Tag Archives: income

Has The CEFL Rebalancing Train Left The Station?

Summary A previous article attempted to predict CEFL/YYY’s new composition for 2016. Three groups of CEFs are analyzed for their recent price, premium/discount and volume behavior. Frontrunning in the underlying CEFs may have already begun. Introduction In last week’s article ” Are You Ready For CEFL’s Year-End Rebalancing ?”, I discussed the fact that not only was the annual rebalancing of the ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA: CEFL ) nearly upon us, but that the index provider has modified its methodology this year so that changes to the index are no longer made public five days before the actual rebalancing event. Ostensibly, this change was enacted to prevent “front-running” of the index (for more information, refer to ” Frontrunning Yield Shares High Income ETF YYY And ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN CEFL: Could You Have Profited ?”), which last year caused heavy losses to CEFL holders as well as those of the YieldShares High Income ETF (NYSEARCA: YYY ), an unleveraged version of CEFL. Both CEFL and YYY track the ISE High Income Index [symbol YLDA], an index consisting exclusively of close-ended funds [CEFs], and both pay high, monthly distributions. However, although the index changes are not announced publicly beforehand this year, the index methodology is published and available to all. Therefore, I was quite certain that professional investors would be able to apply the index methodology to accurately determine which CEFs were to be added or removed from the index. Therefore, two days ago I attempted to replicate the index methodology in order to level the playing field for Seeking Alpha readers. As described in ” CEFL: A Year In Review, And A Prediction Of What’s Ahead “, my crude attempt to reproduce the rebalancing algorithm resulted in the identification of the 16 CEFs that could be added to the index, and the 16 CEFs that could be removed. 14 CEFs are predicted to remain in the index. I stressed that my predictions were only an estimate given that I used only an approximate volume ranking and also because I did not know the exact date from which the index provider would harvest the CEF data. However, I did receive some confirmation on my predictions from reader waldschm85 : Thanks for the article SC! I recalculated this morning and 27/30 of our holdings match. I did go ahead and use the volume as a filter so that is likely the difference. There are a few like NHF and TDF that I’m worried won’t meet the threshold based on the 90-day average volume from Yahoo Finance. That being said, I’m feeling good that some of your top holdings with solid volume like KYN, NFJ, BCX, RVT, etc. will be in the index. Another astute reader, Jhinkle, noted : 11 out of 15 to be sold had abnormally high volume on the last trading day. As well most were flat to slightly up compared to decent gains on the ones to be added. 3 in fact were down on price. It would seem the action has already started. Therefore, I wanted to analyze whether or not traders were already bidding up the CEFs to be added to the index, and/or selling the CEFs to be removed. I also discuss some implications and strategies that investors may take advantage of during CEFL’s rebalancing event. Has the CEFL rebalancing train already left the station? (click to enlarge) Credit: Ben Brooksbank ( some rights reserved ) Fund rotations In my previous article, I presented preliminary lists of CEFs that I predicted were to be added, removed or that will remain in the index. Below are reproduced the same lists except that I’ve arranged the CEFs in order of size, from largest to smallest. The Top 10 CEFs in each category are shown in bold. Added CEFs: RVT (NYSE: RVT ), BCX (NYSE: BCX ), NFJ (NYSE: NFJ ), DPG (NYSE: DPG ), NHF (NYSE: NHF ), DSL (NYSE: DSL ), CEM (NYSE: CEM ), CSQ (NASDAQ: CSQ ), KYN (NYSE: KYN ), CHI (NASDAQ: CHI ), TDF (NYSE: TDF ), USA (NYSE: USA ), NTG (NYSE: NTG ), FEI (NYSE: FEI ), UTF (NYSE: UTF ), BOE (NYSE: BOE ), ETJ (NYSE: ETJ ) Removed CEFs: NCZ (NYSE: NCZ ), NCV (NYSE: NCV ), BGY (NYSE: BGY ), HYT (NYSE: HYT ), CHW (NASDAQ: CHW ), DSL , ETY (NYSE: ETY ), FPF (NYSE: FPF ), VTA (NYSE: VTA ), MCR (NYSE: MCR ), MMT (NYSE: MMT ), EDD (NYSE: EDD ), JPC (NYSE: JPC ), ISD (NYSE: ISD ), EAD (NYSEMKT: EAD ), ERC (NYSEMKT: ERC ), ESD (NYSE: ESD ) CEFs that remain from last year: EVV (NYSEMKT: EVV ), GHY (NYSE: GHY ), EXG (NYSE: EXG ), AOD (NYSE: AOD ), PCI (NYSE: PCI ), GLO (NYSEMKT: GLO ), DSL , AWP (NYSE: AWP ), IGD (NYSE: IGD ), GGN (NYSEMKT: GGN ), FAX (NYSEMKT: FAX ), BGB (NYSE: BGB ), BIT (NYSE: BIT ), HIX (NYSE: HIX ) In this article, I analyze these three groups of CEFs in terms of three metrics: [i] price change, [ii] premium/discount change and [iii] volume change, to see if I could spot any differences in behavior between the three groups. I focus only on the top 10 CEFs in each group for two reasons. Firstly, as those CEFs have the largest weighting in the index, any changes in their price will have a larger impact on CEFL/YYY compared to funds with smaller weighting in the index. Secondly, the higher the allocation of the fund within the index, the more certain I am that that fund is indeed belongs to the category that I have assigned it to. I again wish to stress that all predictions about the CEFs to be added, removed or that will remain in the index are simply predictions, and the actual changes may be significantly different to what I have predicted. For the sake of brevity, however, from this point onwards I will no longer preface my predictions with the word “predicted”. 1. Price change How have the prices of the CEFs fared recently? To analyze this, I plotted the price change of the CEFs over five trading days, from December 21st to the 25th. Top 10 added CEFs RVT Price data by YCharts The graph above shows that out of the Top 10 added CEFs, KYN has the highest 5-day price return of 24.67%, followed by CEM at 13.30%. The average 5-day price return of the 10 CEFs is 7.26%. Top 10 removed CEFs NCZ Price data by YCharts The chart above shows that out of the Top 10 removed CEFs, BGY has the highest 5-day price return of 2.64%, followed by CHW at 1.83%. The average 5-day price return of the 10 CEFs is 1.12%. Top 10 remaining CEFs EVV Price data by YCharts The chart above shows that out of the Top 10 removed CEFs, GGN has the highest 5-day price return of 5.18%, followed by GHY at 3.30%. The average 5-day price return of the 10 CEFs is 2.08%.(Apologies that the above YChart does not appear to be showing correctly. You’ll have to take my word for the numbers). Summary Let’s take stock of the situation. The Top 10 CEFs that were to be added to the index experienced a 5-day price gain of + 7.75% , while the Top 10 CEFs that were to be removed from the index experienced a 5-day price gain of +1.13% . The Top 10 CEFs that remain in the index experienced a 5-day price gain of +1.83 %. Now, the astute reader may observe that two of the Top 10 CEFs to be added (KYN and CEM) are MLP CEFs, which experienced a tremendous rebound over the course of last week. Indeed, KYN rocketed higher by 24.67% while CEM gained 13.30%. Thus, I also calculated an “ex-MLP” average for the remaining 8 CEFs to be added. The answer came out to be +4.33% , which is still significantly greater than the other two categories of CEFs. The above data would support the notion that the CEFs to be added experienced buying pressure while the CEFs to be removed experienced substantially less buying pressure over the past 5 days. 2. Premium/discount change Perhaps a better way to determine buying and selling pressure on CEFs is to study changes in premium/discount value, because the premium/discount value reflects how much more (or less) investors are willing to pay for a CEF compared to its net asset value [NAV]. The following graphs show the change in premium/discount value for the CEFs over the period of last week, from December 21st to the 28th (source: CEFConnect ). Top 10 added CEFs The graph above shows that KYN experienced the largest increase in premium/discount at +4.54%, followed by TDF at +2.41%. 9 out of 10 CEFs to be added experienced positive gains in premium/discount value, while only NFJ had a slightly negative loss of -0.10%. The average of the 10 CEFs was +1.62%. Top 10 removed CEFs The chart above shows that HYT experienced the largest premium/discount increase at +1.52%, followed by VTA at +0.22%. However, 6 out of 10 CEFs experienced decreases in premium/discount value, with MCR and MMT both declining by -1.51%. The average of the 10 CEFs was -0.46%. Top 10 remaining CEFs Of the 10 remaining CEFs, GLO had the highest premium/discount increase of +1.42%, while DSL had the lowest premium/discount change of -1.90%. The average of the 10 CEFs was -0.02%. Summary The Top 10 CEFs that were to be added to the index