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A Conservative Way To Invest In An Energy Rebound

Summary BCX shares have been depressed after a recent closed-end fund merger because of selling by previous shareholders of BQR. BCX is trading at a 15% discount to NAV. BCX owns stocks with strong balance sheets which will be survivors if the energy bust continues. BCX uses an option writing strategy to reduce risk. Recent increase in VIX means higher options premiums and potential increases in the distribution rate. Many investors have been looking for a good way to benefit from a “bounce” in the energy sector. There are certainly big gains in store if you buy highly leveraged small cap energy stocks and if oil and gas prices quickly recover their losses. But there is also a risk that oil prices will stagnate for quite some time which would lead to many bankruptcies or restructurings in the energy sector. A safer way to invest in an energy rebound is to buy a diversified fund that mainly holds strongly capitalized large cap energy stocks that also hedge using an option over-writing strategy. There is one closed-end fund that currently trades at a 15% discount that fits into this category. The BlackRock Resources & Commodities Strategy Trust (NYSE: BCX ) seeks high current income and current gains, with a secondary objective of capital appreciation. The fund normally invests at least 80% of its total assets in equity securities issued by commodity or natural resources companies, or derivatives linked to commodity/natural resource companies. The fund generally invests in a portfolio of equity securities and utilizes an option over-writing strategy in an effort to seek total return performance and enhance distributions. On December 8, 2014, a three way fund merger was completed where BCF and BQR were merged into BCX. I believe that one cause for the currently wide discount to NAV is that some of the old shareholders of BQR are unhappy with the merger and have been selling their shares of BCX acquired via the merger. I wrote an article on BQR (Blackrock EcoSolutions) about a year ago. The fund was marketed as investing in companies that are “environmentally friendly”. A few weeks ago, I received a message from one of my Seeking Alpha readers who said he bought BQR as a long term investment because he liked their socially conscious investments and good dividend. Shortly after the merger was completed, he looked at his brokerage account and could no longer find BQR. After some digging, he realized it was replaced by BCX. In his words- “If it wasn’t so real I would think this is a cruel joke. Eco Solutions was replaced by Big Oil”. Distributions for BCX vary over time and were reduced late last year because of drops in the underlying portfolio value. The fund currently pays a monthly distribution of $0.0771. Because of weakness in the energy sector, tax loss selling and other selling by prior BQR/BCF shareholders, this may be a good time to buy BCX for bottom fishers or contrarian investors. The discount to NAV is -15.32% which is well above the six month average discount of -13.87%. The 6 month discount Z-score is -1.47, which means that the discount to NAV is about 1.5 standard deviations below the average discount over the last six months. The one year discount Z-score is also attractive at -1.46. Because of the relatively high distribution rate of 9.72% and high discount to NAV, you get to recapture a decent amount of the discount every year. Buying BCX at the market price and receiving NAV from a distribution is equivalent to a gain of 18% on those shares. Multiply this by the distribution rate and you get a discount capture “alpha” of about 1.75% per year. This is more than the annual expense ratio of 1.25%, so adjusted for discount capture, BCX has a negative expense ratio and the fund pays you to own it. Distributions for BCX vary over time and were reduced late last year because of drops in the underlying portfolio value. The fund currently pays a monthly distribution of $0.0771. But if there is a recovery in the energy sector, we could easily see distributions increase dramatically. The recent increase in options volatility, with the VIX above 20, should also benefit funds like BCX that use an options overlay strategy and could lead to a higher distribution rate as they capture the higher option premiums. BCX is more liquid than most other closed-end funds. It trades about $4.5 million a day and usually has a bid-asked spread of only a penny. In summary, BCX is currently a good holding for a patient investor who wants to participate in the energy sector, but wants to get paid a generous distribution while waiting for a rebound. There is good chance of a rebound in