Tag Archives: income

SCHH: A Little Too Much SPG, But I’m Still Using It

Summary SCHH is a great REIT ETF with a very low expense ratio. The holdings are little too heavy on SPG and the retail REIT sector in general. When considered within a portfolio the diversification benefits of SCHH are less important when the portfolio already has a large bond holding. Investors should treat SCHH as an optional replacement for a combination of equity and bonds. If I could make a modification to the SCHH portfolio, it would be to decrease retail REITs and increase residential REITs in lower income markets with higher capitalization rates. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. I’m working on building a new portfolio and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the Schwab U.S. REIT ETF (NYSEARCA: SCHH ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio SCHH has an expense ratio of .07%. The expense ratio is great for equity REIT ETF options. This is one of the holdings I’ve been adding to whenever I saw it dip. Largest Holdings I love what a REIT index does for diversifying a portfolio. However, when I look at the internal holdings of the ETF, I wish there was a little more diversification. Namely, I would like to see a cap on exposure to any individual REIT at about 5% to 6% of holdings. The holdings are shown below: (click to enlarge) Nothing against Simon Property Group, Inc. (NYSE: SPG ), I just don’t want to see 10% of my index fund invested in a single company. Types of REITs (click to enlarge) When we look at the type of REIT holdings by sector, I get the feeling that I would prefer to see retail REITs with a lower weights and residential REITs with a higher weight. I suppose that comes back to my issue with having over 10% of the portfolio in SPG. Drop that down and put the capital into a heavier weight on residential REITs and I’d be very happy with the overall portfolio composition. Building the Portfolio I put together a hypothetical portfolio using only ETFs that fall under the “free to trade” category for Charles Schwab accounts. My bias towards these ETFs is simple, I have my solo 401k there and recently moved my IRA accounts there as well. When I’m building a list of ETFs to consider I want to focus on things I can trade freely so that I can keep making small transactions to buy more when the market falls. Within the hypothetical portfolio there are no expense ratios higher than .18%. Just like trading costs, I want to be frugal with expense ratios. The portfolio is fairly aggressive. Only 30% of the total is allocated to bonds and I would consider that the weakest area in the portfolio. I’d like to see more bond options (with very low expense ratios) show up on the “One Source” list for free trading. (click to enlarge) A quick rundown of the portfolio The Schwab U.S. Dividend Equity ETF (NYSEARCA: SCHD ) is a dividend index. The Schwab U.S. Broad Market ETF (NYSEARCA: SCHB ) is a broad market index. The Schwab U.S. Large-Cap ETF (NYSEARCA: SCHX ) is focused on blended large cap exposure. The Schwab International Equity ETF (NYSEARCA: SCHF ) is developed international equity. The Schwab Emerging Markets ETF (NYSEARCA: SCHE ) is emerging market equity. The Schwab International Small-Cap Equity ETF (NYSEARCA: SCHC ) is developed small capitalization equity. is domestic equity REITs. The Schwab U.S. Aggregate Bond ETF (NYSEARCA: SCHZ ) is a remarkably complete bond fund. The SPDR Barclays Long Term Treasury ETF (NYSEARCA: TLO ) is a long term treasury ETF. The PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (NYSEARCA: ZROZ ) is an extremely long term treasury ETF. Notice that the 3 international equity ETFs have only been weighted at 5% while the broad market index has been weighted at 25%. I find heavy exposure to international equity to bring more risk than expected returns so I try to keep my international exposure low. I prefer no more than 20% in international equity. Plenty of domestic companies already have enormous international operations so the benefit of international diversification is not as strong as it would be if the markets were isolated from each other. Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. When TLO and ZROZ post negative risk contribution it is because the negative correlation to most of the equity holdings results in the long term treasury ETFs reducing the total portfolio risk. In my opinion, this is the best argument for including them in the portfolio. Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio and with the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. (click to enlarge) The Role of SCHH REIT ETFs can perform a couple roles within a portfolio. One major use of REITs is to boost the income yield from the portfolio, but SCHH doesn’t pay out as high of a dividend yield as some of the other equity REIT index funds. In my book, that makes it more useful for investors that are not concerned about distributions for decades. Since I’m holding the ETF in a tax advantaged account, I won’t have to worry about capital gains taxes either. Since SCHH is not offering a high current yield for investors, it is useful to look at the diversification benefits because SCHH runs between .70 and .60 on correlation with all of the other equity ETFs in the portfolio. The only real weakness for holding a large allocation in equity REITs is the correlation with bonds is not as favorable as it is for the other equity ETFs. If an investor wants to completely avoid using bond exposure in their portfolio, as I’ve been doing, then equity REIT indexes are absolutely critical in reducing the risk level. When the portfolio is including a substantial allocation to bonds it will reduce the optimal allocation for equity REITs. Conclusion SCHH may not offer a high dividend yield, but for long term investors looking to build an optimal portfolio it makes sense as a solid index fund with a very low expense ratio. When investors increase their allocation to equity REIT indexes it may be appropriate to fund the portfolio by selling both domestic equity and bond ETFs. If the investor sells out of their position in REITs, the most intelligent allocation strategy would be to split the proceeds between bonds and equity. With the domestic equity REIT space, SCHH is a very attractive ETF for having a very low expense ratio. The biggest thing I would like to see changed is moving some the retail REIT exposure to residential REIT exposure. If I were to get even more specific, I would love to see the residential REIT exposure focused on markets with higher capitalization rates and lower value properties that would be expected to do better in a recession. If I were adding individual equity REITs to my portfolio to compliment SCHH, I’d start with looking for ones that operated low income properties. Disclosure: I am/we are long SCHB, SCHD, SCHF, SCHH. (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. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

Opportunity In Calamos Convertible Opportunities And Income Fund

Summary The recent sell-off in the CEF space has brought CHI to a discount value not seen since the financial crisis. 2- and 4-year z-scores in excess of negative 3.5 indicate extreme oversold conditions. CHI offers a current 10.91% yield with a possible chance of capital appreciation. With a fixed number of shares, CEFs can exhibit substantial premia or discounts to their net asset values [NAVs]. When investors become pessimistic, they become inclined to sell their CEF holdings even it if means selling at a price below the intrinsic value of the fund. Not surprisingly, the recent market turmoil has punished CEFs especially hard. As detailed in my recent article entitled ” Sell-Off In CEF Space Brings CEFL’s Discount To Record High “, 20 of the 30 constituents of the fund-of-funds CEFL (NYSEARCA: CEFL ) are at or close to 52-week high discounts. Exploiting of mean reversion in CEFs is a potential strategy to lock in higher yields as well as the chance for capital appreciation. In a July 2014 paper entitled Exploiting Closed-End Fund Discounts: The Market May Be Much More Inefficient Than You Thought , authors Patro, Piccotti and Wu provide significant evidence of mean reversion in closed-end fund premiums. This article identifies an opportunity to buy the Calamos Convertible Opportunities And Income Fund (NASDAQ: CHI ) at a greater discount than any time since the financial crisis. The fund Pertinent details for the fund are shown below. Details were obtained from Morningstar , CEFConnect or Calamos . CHI Inception 6/2002 AUM $731M Avg. volume 293K Yield (on price) 10.92% Yield (no NAV) 9.72% Adjusted yield (on price) 8.51% Adjusted yield (on NAV) 7.57% Leverage 28.34% Premium/discount -10.91% 5-year average P/D -0.30% Expense ratio 1.35% Active expense ratio 0.65% Morningstar rating **** As can be seen from the table above, CHI currently sports a 10.92% yield on price, while distributing 9.72% on its NAV. The reason for this discrepancy is due to its wide discount of -10.91%. Additionally, CHI uses 28.34% leverage. The adjusted yields shown assume 100% leverage for easier comparison to an unleveraged fund. CHI charges a total expense ratio of 1.35%. I previously devised an “active expense” metric that takes into account two factors: leverage and the expense ratio charged for a corresponding passive instrument. Taking into account the 28.34% leverage of CHI and the 0.40% expense you would to pay for the SPDR Barclays Convertible Securities ETF (NYSEARCA: CWB ), the price for the active management of CHI is a reasonable 0.65%. In terms of composition, CHI has its majority of assets in convertibles (57.06%), followed by corporate bonds (38.54%). Short-term debt and equity make up a very minor component of CHI. Widening discount Until recently, both CHI and the benchmark ETF CWB have had robust performances over the past few years. As can be seen from the graph below, CHI and CWB moved very closely from Jan. 2013 to around Mar. 2015 of this year. However, a major divergence suddenly