Tag Archives: investment

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 .

3 Mutual Funds To Buy If Fed Opts For Rate Hike

In our Mutual Fund Commentary yesterday we spoke about funds in focus if the U.S. Fed decided against a rate hike as soon as September. Utilities funds demand attention then as low interest rate environment, which has for sometime been near a zero level, has been extremely conducive for its growth. The capital intensive utilities industry needs to access external sources of funds to expand its operations. While it remains too close to call, today let’s look at funds that investors may immediately add to their portfolios if the Fed announces rate hike. Amid the market volatility, the Fed seems to be stuck between global central banks’ easing measures, dollar strengthening, deflationary pressures arising from the energy sector and troubles in the global economy. While most polls recently turned against a September rate hike, a recent CNBC survey shows that 49% predict a rate hike now. We do not rule away the chances of a rate hike completely, may be by 0.25%, but uncertainty is what is ruling the roost. Whether lifting the monetary policy stimulus would be a prudent move is the question that the Fed needs to answer. The two-day Federal Open Market Committee’s policy meeting ends today. The finance sector, in this regard, seems to be a good bet, as several industries including insurance, banking, brokerage and asset managers tend to benefit from the rising rates. Before we pick the funds, let’s look at some other details. CNBC Survey Goes Against Other Polls According to a CNBC survey, 49% of respondents out of 51 economists are projecting a rate rise now. This data as of Sep 16 is in line with predictions on Aug 25. On the other hand, those believing in a delayed rate hike dropped to 43% from 47% on Aug 25. The rate has increased for those who are unsure, as the percentage is at 8% as of Sep 16 compared with 5% on Aug 25. They predict that the Fed will finish hiking rate in this cycle, or take it to “terminal rate” in the first quarter 2018. This brings the prediction forward by six months. Separately, most are of the view that markets have priced in the hike. While 56% believed its priced into stocks, 60% said its priced into bonds. However, the Standard & Poor’s 500 is estimated to finish 2015 at 2,032, lower that prior projection of 2,135. Meanwhile, a Reuters poll shows that 45 respondents out of 80 economists believe that the Fed will leave its benchmark interest rate between zero and 0.25%. Only 35 respondents expected a rate rise. Looking at the primary dealers or economists from banks dealing directly with the Fed, 12 banks see no rate hike now as against 10 expecting a rate hike. Financials to Gain While Deutsche Bank believes they expect a “hawkish hold,” stance, UBS chairman Axel Weber is expecting a rate hike. He said: “The underlying economic data in the U.S. warrants a rate hike. The U.S economy can stand it. The U.S. economy in my view actually needs it medium- to long-term and I’m pretty convinced that the U.S. will see a rate hike, most likely in September.” The financial sector will be among those which will gain if a rate hike occurs. One particular beneficiary of higher rates is the insurance industry. This is because they take in premiums from customers, invest them — usually in fixed income securities — and then pay out claims in the future. Also, brokerages earn interest income on un-invested cash in customer accounts. So when rates rise, they can invest this cash at higher rates. Banks may benefit from rising interest rates, as long as long-term rates move up more than short-term rates. Banks derive benefits from a steep yield curve, i.e. when the spread between long-term and short-term rates is wide. The interest rates on deposits are usually tied to short-term rates while loans are often tied to long-term rates. This