experienced a 1-week premium/discount change of +1.62% , while the Top 10 CEFs that were to be removed from the index experienced a 1-week premium/discount change of -0.46% . The Top 10 CEFs that remain in the index experienced a 1-week premium/discount change of – 0.02% . The above data would support the notion that the CEFs to be added experienced buying pressure while the CEFs to be removed experienced slight selling pressure over the past 1 week. 3. Volume changes Volume changes can reveal unusual buying or selling pressure on individual CEFs. The below graphs show the changes in 30-day average daily volume for the CEFs over the past one month. I used the 30-day average daily volume rather volume to reduce the effect of volume spikes and make the data more easy to visually interpret. Top 10 added CEFs RVT 30-Day Average Daily Volume data by YCharts The Top 10 CEFs added averaged a +67.73% increase in 30-day average daily volume over the past month. Top 10 removed CEFs NCZ 30-Day Average Daily Volume data by YCharts The Top 10 CEFs removed averaged a +42.00% increase in 30-day average daily volume over the past month. Top 10 remaining CEFs EVV 30-Day Average Daily Volume data by YCharts The Top 10 CEFs remaining averaged a +41.11% increase in 30-day average daily volume over the past month. Summary The Top 10 CEFs that were to be added to the index experienced a 30-day average daily volume increase of +67.73% over the past month, while the Top 10 CEFs that were to be removed from the index experienced a 30-day average daily volume increase of +42.00% . The Top 10 CEFs that remain in the index experienced a 30-day average daily volume increase of +41.11% . The above data would support the notion that the CEFs to be added experienced buying pressure over the past 1 month. However, the volume of the CEFs to be removed was not significantly greater than that for the remaining CEFs (the control set). Discussion of results In this study, I compared the 5-day price change, 1-week premium/discount change and 1-month 30-day average daily volume change for three groups of CEFs. The first group were the Top 10 CEFs by weighting that I predicted were to be added to the index. If frontrunning of the index were to occur, this group would experience buying pressure before the rebalancing date. The second set were the Top 10 CEFs by weighting that I predicted would be removed from the index. If frontrunning were to occur, this group would experience selling pressure before the rebalancing date. The final group were the Top 10 CEFs by weighting that I predicted would remain in the index. While these CEFs may change in weighting depending on whether their relative allocations were to be increased or decreased, I still used this group as a control set because I would expect the increases or decreases to partially offset each other. The characteristics of the three groups are presented below. Top 10 added CEFs: +7.75% ( +4.43% ex-MLP) price change, +1.62% premium/discount change and +67.73% volume change. Top 10 removed CEFs: +1.13% price change, -0.46% premium/discount change and +42.00% volume change. Top 10 remaining CEFs: +1.83% price change, -0.02% premium/discount change and +41.11% volume change. Now, readers may draw their own conclusions from the data, but it is clear to me that the frontrunning may have already begun. Both the price and premium/discount data support this idea across three data sets. The volume data indicates higher buying pressure among the added CEFs, although the volumes of the removed CEFs and the remaining CEFs were similar. What are the implications for investors? If this frontrunning behavior were to continue, there are a number of possible strategies for investors depending on the time frame: Sell CEFL or the CEFs to be removed now. While the CEFs to be added have already shown significant increases in price, the CEFs to be removed have not yet experienced heavy selling. Last year, the top 10 CEFs to be removed declined by -3.38% in the one week before the rebalancing date. If further selling in these CEFs were to occur, CEFL will decline in value. Sell the added CEFs just before rebalancing . A number of the CEFs to be added showed increases in both price and premium/discount values. If these were to revert after rebalancing, then those CEFs will decline in value. The best time to execute this strategy may be just before the rebalancing is to take place. Buy the removed CEFs