the NAV along with a narrowing of the discount within the next year. Top Industry Sector Holdings (12/31/2014) Energy 33.4% Agriculture 31.2% Mining 22.8% Other 10.5% Cash + Derivatives 2.0% Top 10 Holdings (12/31/2014) Exxon Mobil (NYSE: XOM ) 5.92% Chevron (NYSE: CVX ) 5.69% Monsanto (NYSE: MON ) 4.32% Conoco Phillips (NYSE: COP ) 3.89% Royal Dutch Shell (NYSE: RDS.A ) (NYSE: RDS.B ) 3.72% Rio Tinto (NYSE: RIO ) 3.40% Weyerhauser (NYSE: WY ) 2.56% Potash Corp. of Sask. (NYSE: POT ) 2.49% CF Industries (NYSE: CF ) 2.44% Syngenta (NYSE: SYT ) 2.41% Market Cap Breakdown (12/31/2014) Large Cap (> 10 bill) 79.2% Mid Cap (2-10 bill) 13.2% Small Cap ( < 2 bill) 5.5% Cash + Derivatives 2.0% Geographic Breakdown (as of 12/31/2014) United States 67.0% Canada 10.1% United Kingdom 9.2% Switzerland 2.5% Hong Kong 2.3% Cash + Derivatives 2.0% Norway 1.7% France 1.0% Japan 0.9% Australia 0.8% Ticker: BCX BlackRock Resources & Commodities Trust Pays monthly distributions Total Net Assets= $1,112 million Total Common assets= $1,112 million Monthly Distribution: $0.0771 ($0.9252 annual) Annual Distribution (Market) Rate= 9.72% Fund Baseline Expense ratio= 1.25% Discount to NAV= -15.23% Portfolio Turnover rate= 62% Effective Leverage: None Average Daily Volume: 469,000 shares Average $ Volume: $4,500,000 % Overwritten by Options= 23.82% Type of Options= Single Stock

Adams Express: A Good Fund, But Recent Changes Are A Risk

ADX has a storied history unique in the CEF space. That said, ADX recently went though a management change resulting in a new investment approach. Although history suggests ADX is a solid CEF offering, the new manager has yet to be tested by a notable downturn. Adams Express (NYSE: ADX ) traces its history back to 1929 . It’s paid a dividend consistently since 1935. Unlike most closed-end funds, or CEFs, it is its own company with no sponsor to appease. The longevity, a mandate to distribute at least 6% of assets annually, and low expenses are all good reasons to own Adams. However, you’ll need to take a step back and consider the new guy at the top before you pull the trigger. I did it my way Adams Express really is an odd duck for a CEF. While most CEFs are sponsored by major financial companies, which get paid to manage the funds, Adams is a company unto itself. In fact, the CEO heads up the investment process. I highly doubt the CEO of Eaton Vance Corp (NYSE: EV ) has anything to do with the closed-end funds his company sponsors. And Adams Express has an impressive history of paying dividends. For example, between 2007 and 2014 the CEF paid out $18 a share in distributions. It started that period out with a market price of around $13 a share. It’s recently been trading hands at around $13.50 a share. If you lived off of those dividends you can’t exactly brag about capital appreciation, but you certainly can’t complain that your capital has been slowly returned to you, bleeding the fund’s assets in the process. And the CEF has an extremely low expense ratio at around 0.6%, according to the Closed-End Fund Association . It isn’t unusual to see closed-end funds with expense ratios two to three times greater than that. Low costs are a true benefit to shareholders over the long term. But what about management? All of the above points are solid reasons to consider Adams Express as a long-term holding for your portfolio. That said, there are some reasons to avoid it, too. For starters, the 6% dividend policy ensures that distributions will fluctuate from year to year. And, generally, the CEF pays three small distributions and then one large one at the end of the year. If you are looking for regular income, this isn’t the best option. But the bigger issue is actually management. In 2013 , Mark Stoeckle replaced long-time CEO Douglas Ober. Stoeckle has over 30 years of experience in the finance industry, spending time at BNP Paribas, Liberty Financial, and Bear Stearns. At BNP he was the Chief Investment Officer for U.S. Equities and Global Sector Funds. That’s not a bad pedigree. That said, as you might expect, he came in, took a look at the portfolio, and made some changes. That’s what all new managers usually do. But, more important, it meant a 55% turnover for the fund in 2013. In the four prior years, the highest turnover was roughly half that at 27%. Turnover through the first nine months of 2014 was around 30% on an annualized basis. So he’s clearly gotten the portfolio pretty close to the way he’d like it. However, his approach at Adams Express hasn’t been tested by a major market downturn. That fact alone is enough reason to take a wait and see attitude, or to at least start slowly and build a position over time. Still, it’s worth delving into what Stoeckle