means that the potential rise in rates will enable the banks to charge more for loans, leading to an increase in the spread between lending rates and the rates paid on deposits. Moreover, an improving economy means that credit quality will likely improve, which will also aid banks’ profitability. Insurance companies invest majority of the premium income received from policyholders in government and corporate bonds to earn investment income. They utilize this investment income in meeting their future commitments to policy holders. The potential rise in rates will allow the insurance firms to invest their new premium income in higher yielding securities, thereby leading to higher future returns. With a rise in rates, brokerage firms are likely to engage in more investment activity. Brokerage firms earn interest income on un-invested cash in customer accounts. The rise in rates will allow the brokerage firms to invest at higher rates. Further, asset managers can position themselves favorably with the rise in rates. In the fixed income sector, default rates are likely to decline and higher interest rates will enable reinvestment at higher yields, which ultimately will boost portfolio returns. The benefit can be achieved by positioning fixed income portfolios strategically through proper management of duration, diversification of sources of yield and maximize the reinvestment of income. 3 Financial Mutual Funds to Buy Below we present 3 Financial mutual funds that carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy). We expect the funds to outperform its peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund. The funds have encouraging year-to-date, 1-year and 3 and 5-year annualized returns. The minimum initial investment is within $5000. These funds also have low expense ratio and carry no sales load. Emerald Banking and Finance Fund A (MUTF: HSSAX ) seeks long-term growth through capital appreciation. Income is a secondary objective. HSSAX generally invests at least 80% of its net assets in common stocks. Emerald Banking and Finance’s managers limit the fund investment to 50 companies and the fund invests primarily in U.S. based companies. HSSAX currently carries a Zacks Mutual Fund Rank #2. It boasts year-to-date and 1-year returns of 11.9% and 18.3%. The 3 and 5 year annualized returns are 20.1% and 18%. Annual expense ratio of 1.60% is however higher than the category average of 1.52%. Moreover, HSSAX also has low beta score. The 1, 3 and 5 year beta scores are 0.58, 0.63 and 0.75. Franklin Mutual Financial Services Fund A (MUTF: TFSIX ) seeks capital growth. TFSIX invests a lion’s share of its assets in undervalued companies that are involved in the financial services domain. TFSIX may also invest in merger arbitrage securities and securities of distressed companies. TFSIX currently carries a Zacks Mutual Fund Rank #2. It boasts year-to-date and 1-year returns of 4% and 7.3%. The 3 and 5 year annualized returns are 13.9% and 11.2%. Annual expense ratio of 1.44% is lower than the category average of 1.52%. Moreover, TFSIX has 1, 3 and 5 year beta scores of 0.81, 0.83 and 0.70. John Hancock Regional Bank Fund B (MUTF: FRBFX ) invests most of its assets in equities of regional banks and lending companies. These may include commercial banks, industrial banks, savings and loan associations, financial holding companies, and bank holding companies. FRBFX may also invest in other U.S. and foreign financial services companies. A maximum of 5% may be invested in stocks outside the financial services domain. FRBFX currently carries a Zacks Mutual Fund Rank #2. It has year-to-date and 1-year returns of 2.2% and 8%. The 3 and 5 year annualized returns are 14.3% and 13.2%. Annual expense ratio of 1.98% is however higher than the category average of 1.52%. Moreover, FRBFX has 1, 3 and 5 year beta scores of 0.62, 0.65 and 0.88. Link to the original article on Zacks.com