after the rebalancing. Frontrunning may cause the prices and premium/discount values of the removed CEFs to be artificially depressed in price. This might make these funds good buys after the rebalancing is complete. I close by repeating again that my list of CEFs are simply predictions of the upcoming changes and the actual changes may be materially different to my predictions. A final cautionary note is warranted, as presented by reader cpyles42 : Furthering your cautionary note for all the amateur front runners – if UBS has already front run, they will simply cross their positions at rebalance, book a nice profit for themselves and the buying/selling that everybody is expecting to emerge to get them out of their front run positions at the beginning of the year will be absent. if enough people front-ran you could even see a paradoxical response, this happens all the time in markets because market positioning if often the most important short-Term factor. I have provided the 5-day price changes for all the CEFs in each of the three groups for further consideration by readers, in order of largest to smallest price change. 16 added CEFs (click to enlarge) 16 removed CEFs (click to enlarge) 14 remaining CEFs

XLF: The Heavy Financial Sector Exposure Doesn’t Appeal To Me

Summary The fund offers a reasonable expense ratio and incorporates more than banks. One of the challenges for investors is the combination of REITs and other stocks in a single ETF. Looking into the REIT holdings, I’d rather not see such a huge focus on the biggest companies. The historical volatility on the fund demonstrates the risk of going so heavy on the sector. 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 Financial Select Sector SPDR Fund (NYSEARCA: XLF ). 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. Index XLF attempts to track the total return (before fees and expenses) of the Financial Select Sector Index. Substantially all of the assets (at least 95%) are invested in funds included in this index. XLF falls under the category of “Financial”. It sounds like the ETF would be very highly concentrated, but it includes everything from diversified financial services to REITs and banks. When I was first reading about the holdings, I was expecting more diversification than I found. You’ll see what I mean when I get to the holdings section. Expense Ratio The expense ratio is .14%. It could be a little better, but it isn’t too bad. Industry The allocation by industry is interesting. Investors that are new to the fund may simply assume that it allocates everything to “financials”, but the fund’s website goes much deeper in explaining which parts of the financial sector is going to get the weights. The allocation to banks is heavy, but it is also well below 100%. The fund also uses heavy allocations to insurance and REITs. I certainly prefer this strategy to going exceptionally heavy on the banking sector, but I find the holdings somewhat problematic as I prefer to run my REIT exposure through tax advantaged accounts. This is a challenge for any ETF that wants the diversification benefits of incorporating REITs. There isn’t much an ETF can do to get around this other than simply not holding REITs. Holdings Since I’m primarily a REIT analyst, the REIT exposure is the first part of the portfolio that my eyes are drawn to. The heaviest REIT allocation here is Simon Property Group (NYSE: SPG ) which I find a little disappointing. I find the REIT sector attractive for investing, but REITs should be divided between types the same way that banks and insurance companies were split up into different sectors. SPG is an absolutely enormous REIT, but I’d rather see exposure to Realty Income Corporation (NYSE: O ) or the fairly new STORE Capital (NYSE: STOR ). I simply prefer triple net lease REITs like O and STOR to most other types of REITs. Realty Income Corporation is included in the portfolio, but it is only .43% of the total portfolio. Since I prefer keeping REIT exposure inside tax advantaged accounts, there was already one challenge with the REIT allocation. I’m not thrilled with the allocation strategy for choosing REITs, which creates another challenge. Return History Historical returns shouldn’t be used to predict future returns, however the historical values for factors like correlation and volatility over a long time period can provide investors with a base line for setting expectations on whether the asset would