Tag Archives: investing

A Market Neutral Strategy To Profit From High Yield Bonds

Summary KKR Income Opportunities is a closed end fund that invests in high yield bonds and senior loans. While the 10.6% yield and the 14% discount to NAV may look tempting, some investors are worried about a continuation of the weak trend in this space. In this article I will present a market neutral strategy that can benefit from a compression in NAV discount while hedging a significant portion of the market risk. In a recent post I talked about the KKR Income Opportunities Fund (NYSE: KIO ) and how I found it attractive for income seeking investors. The biggest concern I have on that fund is the risk that weakness in high yield and leveraged loans may persist in 2016. In that case the 10% yield may be partially eroded by a declining NAV or a widening of the discount to NAV. For this reason I decided to dig further into this space and tried to devise a strategy that reduces the market risk while allowing investors to benefit from a reduction in the NAV discount. This strategy may be interesting for sophisticated investors that have access to and are familiar with the pros and cons of shorting. The strategy The strategy I have in mind involves going long KIO and at the same time hedging the position by shorting a combination of two related ETFs: the iShares iBoxx High Yield Corporate Bond ETF (NYSEARCA: HYG ) and the SPDR Blackstone/GSO Senior Loan ETF (NYSEARCA: SRLN ). For more details on KIO I encourage you to read my previous post . Here I am going to give you a quick snapshot on HYG and SRLN before detailing the reason why I believe this strategy could deliver superior risk adjusted returns. HYG is an ETF that gives you exposure to US high yield bonds. It is very well diversified, with more than a thousand securities in the portfolio and a concentration of 4.7% of NAV in the top 10 names. The effective duration of the fund is 4.3 years while the total expense ratio is 0.5%. According to the latest fact sheet the credit rating breakdown is the following: SRLN is an ETF that gives you exposure to leveraged loans. It is less diversified than HYG with a total of 192 securities and has a concentration of 15% of NAV in the top 10 names. The average maturity is a bit less than 5 years but interest rate risk is minimal as loans are generally indexed to Libor. The total expense ratio is 0.7% and the most recent credit breakdown is the following: Analysis of the trade Considering that KIO is a fund that invests in high yield bonds and loans and is trading at approximately 15% discount to NAV I believe one could effectively short a combination of HYG and SRLN at prices close to NAV and go long KIO to take advantage of the mispricing. I would go short $1,500 of HYG + SRLN for each $1,000 in KIO to take into consideration the level of leverage in the KKR fund (a third of the assets are financed through a credit facility). The following analysis shows the NAV performance of $1,000 invested in KIO since the beginning of the year and compares it with the NAV performance of $1,500 invested in HYG +SRLN. The analysis includes the dividends distributed by all the funds. What you can see from the analysis above is that KIO outperformed both HYG and SRLN on a distribution adjusted basis in terms of NAV. I attribute a good part of that outperformance to the significant underweight in the energy sector of the KIO fund. Despite that, the stock performed poorly, down 12% for the year due to an increase in the NAV discount or down 4% after taking into consideration the distributions received. What to expect from the trade As you are short $1.5 for each $1 invested in KIO you are expected to “pay” a dividend cost of approximately 7.5% for your short: 5% is the average yield on HYG and SRLN and that needs to be multiplied by 1.5. This outflow will be more than compensated by a 10.6% dividend in KIO. All things staying the same and excluding tax considerations you net 3% and you are likely left with some spare cash given that you are shorting more than your long investment. In a positive scenario you can expect the NAV discount to reduce over time providing an additional source of profits. In terms of NAV performance you can expect a very similar development for your long and your short: KIO is a bit weaker in terms of average rating but has a lower exposure to the tricky energy sector. Some of you may ask a question: is this a pure arbitrage trade? I want to stress that this is not an arbitrage trade. Underlying securities in the two portfolios are different, sector weightings are different and portfolio concentration is different. However overall performance of the different assets should show a very strong correlation, with the main difference being that you buy a portfolio at a 15% discount and you sell a similar (but not identical) portfolio at par. Your biggest risk exposure lies in the possibility that the discount to NAV widens further in KIO. That should happen only in case of a new sharp drop in the value of the assets. I believe that would represent a great opportunity to cover my short at a profit and double down on KIO at an even cheaper valuation relative to the market value of its underlying assets and I would be more than willing to take that risk.

