Tag Archives: management

Buy These Funds To Beat A Choppy Q4

Unlike the previous two years, 2015 has turned out to be very frustrating for investors. It has been a bear story so far with the downtrend intensifying every passing quarter. August was particularly disturbing, when the market rout dragged the Dow & S&P 500 to their correction territories. In the third quarter, the Dow, S&P 500 and Nasdaq declined 7.6%, 7% and 7.4%, respectively. As for mutual funds, just 17% of mutual funds managed to finish in the green. This is a slump from 41% in the second quarter, which was again a sharp fall from 87% of the funds ending in positive territory in the first quarter. Unfortunately, we are not too bullish about the overall trend in the fourth quarter as well. Rather, lingering concerns from the third quarter may continue to disrupt the markets. Moreover, we are all too aware of the increased volatility that has worsened the investment climate in recent months. Market movements may yet again be volatile as investors continue to grapple with global growth worries, oil’s decline notwithstanding the momentary upsides, and a looming Fed lift-off. Three primary questions will keep the volatility alive – firstly, when will Fed hike rates; will China continue to negatively impact markets; and is the Bull Run over. As we move into the fourth quarter, Market Neutral mutual funds, Long Short mutual funds or Bear market funds should be the best picks at the moment. Market Neutral funds maintain a low correlation to market trends, helping to beat the volatility. Before we pick these funds, let’s look at the economic conditions: China, Global Growth Fears Linger The International Monetary Fund (NYSE: IMF ) has yet again trimmed the global economic growth projection. IMF’s latest World Economic Outlook (WEO) projects global economic growth of 3.1%, down from prior expectations of 3.3%. Slowdown in the emerging markets is largely to be blamed for the world economy expanding at its weakest pace since the financial crisis. Emerging markets are now expected to grow at 4% in 2015, down from the previous projection of 4.2%. Modest growth in the U.S. and a small recovery in the Eurozone won’t be strong enough to stem the declining trend in the emerging markets. Maurice Obstfeld, the IMF’s new chief economist, stated: “Six years after the world economy emerged from its broadest and deepest postwar recession, a return to robust and synchronized global expansion remains elusive.” The downward projection comes after China-led growth concerns have already wreaked havoc. A number of economic data out of China had confirmed that the world’s second largest economy was shaky. In China, lower-than-expected investment and factory output, dismal manufacturing data, significant trade gap and decline in foreign exchange reserves were among the dismal reports. Asian Development Bank’s (ADB) weak economic outlook for China also dented investor sentiment. China’s key benchmark moved down to the 3K level, from the 5K level enjoyed by the Shanghai Composite Index in early June. China Region fund category was the third best gainer in the first half of 2015, but the market rout has now made it the third biggest loser in the third quarter. Government measures to prop up markets did not have much success in China. However, it must be noted that the Chinese government has been implementing financial reforms, fiscal reforms and structural reforms for sustaining long-term growth. The implementation may have slowed growth in the short term. Going forward, it seems that support measures announced by the government hold the key to market movement. Investors need to look for such indications before placing their bets. Fed Rate Hike in December? The hullabaloo about the September rate hike was put to rest after the policy makers decided against a lift-off. However, while 9 out of 10 policy makers voted in favor of keeping the rate at the near zero level; 13 out of 17 committee members indicated that a rate hike may be possible this year. The chance of a rate hike in December was further fueled by Federal Reserve President Dennis Lockhart’s hawkish comments. Lockhart said: “As things settle down, I will be ready for the first policy move on the path to a more normal interest-rate environment. I am confident the much-used phrase ‘later this year’ is still operative.” Meanwhile, weak jobs report for the month of September raised speculation that the Federal Reserve may become more circumspect about raising rates this year. The Fed has been keeping an eye on further improvements in the labor market for hiking interest rates. Ultra-low interest rates have aided economic recovery and helped the markets enjoy a bull