appeared over the last few months, causing CHI to underperform by some 15% over brief period. What was the cause of CHI’s underperformance? Tracking the market price and NAV changes of the fund reveals the answer. As can be seen from the graph below, while the NAV of CHI decreased by around 10% over the past few months, mainly due to a general malaise in the high-yield credit market, the market price of CHI slumped by 20% over the same time period. The premium/discount chart of CHI over the past 1-year period shows this clearly (source: CEFConnect). Historical premium/discount Just having a wide discount alone is not good reason to buy a CEF. For mean reversion to take place, one must consider the historical premium/discount behavior of the fund. As can be seen from the chart below (source: CEFConnect), the current discount of CHI has reached levels that have not been seen since the financial crisis. Moreover, that was also the only time that the discount has exceeded -10%. In the boom years of 2002 to 2007, CHI actually experienced premia of 10%-20%, although this is unlikely to be replicated given that the ETF CWB became available from 2009 onwards. The following chart shows the current, and 1-, 3- and 5-year premium/discount values for CHI (data from CEFConnect). The z-score is a measure of the deviation of the premium/discount value of CEF from its historical value taking into account the volatility of said value. The following chart shows the 1-, 2- and 4-year z-scores for CHI (source: CEFAnalyzer). Mathematically, the 1-year z-score of -2.59 means that the discount would be expected to appear 0.48% of the time, the 2-year z-score of -3.52 corresponds to a 0.02% probability of appearance, and the 4-year z-score of -3.93 represents a measly 0.004% probability of occurrence. However, one should understand that this doesn’t mean that there’s a 99.996% chance that the discount will narrow, only that the observed discount is an extremely rare statistical occurrence. Moreover, it could be that the current discount represents a “new normal” of sorts, rendering the historical premium/discount value meaningless. Nevertheless, the z-score is a good starting point for gauging the sentiment of CEFs. Historical performance Besides having a large and negative z-score, it is also important to consider the historical performance of a fund. The following chart shows the total return performances of CHI, CWB and the SPDR Barclays High Yield Bond ETF (NYSEARCA: JNK ) since early 2009, the inception date of CWB. CHI Total Return Price data by YCharts We can see from the chart above that CHI has remained competitive with CWB and JNK from early 2009 to the start of 2015. As the premium/discount of CHI remained within a narrow range of +5% to 5% during this time, the price total return profile of CHI during this period roughly approximates its NAV total return profile during this time. The outperformance of CHI over CWB and JNK during rising markets is expected due to CHI’s use of leverage. Moreover, CHI has posted respectable NAV returns since inception in 2002. The following chart shows the annualized price and NAV returns of CHI over various historical time periods (source: Calamos). We can see that CHI’s historical performance has been very strong, with a 10.0% annualized return since 2002, and a 10-year annualized return of 7.3%. Keep in mind, however, that CHI uses leverage, which is currently at 28.34%. Distribution CHI pays a monthly distribution of $0.095, representing an annualized dividend yield of 10.92%. The following chart shows the dividend history of CHI since inception (source: CEFConnect). (click to enlarge) The dividend has been remarkably stable since 2008. However, one warning sign is that the fund has been paying out some of its distributions from return of capital over the past 12 months. My calculations show that 19.8% of the past year’s dividends consisted of return of capital. If this continues, the return of capital distributions will either erode CHI’s NAV, or force a distribution cut. Summary The sell-off in the CEF space has pushed CHI’s discount to levels not seen since the financial crisis. The extreme 2- and 4-year z-scores in excess of -3.5 indicate severe pessimism regarding the fund. Purchasing CHI now allows an investor to lock in a higher yield as well as the opportunity for capital appreciation if mean reversion takes place. Moreover, CHI has a strong historical track record since 2002, and its expense ratio is also reasonable. Risks of CHI include interest rate risk and credit risk of the underlying holdings, as well as a further widening of the discount value. The former risks can be somewhat reduced by pairing a long position in CHI with a short position in CWB and/or JNK, but the latter risk remains. (See my previous articles here and here for previous examples of where mean reversion allowed annualized profits of ~20% to be made on CEF pairs trades). Disclosure: I am/we are long CHI, CEFL. (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.