5 China ETFs Up At Least 20% In Q4

Though the Chinese economy and securities have seen the height of volatility so far this year, the final quarter of 2015 seems quite steady, rather upbeat. This is quite a different picture from Q3 backed by compelling valuation after a bloodbath in August following currency devaluation and several cool economic data. China started to recoup losses from October with its A-Shares ETFs once again seeing runaway success in November. Apart from cheaper valuation, plenty of policy easing to jumpstart its ailing economy and hopes for further easing (as the economy is still reeling under pressure) helped Chinese equities ETFs to rule the top-performers’ list in the quarter-to-date frame (as of December 3, 2015). In October, China reduced the key interest rates by 25 bps, which marked the sixth slash since last November. Not only monetary policy easing, Beijing went on to enact a demographic reform and put an end to the country’s decades-long infamous one-child policy. Investors should note that China has long been working on stepping up domestic consumption, shedding focus on exports and intending to move to a ‘slower and more balanced growth’ economy. If this was not enough, the Chinese currency, the yuan, received a privileged reserve currency status from the IMF recently and joined the league of the major currencies, namely U.S. dollar, pound, euro and yen. China’s currency will have a weight of 10.92%, higher than the yen (8.33%) and the pound (8.09%), in IMF’s reserve currency basket from October 2016. As per the IMF, the step was the outcome of reformative measures presently being undertaken in China, which gives the “freely usable” tag to the yuan. It’s not that China investing is devoid of glitches. In fact, news about the Chinese securities regulators being stricter in their investigation into brokerages led the country’s stocks to suffer the deepest plunge on November 27 since the August uproar. Still, relentless constructive measures by regulators have saved China equities every time. One of China’s latest measures to calm the jittery market will be to launch a “circuit breaker ” on a benchmark stock index of the country next year. Per the new norm, a 5% one-day gain or loss in the CSI300 index (before 2:30 p.m.) would close trading in the country’s all equity indices for 30 minutes. Shifts of over 7% would result in closed trade for the rest of the day. In such a backdrop, investors might want to know about the top-performing China ETFs so far in Q4. For them, we highlight five Chinese equities ETFs that are still up at least 20%. KraneShares CSI China Internet ETF (NASDAQ: KWEB ) – Up 30.2% This product provides concentrated exposure to the Chinese Internet market by tracking the CSI China Overseas Internet Index. In total, the fund holds about 60 securities in its basket. The ETF has amassed $154.4 million in AUM and charges 71 bps in annual fees from investors. P owerShares Golden Dragon China Portfolio ETF (NYSEARCA: PGJ ) – Up 27.7% The $185 million ETF holds about 77 securities. The expense ratio of the fund is 0.70%. The fund is heavy on IT (46.4%) and Consumer Discretionary (38.2%). As far as individual holdings are concerned, Ctrip.com (NASDAQ: CTRP ) takes the top position with a 10.27% weight followed by NetEase (NASDAQ: NTES ) (9.8%) and Baidu (NASDAQ: BIDU ) (9.0%). Guggenheim China Technology ETF (NYSEARCA: CQQQ ) – Up 27.3% This fund targets the overall technology sector in China and follows the AlphaShares China Technology Index, holding 76 stocks in its basket. Alibaba dominates the fund’s return with a 21.5% share while other firms hold no more than 9.4% of assets. In terms of industrial exposure, about 65% of the portfolio is allotted to Internet mobile applications while electronic components and semiconductors round off to the next two spots. The product manages an asset base of $58.4 million. The expense ratio comes in at 0.71%. KraneShares CSI New China ETF (NYSEARCA: KFYP ) – Up 24.1% This fund tracks the CSI China Overseas Five-Year Plan Index, holding about 140 securities in its basket. About one-third of the portfolio is skewed towards Consumer Discretionary, closely followed by Information Technology. The fund is unpopular as depicted by its AUM of $3.2 million. The expense ratio comes in at 0.71%. Deutsche X-trackers Harvest CSI 500 China A-Shares Small Cap ETF (NYSEARCA: ASHS ) – Up 22.4% This product is a combination of China A-shares and smaller capitalization. This ETF attempts to replicate the performance of the CSI 500 index, which tracks 500 small cap companies on the Shanghai and Shenzhen stock exchanges. This $35.8 million fund charges 80bps in fees. Industrials (24.3%) and Consumer Discretionary (15.9%) are the top two sectors. Link to the original post on Zacks.com