run. How to Beat Uncertainty in Q4 Market neutral funds aim to invest in bullish stocks and an equivalent number of bearish stocks. The objective is to generate above-average returns at relatively lower levels of risk. In fact, this category of funds adopts a precision approach to long-short investing, by ignoring the market’s direction. This is particularly relevant in today’s highly volatile market scenario when the objective is to protect the invested capital. This approach aims to identify pairs of assets whose price movements are related. Subsequently, the fund goes long on the outperforming asset and shorts the underperformer. Market neutrality is achieved by allocating the same proportion of assets to both positions. These funds may not offer robust gains, but they may be safe picks in a volatile market. Below we present three Market Neutral mutual funds that carry a favorable Zacks Mutual Fund Ranks. The following funds carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy) as we expect the funds to outperform their 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. The minimum initial investment is within $5000. These funds carry low beta and are in the green over year-to-date and 1-year periods. The 3- and 5-year annualized returns are also favorable. Calamos Market Neutral Income A (MUTF: CVSIX ) invests in equity securities of domestic companies irrespective of their market capitalization. CVSIX also employs short selling to reduce market risk and generate more income. Its average maturity varies within the range of 2 to 10 years. CVSIX may also invest a major portion of its assets in junk bonds. Calamos Market Neutral Income A carries a Zacks Mutual Fund Rank #1. While the year-to-date and 1-year returns are 0.4% and 2.6%, respectively, the respective 3- and 5-year annualized returns are 2.6% and 3.6%. CVSIX’s 1- and 3-year beta scores are -0.31 and 0.05, respectively. Annual expense ratio of 0.94% is lower than the category average of 1.84%. TFS Market Neutral Fund (MUTF: TFSMX ) seeks capital growth while having minimum correlation to the domestic equity market, or the S&P 500 Index, as defined by the advisor. TFSMX mostly invests in common stocks traded on the US exchanges, irrespective of their market capitalization, sector or style. However, average capitalization of TFSMX tends to be in the small-cap range. A maximum of 25% of its assets may be invested (as long and short positions) in other registered investment companies (“RICs”). TFS Market Neutral carries a Zacks Mutual Fund Rank #2. While the year-to-date and 1-year returns are 1.4% and 4.3%, respectively, the respective 3- and 5-year annualized returns are 3% and 3.4%. TFSMX’s 1- and 3-year beta scores are 0.02 and 0.14, respectively. Annual expense ratio of 2.02% is however higher than the category average of 1.62%. Gateway Fund A (MUTF: GATEX ) seeks to achieve maximum return from the equity markets at less risk. The fund focuses on acquiring common stocks to add to its well-diversified portfolio. The fund invests a significant share of its assets in index call options in order to reduce volatility and maintain steady cash flow. Gateway A carries a Zacks Mutual Fund Rank #1. While the year-to-date and 1-year returns are 1.4% and 4.5%, respectively, the respective 3- and 5-year annualized returns are 4% and 4.6%. GATEX’s 1- and 3-year beta scores are 0.4 and 0.36, respectively. Annual expense ratio of 0.94% is lower than the category average of 1.84%. Link to the original post on Zacks.com

Suburban Propane: Better Alternative To AmeriGas

Summary Recent operating history between the two companies is incredibly similar. Long term, shares have traded in tandem. However, Suburban Propane has diverged recently. SPH seems better valued on most valuation methods. If you have to have one, choose the better value. My research on AmeriGas Partners (NYSE: APU ) took a little heat from Seeking Alpha readers. So rather than presenting just the negative case for AmeriGas, I’d like to show Suburban Propane Partners (NYSE: SPH ) as a possible, better alternative for investors looking to establish a new position in companies within this industry. Suburban Propane Partners is a distributor of propane and various refined fuels to more than a million customers throughout the United States by way of its extensive distribution network. The vast majority of the company’s sales are to residential customers who have very few alternatives for heating and cooking within their homes. While propane is generally more expensive on a BTU basis than alternatives like natural gas, it does have the advantage of being easily liquefied and transported. This characteristic makes it ideal to be sold to customers