Are There Any ‘Safe’ CEF Bond Funds?

Investors looking for yield in the CEF bond space are often attracted to high-yield funds. But those aren’t the only options available. Here’s a trio of bond CEFs that don’t play the high-yield game—so much, anyway. The one thing that closed-end funds, or CEFs, do really well that open-end mutual funds don’t do so well is income. That’s true across multiple investment approaches, but particularly in the stock space, where high-yielding CEFs are very common. However, bond CEFs often have very high yields, too. In recent years the search for high-yields has drawn investors to the junk bond arena, an area that hasn’t fared so well lately. And, thus, the question I recently got from a reader: “Are there any high-quality bond CEFs around?” Treasuries The answer to that question is yes, there are. However, you’ll need to know what you are buying. For example, the Federated Enhanced Treasury Income Fund (NYSE: FTT ) invests essentially all of its assets in U.S. treasures. Those are ultra safe investments, giving it an average credit quality of AAA. Now that said, FTT’s yield is a less than inspiring 2.5% or so. But, with so much money in super-safe bonds, what would you expect? The only thing to keep in mind here is the word “enhanced” that sits in front of “treasury” in the fund’s name. This isn’t just a treasury fund, it’s a little bit more. Closed-end funds often make use of tactics that open-end funds don’t. FTT does three things . First, it owns treasury securities. Second, it tries to adjust its duration to take advantage of interest rate shifts. Third, it writes options to enhance income. None of these things is particularly odd or frightening, but they are notable because they can change the dynamics of the investment. For example, if the fund makes a bad call on interest rate movements performance would suffer. But a lot of funds do this very same thing. And options can limit upside potential, though I wouldn’t expect a treasury fund to rocket higher over a short period of time. So this is something to note, but I wouldn’t lose too much sleep over it. However, from a bigger picture, if you are looking at a CEF, you’ll want to know if they do things that similar open-end funds aren’t. Is now the time to look at FTT? Well… If you are concerned about high-risk investments, you might want to consider FTT. But you’d clearly be in good company, since the fund’s average discount has narrowed pretty steadily since last year. It’s currently trading at an around 3% discount versus its three year average of 9% or so. And it’s annualized net asset value, or NAV, performance over the past five years through August is a loss of around 1% a year. That’s not exactly inspiring. So, if you do look at FTT it’s more about a flight to safety than anything else. Investment grade bonds If you are looking for a bond CEF beyond high yield and want a little more than what FTT has to offer, the Invesco Bond Fund (NYSE: VBF ) is another high-quality bond fund that you might want to look at. Around 85% of the fund’s assets are invested in bonds rated BBB or better. Another 10% or so is in BB bonds, the highest quality of the high-yield debt spectrum. So is it a pure investment grade bond fund? No. But it’s a far cry from a junk bond fund. The fund can invest up to around 20% of assets in lower grade debt, if it wants to. But, in general, if you are looking to minimize your exposure to junk bonds, this fund will accomplish that. Like FTT, though, don’t expect a lot of distribution. VBF’s distribution yield is around 4.8% or so. That’s a lot better than the 2.5% offered by FTT, but a far cry from the 10%+ yields you can find in junk bond CEFs. Interestingly, VBF’s discount is currently nearing 9%. That’s slightly wider than its three-year average discount of just under 8%. So investors haven’t been showing this CEF much love of late. The fund actually has a lot more going for it on the performance side of things than FTT, too. For example, over the trailing five years through August the fund’s annualized NAV return was about 5.25%. It’s an older fund than FTT, so it also has a trailing annualized 10-year return of around 5.75% and a trailing 15-year return of 6.25%. All numbers assume reinvested distributions. The fund, for the most part, is pretty boring. It owns bonds. The management team mixes a top-down approach to the bond market with a bottom-up approach to individual bond selection. That’s pretty common stuff in the bond world. So, if you are looking for a long-term bond holding that isn’t junk and isn’t just a flight to safety play, VBF is worth a closer look. Just to prove the case Just to prove there’s more than one option in the investment grade CEF space, here’s another: the Morgan Stanley Income Securities Inc. (NYSE: ICB ). Like VBF it can invest in high yield, but generally doesn’t do so to a material degree. As of March, around 12% of the portfolio was in bonds rated BB or below, a weighting management described as opportunistic. ICB’s distribution yield was recently in the 3% range. It’s discount was about 10%, in-line with its trailing three-year average. Trailing NAV performance, meanwhile, was fairly close to that of VBF, with an annualized return of 5.1% over the trailing five years, 5.7% over the trailing 10 years, and 6.3% over the trailing 15-year period through August. The two funds have fairly similar risk profiles, as well. Yes, there are options… All in, I’d give the edge to Invesco Bond Fund here, but that doesn’t mean you shouldn’t take the time to compare all three funds I’ve noted. And, frankly, there are other CEFs that invest in investment grade debt, too, so I wouldn’t stop my search with this trio. The idea here was to whet your appetite, not sate it. But FTT, VBF, and ICB are all solid, come from well-known families, and would suit the needs of an investor looking for an alternative to a high-yield CEF. 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.