speak volumes about how well managed a company is. What I look for in using what I call the “Michaelis Ratio” is a return of at least 15% or higher. Here for example is our Friedrich chart for Accenture (NYSE: ACN ) that includes the Michaelis Ratio listed for the first time. As you can see Accenture’s Michaelis Ratio came in at 30%, which is twice what I look for as the ideal for this ratio. When you factor in my other original ratios like FROIC and CAPFLOW, you have quite impressive results for the company. But in that chart you will also see the Watson Ratio and the Sherlock Debt Divisor. Obviously, I am a big fan of Sir Arthur Conan Doyle’s work and have named these two powerful ratios after his greatest creations. Having said that, what is the Watson Ratio? The Watson Ratio is one of 30 original abstract ratios that I have created, which along with many others make up Friedrich. This particular ratio deals with the relationship between a company’s free cash flow and its diluted earnings per share. It uses the free cash flow methodology that Arnold Bernhard (the founder of Value Line) created, which is basically cash flow – capital spending and divides that result by the company’s diluted earnings per share. In theory most companies should have (what I call a Bernhard Free Cash Flow) result equal to its diluted earnings per share, so an average result should be 100%. When a company is well managed you will see a result greater than 100%, like Accenture’s result above of 110%, which obviously tells us that Accenture’s Bernhard Free Cash Flow is 10% better than then Accenture’s diluted earnings per share. Thus we end up with bonus points. A major concern that I have these days in analyzing companies is the amount of debt each company takes on relative to its operations and whether management is abusing our current Fed inspired low interest rate policy. Debt as anyone knows, when used wisely, allows for what is called leverage and leverage can be extremely beneficial within means. On the other side of the coin, the use of debt can also be excessive and put a company’s future in jeopardy. So what I have done to determine if a company’s debt policy is beneficial or abusive is create the Sherlock Debt Divisor, which allows us to investigate debt in a different abstract way. What the Divisor does is punish companies that use debt unwisely and rewards those who successfully use debt as leverage. How do I do this? Well I take a company’s working capital and subtract its long term debt. I then divide that result by the company’s diluted shares outstanding, then multiply that result by (-1). So if a company like Accenture has a lot more working capital than long term debt, I reward it and punish others whose long term debt exceeds its working capital. The final result for Accenture came in at $100.13 but the closing stock price was $104.78, so I am rewarding Accenture’s management for doing a great job using leverage. How do I reward them? Well I do so by using $100.13 as my numerator and not $104.78 in all my ratio calculations performed by Friedrich. So since the valuation in the Numerator is less, each ratio naturally generates a much more favorable result than it would have had I used $104.78. What does a company that is not doing very well look like? Well here is the Friedrich chart for Chevron (NYSE: CVX ). First of all, Chevron pays about a 5.09% dividend yield, so the growth for the company on a Main Street is only 1.91% on a Michaelis scale (7%-5.09%). It’s Watson Ratio ratio tells us to avoid it as its free cash flow is a disaster relative to its reported diluted earnings per share. Finally the large debt that Chevron has on its books punishes the company by adding $8.84 to the numerator in all ratio calculations performed by our Friedrich Algorithm. The Max Value you see below uses a different methodology to come up with its result and sometimes that result is skewed as it relies exclusively on what is called the “discounted owners earnings using a two stage dividend discount model’ found in Hagstrom’s great book “The Warren Buffett Way”. The final “Market Value of the Company” you see in the table below is what I call the Max Value. My work also incorporates different free cash flows than Mr. Hagstrom uses as I use the MFCF = Mycroft Free Cash Flow and since my Mycroft Free Cash Flow for Chevron comes in at $-785 million, you are obviously going to end up with a negative result for Max Value. My True Value and Buy Prices are based exclusively on my own ratios and that is why they are positive as they incorporate many more things than free cash flow in the analysis. As you can see if you used the Max Value in 2014 for Chevron you would have sold it then and avoided watching its stock price go down to $69.58, which is the 52 week low for this year. So when operating with abstract ratios sometimes you get such results where the buy price is higher than the Max Value, but what we are trying to do with Friedrich is find companies that are consistent year in and year out, so we do not need to sell. We are looking for just 50 stocks to put two percent in to become fully invested out of 3000 stocks that we analyze as part of our research. There is no such thing as a perfect system as perfection is an illusion that can only be found as a word in a dictionary. Once an investor understands that, she or he automatically matures and becomes a more seasoned investor. Plato once said “Experience is what man calls his mistakes”. Therefore, Friedrich is the culmination of what I have learned over the last 30 years in creating the Friedrich Algorithm, through trial and error and through my personal experiences in the stock market as a Professional Analyst.