in rural areas with no alternatives other than electric heat or fuel oil. However, unlike peers like AmeriGas Partners, Suburban has diversified its operations to some degree. The company also sells fuel oil, kerosene, and diesel fuel (direct competitors of propane) in the Northeast and also sells natural gas and electricity in the deregulated New York and Pennsylvania markets. While the Propane segment constituted more than 80% of 2014 revenues ($1.6B of $1.9B), the added diversification here should let investors sleep a little bit better at night than pure-play alternatives in the sector. Operating Results Revenue is set to fall dramatically in 2015 because of cheap propane prices as propane reached a high of $3.69/gallon in February of 2014 compared to a high of $2.37/gallon in January of 2015. Investors should note that Suburban’s fiscal year ends at the end of September, so there is no risk to the above estimates due to a spike in price as we start the winter heating season. Operating income has remained stable, however, as the company passes along the costs of the underlying commodity to consumers, taking a fairly fixed margin. In periods of lower prices, like what occurred in 2015, SPH can actually achieve higher gross margins as there is little risk of consumers reducing consumption or switching to alternatives. Expected 2015 operating margins are in line with AmeriGas. From a cash flow perspective, the story here is also very similar to AmeriGas. Both businesses have very little in the way of capital expenditures, so the vast majority of distributions go to shareholders. Both companies made game-changing acquisitions in 2011/2012, resulting in larger cash flows in following years. As a refresher, AmeriGas picked up Heritage Propane and Suburban bought Inergy Propane. At face value, Suburban got a better deal, paying about 10x EBITDA while AmeriGas coughed up 11x for similar assets. Both deals were built around the same idea: larger customer base, new geographies, increased economies of scale resulting in synergies, etc. One area of concern for investors to consider when weighing Suburban Propane versus AmeriGas is the leverage involved. While Suburban has the smaller debt load, it is also a smaller company. Suburban coughed up 46% of 2014 operating income towards interest payments compared to 35% for AmeriGas. This has been a long-term trend that has likely contributed to the premium AmeriGas shares have generally commanded compared to Suburban. SPH will likely take the opportunity to refinance its 7.375% senior notes due 2020 and 2021 in a few years ($750M in face value) when there are no penalties on calling at face value if interest rates remain low for interest rate savings. If the bond market remains as it is for the next few years, the company will be able to shave 1.5% off the interest rates assuming similar terms. This will result in tens of millions in savings in annual interest expense, which could free up cash flow for debt retirement or dividend increases if management chooses to do so. Conclusion Over the past two years, SPH has diverged significantly from its larger peer, APU. They’ve largely traded at similar yields (7.44% five-year average for Suburban, 6.99% average yield for AmeriGas), but this spread has expanded noticeably over the past year. This premium has likely widened due to investors buying into the dividend growth at AmeriGas. Investors appear to be ignoring the sustainability of those increases going forward. Suburban has taken the safer route, electing to hold the dividend stable rather than increase the payout in an industry that is facing dramatic change. TTM profit and operating margins remain higher at Suburban Propane, and the company appears to be the better bargain on metrics like Enterprise Value/EBITDA. Because of this disconnect, investors can now capture over 10% yield on Suburban Propane compared to AmeriGas’ 8.3% yield. In my opinion, these two will return to historical yield spreads once the market realizes large future dividend increases are off the table for both. If this is the case, investors in Suburban Propane should enjoy higher payouts while having better preservation of their initial capital investment compared to AmeriGas if buying at current share prices. So, for investors that really do want exposure to this market segment and are wanting to start a new position, I believe Suburban Propane is the better value play here over the next five years. You would be buying into a better yield today dollar for dollar, better margins, a little added business diversification through the fuel oil/deregulated energy business segments, and be partnering with a management that has a less aggressive style.