does. For starters, he, wants to, “…invest in good businesses. These types of companies typically have a visible growth path and a defendable market position that they can use to their advantage.” He’s also fond of business operating in an, “…improving competitive environment…” That’s step one. He also wants to see a management team that has demonstrated its ability by, “…generating cash flow and using that cash to prudently grow the business and fortify its market position and balance sheet…” And before pulling the trigger he also wants to make sure he’s getting a good deal, making valuation a chief concern. After a stock is in the portfolio, meanwhile, Stoeckle and his team set milestones against which to grade each company’s performance. This all sounds great. But it’s roughly similar to things I’ve heard and read from hundreds, if not thousands, of pooled investment vehicles (mostly open-end mutual funds in my former life as a mutual fund analyst for a financial publishing company). Having a good story doesn’t mean you’ll have good performance. That’s not to say that posting a one-year gain of about 13% in 2014, roughly in-line with the broader market according to Morningstar, was a bad showing. Quite the contrary; job well done. But remember, 2014 wasn’t 2007 or 2008, when the broader market was, well, a little less hospitable. So, a new manager who’s only recently gotten Adams Express into fighting shape is a good reason to pause before you pull the trigger. And while the fund is trading at an around 14% discount to net asset value, that’s actually in line with the fund’s average over the last five and 10 years. So it’s probably fairly priced right now, but certainly not cheap. Not ready to pull the trigger I like Adams Express based on its long-term history and unique profile. But I’d wait until the market shakes things up a little before buying. I just want to see how the new CEO handles a bad market.

NOBL Looks Solid Despite A Weaker Dividend Yield Than I Would Have Expected

Summary I’m taking a look at NOBL as a candidate for inclusion in my ETF portfolio. For having “Dividend” in the name, the yield isn’t as strong as I expected. The portfolio has been fairly steady, lower deviation of returns than SPY. The expense ratio is my only real concern here, because the gross and net are not the same. I’m hoping the net stays put. I’m not assessing any tax impacts. Investors should check their own situation for tax exposure. How to read this article : If you’re new to my ETF articles, just keep reading. If you have read this intro to my ETF articles before, skip down to the line of asterisks. This section introduces my methodology. By describing my method initially, investors can rapidly process each ETF analysis to gather the most relevant information in a matter of minutes. My goal is to provide investors with immediate access to the data that I feel is most useful in making an investment decision. Some of the information I provide is readily available elsewhere, and some requires running significant analysis that, to my knowledge, is not available for free anywhere else on the internet. My conclusions are also not available anywhere else. What I believe investors should know My analysis relies heavily on Modern Portfolio Theory. Therefore, I will be focused on the statistical implications of including a fund in a portfolio. Since the potential combinations within a portfolio are practically infinite, I begin by eliminating ETFs that appear to be weak relative to the other options. It would be ideal to be able to run simulations across literally billions of combinations, but it is completely impractical. To find ETFs that are worth further consideration I start with statistical analysis. Rather than put readers to sleep, I’ll present the data in charts that only take seconds to process. I include an ANOVA table for readers that want the deeper statistical analysis, but readers that are not able to read the ANOVA table will still be able to understand my entire analysis. I believe there are two methods for investing. Either you should know more than the other people performing analysis so you can make better decisions, or use extensive diversification and math to outperform most investors. Under CAPM (Capital Asset Pricing Model), it is assumed every investor would hold the same optimal portfolio and combine it with the risk free asset to reach their preferred spot on the risk and return curve. Do you know anyone that is holding the exact same portfolio you are? I don’t know of anyone else with exactly my exposure, though I do believe there are some investors that are holding nothing but SPY. In general, I believe most investors hold a portfolio that has dramatically