This PIMCO CEF Has A 12.2% Distribution And A -9% Discount

Summary PIMCO Income Strategy Fund II is a closed-end fund with a broad mandate in fixed-income investments. It has kept pace with or beaten its peers for price and NAV returns. It is selling at a -9% discount, and yielding 12% at market. Editor’s Note, September 2, 2015: The author has revised the title and content to correct the erroneous distribution rate, as explained in the comments section. There has been a huge sell-off in high-yield, fixed-income closed-end funds. Uncertainties abound in high-yield fixed-income, so most carry substantial risk and are probably best avoided at this time. The more speculative investor, however, may be inclined to shop for bargains. One such bargain could be the PIMCO Income Strategy Fund II (NYSE: PFN ). Along with its peers, PFN has seen sharp moves in its discount, which has dropped to a point well below where it was a year ago. But, in a volatile space, PFN has quite consistently turned in respectable performances while paying out high distribution yields. Performance For openers, let’s note that the fund has performed reasonably well over time. The following charts (from cefconnect.com) show its performance in comparison to the category of Fixed-Income, Multi-Sector CEFS. (click to enlarge) As we see here, the fund has outperformed the category every year since 2008 on both NAV and market returns. Recent returns have been ugly for PFN but even so, the fund has managed to outperform the category where things have been even uglier. (click to enlarge) The fund has turned in a positive NAV return for 1 year and 6 month periods while its peers have been deep in the red. Although one-year return at market is in the red, the fund’s NAV total return for the period (from cefanalyzer.com) stands at 2.50%. This compares to a median for the entire fixed-income category of -0.26%. My point here is not that PFN has shown outstanding recent performance, nothing in this space has, but that it is sufficiently well managed to have consistently outperformed its peers through good and bad times. The fund was managed by Bill Gross prior to his departure from PIMCO a year ago. It has been managed by Mohit Mittal and Alfred T. Murata since Gross left. Along with several of the other funds that had been managed by Gross, the fund suffered with the management change. When I wrote about PIMCO funds at the time ( here ), several readers expressed strong confidence in the future of PFN. Despite the deepening of the discount discussed below, that confidence does not seem to have been misplaced. Discount and Distributions The current discount for PFN is -9.93%, well below its 52 week average discount of -2.96%. The 1-year Z-score (a measure of how far the discount is from its average value) stands at -2.45, which means the current discount is nearly 2½ standard deviations below the average for the past year. One can easily exaggerate the importance of Z-scores, but they help to identify potentially attractive entry points. The current distribution rate is 12.21%, which includes a special distribution in December. Without considering the special distributions, the fund yields 10.2% vs. a category median of 8.14%. The regular distribution of $0.08/share has been stable since 2012 when it was raised from $0.065/share. One might compare PFN to another PIMCO fixed-income CEF, the PIMCO High Income Fund (NYSE: PHK ) which has run substantial premiums (as high as 67% earlier this year). PHK currently pays 24.07% as its premium has fallen to 33.15%. It too is paying a special distribution, without which its yield is 15.43%. I have considered PHK’s massive premium to put the fund’s value at risk, but its exceptionally attractive yield continues to appeal to investors. As noted above, PFN has been a consistent performer over a long time scale. PHK, by contrast, is woefully underperforming its category on any measure but distribution yield. It will be interesting to see if that 15% yield can continue to sustain the still-outsized premium. Eli Mintz emphasized the relationship between NAV Yield and Premium/Discount as an indicator of value in municipal bond CEFs. Applying his observations here generates this chart. (click to enlarge) Following Mintz’s analysis, funds falling below the trendline are worth exploring for potential value. Clearly, by this criterion, PFN represents high value and PHK represents the lowest by a considerable margin. Be aware, however, that like most single metrics, the Mintz relationship is only an indication that may provide insight into funds worth looking at in some detail. for example, from this chart one might consider the Stone Harbor Emerging Markets Income Fund (NYSE: EDF ) and the Stone Harbor Emerging Markets Total Income Fund (NYSE: EDI ) as standouts. Their yields are high (above 15%) but even a cursory look at these funds might discourage investors who look beyond yield. Summary PFN appears at this time to be a strong candidate for an investor who considers high-yield fixed income to be ripe for entry. The fund has a solid history of outperforming its peers, pays an attractive and stable distribution, and is priced at a substantial discount relative to its recent history. It has effective leverage of 19.33%, below the category median of 30.26%. Leverage-adjusted portfolio effective duration is modest at 4.16 years (data from PIMCO ). Without question, the high-yield sector is a high-risk sector. This is particularly the case in today’s unsettled market. Disclosure: I am/we are long PFN. (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. Additional disclosure: I remind readers that this article does not constitute investment advice. I am passing along the results of my research on the subject. Any investor who finds these results intriguing will certainly want to do all due diligence to determine if any fund mentioned here is suitable for his or her portfolio. As always I welcome your comments and critiques, particularly from those readers who have contrary opinions.