Drawing Inspiration From Short-Sellers In Avoiding Potential Value Traps

Summary Risk and opportunity are intertwined; avoiding value traps is key to investing success. Short-sellers have had a good track record and there are valuable insights to be drawn from their work. My exclusive research service, Asia/U.S. Deep-Value Wide-Moat Stocks, flags potential value traps with corporate governance issues, financial statement manipulation risks and other red flags. Short-Sellers And Their Track Record I recently wrote an article about value traps titled “How To Avoid Potential Value Traps With Net-Nets And Other Deep Value Stocks.” In the article, I highlighted several categories of stocks that I will reject as potential value traps, including those which were past targets of short-sellers. The short-sellers are “smart money” which I will not bet against, and I quote relevant research below to support my claims. Lei Chen, a researcher at Southwestern University of Finance and Economics, first published a paper titled “The Informational Role of Short Sellers: The Evidence from Short Sellers’ Reports on U.S.-Listed Chinese Firms” in January 2014 (The current version of the research paper is dated January 22, 2015). The study found that U.S.-listed Chinese firms targeted by short-sellers “experience an average three-day cumulative abnormal return (NASDAQ: CAR ) of -6.1% and -13.4% for initial coverage of the firm.” Lei Chen also added that “short sellers are more effective than equity analysts who follow Chinese firms,” and “targeted firms suffer long-term stock price declines and are often subsequently subject to class action lawsuits and SEC enforcement.” Activist Shorts Research, which calls itself “an independent database dedicated to tracking activist short-seller campaigns,” tracked the campaigns of 28 top activist short-sellers and published its findings in August 2014. A significant finding was that investors, who “piggybacked” short-sellers by shorting the targeted companies a week after the announcement of the activist campaign and continuing to hold the stocks till the end of the activist campaign, outperformed the S&P 500 by an average of 12.5% over the same period. Delving deeper into the track records of individual short-sellers, a prominent short-seller, Muddy Waters Research summarized the track record of its nine “strong sell reports” as follows: Four de-listings; Four resignations of auditor / CFO / board members; and Six or more formal investigations by regulators into covered companies. I intend to provide subscribers to my Asia/U.S. Deep-Value Wide-Moat Stocks exclusive research service with a list of the key short-sellers, their reports and the companies they have targeted in a separate bonus watchlist article. Categories Of Red Flags To Watch Out For While it is not possible for an individual investor to replicate the in-depth detective work that some of these professional short-seller firms have done in coming up with their short theses, there are a lot of takeaways. In particular, one can draft his or her own investment checklist incorporating certain red flags that can be detected using data & information from annual reports, public filings and other forms of desktop research. I list a couple of red flag categories in the sections below. Notwithstanding the accuracy of the allegations made by short-sellers, investing in stocks which are likely to be targets of short-sellers will most probably lead to significant financial losses, as per research referenced above. Therefore, it pays to understand what kind of companies are “favored” by short-sellers. Financials If something is too good to be true or simply does not make sense, investors should sit up and take notice. One example is companies with significantly higher margins than their peers despite similar (or even smaller) scale of operations compared with competitors, lack of competitive advantages and the commoditized nature of the industries they operate in. Shenguan Holdings ( OTCPK:SHGXY , 829 HK) was the subject of a September 2014 short-seller report titled “The Thick Skin of Shenguan’s High Margins” by Emerson Analytics.” Emerson Analytics wrote in its report: Shenguan has reported very high EBIT margins that averaged 53% in the last few years, much higher than the 18% or so enjoyed by two global giants Viscofan Group and Devro PLC. Its gross margin at 55- 60% was also a lot higher than the 25-40% reported by Liuzhou Honsen, a smaller Chinese competitor. This is just too good to be true. That being said, there are positive factors for Shenguan that should not be ignored in any balanced analysis of the company. Shenguan has engaged and retained Ernst & Young as auditors since IPO. It has also paid out dividends in every year since 2009 (IPO year), although it must be noted that Shenguan’s directors did not propose any interim dividend for 1H2015. For the record, Shenguan’s share price has declined from HK$2.80 (share price indicated in the short-seller report) in September 2014 to HK$1.15 as of October 15, 2015. Other red flag indicators include a combination of high cash levels with either low interest income, low dividend payout or high levels of debt; long or increasing cash conversion cycle; and divergence between cash flow and earnings. Auditing Auditors, or more specifically auditor turnover, need to be watched closely. Huabao International ( OTCPK:HUIHY , 336 HK) was the target of short-seller Anonymous Analytics in April 2012 in a report titled “Smoke and Mirrors.” One of the red flags highlighted by Anonymous Analytics was auditor turnover. Deloitte Touche Tohmatsu (NYSE: DTT ) resigned as Huabao’s auditors in March 2006, less than two years after Huabao was listed in April 2004. Huabao countered the short-seller’s allegations by clarifying that “DTT resigned in late March 2006 because the Company and DTT could not reach a consensus on the audit fees for the financial year ending 31 March 2006. DTT had also confirmed that there was no disagreement between it and the Company when it resigned.” Also, it is worth noting that PricewaterhouseCoopers ((PwC)) has remained as Huabao’s auditors since taking over in 2006 and has continued to provide an unqualified opinion on the company’s accounts since then. Huabao’s share price as of October 15, 2015 was HK$2.97, compared with its share price of HK$4.33 in April 2012 when Anonymous Analytics’ report was released. On that note, I will also to share some contrarian views on the risk factor with respect to having a non-Big Four auditor. The companies involved in arguably the “biggest” accounting frauds such as Enron, Sino Forest and Satyam engaged Big Four (or Five including Arthur Andersen at that time) auditors. Also, putting fees aside, Big Four audit firms, like any other profit-making enterprise, will give their biggest clients the top priority, suggesting that smaller companies can possibly get more attention and better service with a non-Big Four auditor. Other factors to take note of include different auditors for the parent and subsidiaries; auditor located in a different country from client’s key business operations; and delays in result announcements. Corporate Governance The Board of Directors serves as one of the most important checks & balances for companies. The behavior and past actions of directors provide clues as to how effectively a company is managed. Emerson Analytics issued a short-seller report on Sound Global ( OTCPK:SGXXY , 967 HK) in February 2015. Sound Global remains suspended for trading since March 16, 2015, when it announced that “the Company requires more time to prepare the required information to the auditors and the auditors are not able to complete the audit of the consolidated financial statements of the Company and its subsidiaries for the year ended December 31, 2014 (the “2014 Annual Results) by March 31, 2015, there will be a delay in the release of the 2014 Annual Results.” Even prior to the release of the short-seller report, there were certain disclosures by Sound Global which investors should have been concerned with. In 2013, it was disclosed that Mr. Wen Yibo, a controlling shareholder and executive director of Sound Global, has pledged his shares in Sound Global in connection with borrowings for the company in announcements here and here . In December 2014, Mr. Wen was publicly criticised by the The Securities and Futures Commission for a breach of Rule 31.3 of the Takeovers Code, which “provides shareholders with certainty that the offeror will not pay a price higher than the offer price for the shares in the offeree company in the 6-month period after the close of the offer.” Mr Wen bought 5.6 million Sound Global shares at prices ranging from $5.94 to $7.55 per share between March and May 2014, which were higher that the HK$4.37 conditional cash offer for all the shares in Sound Global in September 2013. Further to that, Sound Global announced on March 31, 2015 that its audit and nomination committee chairman, Mr. Wong See Meng, resigned on 26 March 2015 due to family and personal commitments. Mr Wong is also a member of remuneration committee. In addition, Sound Global’s audit committee comprising Mr Wong See Meng (Chairman), Independent Non-Executive Directors, Mr Seow Han Chiang Winston and Mr Fu Tao do not have either accounting or auditing experience. In July 2015, Sound Global announced that Deloitte Touche Tohmatsu has resigned as auditors of the company on 17 July 2015. Moving away from Sound Global, investors should consider factors such as the number of independent directors on the Board, the composition of the Audit and Remuneration Committees, and the profile & track record of the individual directors, when they are evaluating the Board of companies they are vested in. Closing Thoughts Risk and opportunity are intertwined. For example, Hong Kong-listed companies probably rank second in the list of global stocks targeted by short-sellers, after U.S. firms. But at the same time, Hong Kong is the stock market with the second most number of net-nets after Japan. Therefore, I will advise investors not to throw the baby out with the bathwater when they are considering emerging market opportunities, particularly in countries and markets where companies with corporate governance issues, financial statement manipulation risks are more prevalent. Note: I flag potential value traps with corporate governance issues, financial statement manipulation risks and other red flags as part of my Asia/U.S. Deep-Value Wide-Moat Stocks exclusive research service. My subscribers get access to the list of value traps for both deep value & wide moat stocks, in addition to monthly top ideas, potential investment candidate profiles and potential investment candidate watchlists.