more risk than required to reach their expected (under economics, disregarding their personal expectations) level of returns. In my opinion, every rational investor should be seeking the optimal combination of risk and reward. For any given level of expected reward, there is no economically justifiable reason to take on more risk than is required. However, risk and return can be difficult to explain. Defining “Risk” I believe the best ways to define risk come from statistics. I want to know the standard deviation of the returns on a portfolio. Those returns could be measured daily, weekly, monthly, or annually. Due to limited sample sizes because some of the ETFs are relatively new, I usually begin by using the daily standard deviation. If the ETF performs well enough to stay on my list, the next levels of analysis will become more complex. Ultimately, we probably shouldn’t be concerned about volatility in our portfolio value if the value always bounced back the following day. However, I believe that the vast majority of the time the movement today tells us nothing about the movement tomorrow. While returns don’t dictate future returns, volatility over the previous couple years is a good indicator of volatility in the future unless there is a fundamental change in the market. Defining “Returns” I see return as the increase over time in the value known as “dividend adjusted close”. This value is provided by Yahoo. I won’t focus much on historical returns because I think they are largely useless. I care about the volatility of the returns, but not the actual returns. Predicting returns for a future period by looking at the previous period is akin to placing a poker bet based on the cards you held in the previous round. Defining “Risk Adjusted Returns” Based on my definitions of risk and return, my goal is to maximize returns relative to the amount of risk I experienced. It is easiest to explain with an example: Assume the risk free rate is 2%. Assume SPY is the default portfolio. Then the risk level on SPY is equal to one “unit” of risk. If SPY returns 6%, then the return was 4% for one unit of risk. If a portfolio has 50% of the risk level on SPY and returns 4%, then the portfolios generated 2% in returns for half of one unit of risk. Those two portfolios would be equal in providing risk adjusted returns. Most investors are fueled by greed and focused very heavily on generating returns without sufficient respect for the level of risk. I don’t want to compete directly in that game, so I focus on reducing the risk. If I can eliminate a substantial portion of the risk, then my returns on a risk adjusted basis should be substantially better. Belief about yields I believe a portfolio with a stronger yield is superior to one with a weaker yield if the expected total return and risk is the same. I like strong yields on portfolios because it protects investors from human error. One of the greatest risks to an otherwise intelligent investor is being caught up in the mood of the market and selling low or buying high. When an investor has to manually manage their portfolio, they are putting themselves in the dangerous situation of responding to sensationalistic stories. I believe this is especially true for retiring investors that need money to live on. By having a strong yield on the portfolio it is possible for investors to live off the income as needed without selling any security. This makes it much easier to stick to an intelligently designed plan rather than allowing emotions to dictate poor choices. In the recent crash, investors that sold at the bottom suffered dramatic losses and missed out on substantial gains. Investors that were simply taking the yield on their portfolio were just fine. Investors with automatic rebalancing and an intelligent asset allocation plan were in place to make some attractive gains. Personal situation I have a few retirement accounts already, but I decided to open a new solo 401K so I could put more of my earnings into tax advantaged accounts. After some research, I selected Charles Schwab as my brokerage on the recommendation of another analyst. Under the Schwab plan “ETF OneSource” I am able to trade qualifying ETFs with no commissions. I want to rebalance my portfolio frequently, so I have a strong preference for ETFs that qualify for this plan. Schwab is not providing me with any compensation in any manner for my articles. I have absolutely no other relationship with the brokerage firm. Because this is a new retirement account, I will probably begin with a balance between $9,000 and $11,000. I intend to invest very heavily in ETFs. My other accounts are with different brokerages and invested in different funds. Views on expense ratios Some