fit in their portfolio. I ran the returns since January of 2000 through Investspy.com and came up with the following charts: (click to enlarge) Since 2000 the ETF has a total return of about 45% compared to the S&P 500, represented by SPY , having a return of 90.3%. The underperformance isn’t so much of an issue as the risk level. The fund had an annualized volatility of 33% compared to 20% for SPY. There were two market crashes during that period which leads to much higher volatility numbers, but the general premise remains. The fund is substantially more volatile. Since the holdings are also more concentrated, that makes sense. Unfortunately, when we switch to using beta as our measurement of risk the problem remains. The sector allocation simply lends itself to too much volatility for my portfolio. Conclusion XLF is a huge ETF for exposure to the financial sector. There are some bright spots for the fund, but the overall product is a little lacking for my tastes. The combination of other financial sectors with REITs may be acceptable for investors that have plenty of room in their tax advantaged accounts or investors that aren’t concerned with tax planning. Even moving past that, I’m not thrilled with the methodology for selecting REITs as it results in prioritizing enormous REITs. That is an area where I’d rather be adding individual stocks or using REIT specific ETFs with lower expense ratios. Seeing the enormous volatility reinforces my concerns about overweighting this particular sector. The fund may do very well in a continued bull market, but I’d rather keep a more defensive allocation. I just don’t like the risk of facing a third correction before the decade is over. I’ll keep most of my portfolio in equity, but I’ll stick to the more defensive companies and sectors.

Should You Stick With Duke Energy After A Rough Year?

Duke Energy has received the first two regulatory approvals to proceed with its acquisition of Piedmont. The annual average residential electricity sales will drop 0.5% in 2016, but the prices increase will offset the impact of unfavorable weather conditions. Duke Energy is trading at very reasonable valuation and offers a very attractive dividend yield of 4.58% at current levels. Duke Energy (NYSE: DUK ) has received the first two regulatory approvals to proceed with its acquisition of Piedmont Natural Gas (NYSE: PNY ). Now the approval of Piedmont’s shareholders and permission from the N.C. Utilities Commission is required to complete the transaction. So far the process has progressed smoothly, and Piedmont’s shareholders will meet on January 22, for that purpose. Duke Energy will become the largest gas utility in the state and N.C. Utilities Commission could raise concern over the dominance position, but the management expects to complete the transaction on time. Duke Energy, like most of the other utility stocks, underperformed during 2015 primarily due to uncertainty over interest rate hike. Now finally, Fed has raised the rate and would continue to hike steadily during 2016. The only downside of interest rate increase for Duke Energy is that incremental financial burden could restrict the earnings growth. In this scenario, the investor might be concern over the sustainability of future dividend payments. However, consistently growing regulated electric & gas operations and stout cash flow position will enable Duke Energy to bear the shock and continue to return cash to shareholders. So far this year, Duke Energy has delivered satisfactory performance despite very rough weather conditions. In the coming quarters, the outlook of unregulated utilities is likely to remain challenging primarily due to declining power and natural gas prices and soft electricity demand. On the contrary, regulated utilities will benefit from the supportive regulatory environment, resulting in steady operating earnings growth in 2016. While overall sector earnings are likely to grow 3.7% during, Moody’s (NYSE: MCO ) expects that regulated utilities will witness better operating earnings growth. Source: Factset Duke Energy’s regulated utilities segment recorded operating revenue of $17.09 billion, an increase of only $16 million year-over-year. The flat top-line was due to unfavorable weather during the first half of 2015, but the segment revenue increased 2.7% during the third quarter on the back of mid-single digit increase in electricity demand. Currently, the regulated electricity