Considerations For Building A Currency Hedged Strategy

By Jane Leung It’s been nearly impossible to ignore the news about the dollar, especially for those of us who are taking advantage of the upcoming vacation season to travel overseas. The greenback’s movement also has implications for investors. One of the things I’m hearing most from colleagues and clients is that investors know they need to have a view on the dollar – whether it will go up or down – and also be very aware of their investing time horizon. Unfortunately, they’re still unsure of how to implement a currency hedged strategy in their portfolio. Of course, predicting exact currency movements is impossible, especially in today’s environment. On one hand, you have the Federal Reserve angling to boost interest rates, while on the other, central banks in Europe and Japan continue efforts to lower rates, thus weakening their respective currencies. So let’s focus on the variable that’s easier to measure: time horizon. Why Time Matters Investors seeking to limit the effects of currency risk on their portfolios have a number of hedging strategies to consider, but what to do depends on the investment horizon. A quick review of the numbers shows that there is a big difference in the risk/return ratio of hedged and unhedged strategies depending on how long you remain invested. The chart below shows developed market return/risk ratios and reveals that results vary significantly over time. Of course, it’s important to remember that currency returns are generally viewed, over the long term, as a zero-sum game. And, as we can see, over a 15-year period, hedged and unhedged strategies, as measured by MSCI (daily index returns from April 1, 2005 to March 31, 2015) produced nearly the same results. However, applying some form of currency hedged strategy may help reduce volatility. In the example below, at 10 years, there was a higher return/risk ratio for a hedged v. unhedged index. The differences keep becoming more pronounced as you look at shorter time periods. Over a 1-year time period, a 100 percent hedged portfolio would have resulted in a 0.8 risk/return ratio while 100 percent unhedged would have resulted in a -0.6 risk/return ratio. EAFE HEDGING How to Build a Hedged Strategy When deciding how much of your portfolio should be hedged for currency risk, a good rule of thumb is to think about developing an asset allocation and hedging “policy” at the same time. To clarify my point, I’m including a simple risk-and-return illustration. Low risk/low return investments such as cash and U.S. bonds reside in the left corner and the potentially high risk/high return investments such as unhedged international equities in the upper right corner. The orange dot is where a hypothetical investor may indicate her risk tolerance. HYPOTHETICAL RISK TOLERANCE Considerations for Investing Overseas When you think about international investing, it is also important to recognize the distinct characteristics of each country that makes up a foreign region. Some of these features may or may not be correlated with the U.S., and this can affect the decision of whether or not to hedge and, if so, how much. Take a look at the annualized volatility over 10 years for a variety of single countries and international regions, as represented by MSCI: ANNUALIZED VOLATILITY: 10 YEARS We can see from the graph above that the annualized volatility over 10 years was consistently higher for unhedged positions than hedged positions and that different countries and regions had different levels of volatility relative to each other. In short, your asset allocation should depend on how much risk you’re willing to take on any given investment. If you have a portfolio that is heavily weighted toward international investments, has high currency volatility or high correlation between the currency and the underlying assets, a higher proportion of currency hedged investments might be appropriate. If you are more risk averse, and your portfolio is more heavily weighted towards U.S.-based investments, has lower currency volatility, or low correlation between the currency and the underlying asset return, you may consider having a lower proportion of currency hedged investments. Whatever your risk tolerance, you may want to consider a currency hedge as a way to help minimize the effects of volatility over the long term, regardless of short-term dollar movement. This post originally appeared on the BlackRock Blog.