analysts are heavily opposed to focusing on expense ratios. I don’t think investors should make decisions simply on the expense ratio, but the economic research I have covered supports the premise that overall higher expense ratios within a given category do not result in higher returns and may correlate to lower returns. The required level of statistical proof is fairly significant to determine if the higher ratios are actually causing lower returns. I believe the underlying assets, and thus Net Asset Value, should drive the price of the ETF. However, attempting to predict the price movements of every stock within an ETF would be a very difficult and time consuming job. By the time we want to compare several ETFs, one full time analyst would be unable to adequately cover every company. On the other hand, the expense ratio is the only thing I believe investors can truly be certain of prior to buying the ETF. Taxes I am not a CPA or CFP. I will not be assessing tax impacts. Investors needing help with tax considerations should consult a qualified professional that can assist them with their individual situation. The rest of this article By disclosing my views and process at the top of the article, I will be able to rapidly present data, analysis, and my opinion without having to explain the rationale behind how I reached each decision. The rest of the report begins below: ******** (NYSEARCA: NOBL ): ProShares S&P 500 Dividend Aristocrats ETF Tracking Index: S&P 500 Dividend Aristocrats Index Allocation of Assets: At least 80% (under normal circumstances) Morningstar Category: Large Blend Time period starts: November 2013 Time period ends: December 2014 Portfolio Std. Deviation Chart: (click to enlarge) (click to enlarge) Correlation: 94.40% Returns over the sample period: (click to enlarge) Liquidity (Average shares/day over last 10): Around 178,000 Days with no change in dividend adjusted close: 5 Days with no change in dividend adjusted close for SPY: 0 Yield: 1.6% Distribution Yield Expense Ratio: .35% Net and .70% Gross Discount or Premium to NAV: .08% premium Holdings: (click to enlarge) Further Consideration: Yes Conclusion: For a dividend yield ETF, the yield was lower than I expected. However, the ETF has very strong liquidity which reinforces the correlation. While I’d love to see lower levels of correlation, I don’t expect to see low levels in an ETF designed to invest in several large dividend companies. The cross over between SPY and NOBL is going force correlation to be fairly high. ETF investors may be more impressed with the lower standard deviation of returns. The 5 days in which dividend adjusted close didn’t change were not reflecting any liquidity problems, as volume was not 0 for any of the days in my sample. The Net expense ratio isn’t bad, but I would want to look into provisions that would keep it from increasing. At a .35% net expense ratio I’m interested, but if that were to climb, my interest level would fade pretty rapidly. I have no problem with the holdings, though I prefer a little more diversification. I can’t complain too much though with the positions being around 2%. The standard deviation of returns was fairly interesting to me given how the stock ended up with almost exactly the same gains as SPY and very high correlation. I put together a little bit of theory on that in the section below. Be warned, it’s written for people that are already familiar with statistics and enjoy the theory. I put it after the conclusion because I believe it will confuse many readers and the information is not necessary to understand my analysis. For the statistics lovers The stock trades at around $50.00 rather than around $200 for SPY. The lower share price means smaller deviations in value (by fractions of a cent) may be rounded down to nothing. This could result in a slightly lower standard deviation of returns. Some readers thinking about the bell curve may recognize that this could be a double edged sword for the standard deviation. While rounding towards the mean would reduce the standard deviation, when the scale tips in the other direction the rounding could increase the standard deviation. The reason I expect those factors to not offset perfectly is because the bell curve is tallest in the middle. If the population was a standard normal distribution, the values should be rounded towards the center more often than they would be rounded away. On the other hand, each time that it is rounded away from the mean produces more standard deviation than the times in which it is rounded towards the mean. I don’t expect the factors to offset perfectly, but it is beyond my knowledge to know which way it would tilt the deviation because of the two opposing forces.