business is 91.3% of total revenue flowed by 6.4% nonregulated and 2.3% regulated natural gas. Going forward, the addition of approximately $1.4 billion annual sales from Piedmont will significantly increase the revenue contribution of Duke Energy’s existing regulate natural gas business. In the advantageous scenario, the aggressive acquisition of regulated assets will fuel the company’s earnings. (click to enlarge) Source: Company Presentation The commercial and industrial demand is steadily rising, but the mild weather is negatively impacting the demand for residential electricity. The Energy Information Administration (EIA) estimates that annual average retail residential sales will drop 0.5% in 2016, but electricity sales to the commercial and industrial sector will increase by 0.7% and 1.4%, respectively. Source: EIA Duke Energy may continue to witness flat residential usage per customers owing to stable demand and improving efficiency level, but an increase of 0.7% in residential electricity prices will support the growth during 2016. Moreover, the diversified customer base and the addition of new residential customer at a low single-digit, the company added 1.3% new customer over the past twelve months, will boost the top-line at a steady pace. On the other hand, the potential ease in currency headwind and divestiture of poor performing assets could also improve the revenue from international operations. Thus, the trickling down of revenue growth, solid gross margins, and a massive $10 billion investment in gas & electric infrastructure will enable Duke Energy to accelerate an average long-term earnings growth of 4% – 6%. Duke Energy pland to invest approximately $20 billion in new generations and infrastructure development between 2015 and 2019. So far, the company has spent $4.64 billion in CAPEX during 2015, while it generated $5.4 billion in operating cash flow with cash & cash equivalent of $1.37 billion cash. The cash flow position looks pretty healthy, which depict that the company would be able to manage CAPEX and dividend payments without any cut if the interest rate increases further. Duke Energy increases dividends each year, and it has paid the quarterly dividend for 89 consecutive years. Duke Energy is one of the high yield utility stocks and currently, it offers a yield of 4.58%, significantly higher than the average 3.90% yield of large-cap electric utilities in the U.S. Duke Energy has increased the dividend at a CAGR of approximately 2% between 2009 and 2014. Now, the company has recently boosted the increase rate to 4%. The management expressed the intention to increase the future dividend more in line with the long-run earnings growth, which is 4% – 6%. Though interest rate is a threat, the healthy balance sheet will enable the company to maintain the dividend growth. Source: Finviz The balance sheet of the company is very sound with total assets of $121 billion. In contrast, the company has a total debt of $40.2 billion. The debt would increase in 2016 owing to partial debt financing to complete the acquisition and additional debt from Piedmont. Despite the substantial debt, the company’s financial health is likely to remain rigorous as it invests in quality assets to generate growing cash flows, and its total debt to asset ratio, excluding goodwill, is only 0.38 times. Currently, the total debt to equity ratio of Duke Energy is 1.07 times, which seems quite high but is significantly lower than the large-cap electric utilities average and median of 1.38 times and 1.21 times, respectively. Moreover, the interest coverage ratio of 3.85 times depicts that Duke Energy is in a very comfortable position to cover the future interest expense while raising the dividend in line with the earnings growth. Duke Energy delights the investors by raising dividends, which are backed by consistently growing earnings. Unfortunately, Duke Energy is one of the stocks to lose double-digit value during 2015 primarily due to interest rate turmoil throughout the year. On the flip side, Duke Energy is now trading at very reasonable valuation, and its yield has increased due to a steep decline in share price. Duke Energy is currently trading at forward PE of 15.31x, which is slightly less than the utility sector forward PE of 15.5x. That said, Duke Energy is a very decent utility stock to hold for growing dividends and investors should not worry about the interest rate as it is already priced-in.