Tag Archives: management

Looking For REIT ETFs? Only 2 Of These 3 Should Be On Your Watch List

Summary These ETFs offer respectable dividend yields by investing in REITs. I see VNQ as the top ETF in the batch, but if either were to beat VNQ over the long term I think IYR has a better chance of doing. Due to similarity of holdings between VNQ and FRI, it would be difficult for FRI’s underlying assets to outperform VNQ’s assets by enough to cover the expense ratio difference. One of the areas I frequently cover is ETFs. I’ve been a large proponent of investors holding the core of their portfolio in high quality ETFs with very low expense ratios. The same argument can be made for passive mutual funds with very low expense ratios, though there are fewer of those. In this argument I’m doing a quick comparison of a few domestic equity REITs ETFs that investors may be contemplating. Ticker Name Index IYR iShares U.S. Real Estate ETF Dow Jones U.S. Real Estate Index VNQ Vanguard REIT Index ETF MSCI US REIT Index FRI First Trust S&P REIT Index ETF S&P United States REIT Index Dividend Yields I charted the dividend yields from Yahoo Finance for each portfolio. While IYR and VNQ are both yielding a little over 3.65%, the yield on FRI appears substantially lower. Since the yield was so weak I decided to look up the dividend history on Yahoo Finance and manually calculate it. Occasionally this results in a different value than the reported trailing yield. It isn’t common, but I wanted to double check some REITs ETFs will usually have higher dividend yields. There was no mistake that I could find. Expense Ratios The expense ratios run from .12% to .50%: VNQ is one of the cheapest REIT ETFs available. That is the reason I started building my own portfolio’s REIT allocation by buying up shares of VNQ. The combination of a very high yield and a low expense ratio made VNQ a natural choice for my portfolio. Strategy Earlier in the article I referenced which index each ETF would cover, but that doesn’t tell investors a great deal about how the individual allocations are created. Normally I would focus on comparing factors like the sector allocations of each ETF, but that wouldn’t make any sense when each ETF will simply be listed as being 100% invested in real estate. Fact Sheets To learn more about the ETFs, I pulled up the fact sheets for each: IYR’s Strategy Ironically, IYR does not explain their strategy in either the fact sheet or the general page on the ETF . I loaded up the prospectus on the ETF and finally found some answers. The fund managers use “a passive or indexing approach to try to achieve the Fund’s investment objective.” It is helpful to know that the fund is being passively managed, but it makes me wonder about the expense ratio. When the ratios are over .40% I usually expect to see some form of active management either in the portfolio or some rebalancing to follow an index that is changing significantly. The first response not being able to find the information I wanted in any of the three sources might be to look up the Dow Jones U.S. Real Estate Index, so I did that. It turns out that the Dow Jones Real Estate Indices do not include a single index with that precise name. Instead, they include several indexes with similar names. (click to enlarge) Without knowing precisely which of these indexes is being tracked, I don’t see a solid method to enhance the research. VNQ’s Strategy VNQ uses a passively managed, full-replication strategy and their index covers two-thirds of the REIT market. The fund’s management seeks to minimize their net tracking error by having a very low expense ratio. For investors that are not familiar with the net tracking error, it refers to the difference between the results of the ETF and the results of the index. A REIT is only eligible for inclusion in the index if it has a market capitalization of at least $100 million. RFI’s Strategy While the fact sheet does not discuss the strategy of the fund directly, they do discuss the index which gives us some insight. The index is maintained in a manner that includes implementation of daily corporate actions, quarterly updates of significant events, and the portfolio is reconstituted on an annual basis in September. The index appears to be passively managed as over each period the fund is lagging the index by a hair over the expense ratio. (click to enlarge) This is about how a passively managed fund should look when investors compare the NAV performance of the fund with the underlying index. An actively managed fund would miss by more significant amounts which could be outperforming the index or trailing it. Holding Similarity Since I’m seeing passively managed ETFs with materially different expense ratios, I wanted to determine how reasonable it would be for a substantial difference in performance. I checked the holdings of each ETF. The top holding across all 3 is Simon Property Group (NYSE: SPG ). It ranged from 7% to 8.35% of the holdings depending on which ETF I was looking at. VNQ and F had precisely the same top four holdings in the same order, though the percentage allocations varied slightly. Number two is Public Storage (NYSE: PSA ). Number three is Equity Residential (NYSE: EQR ). Number four is AvalonBay Communities (NYSE: AVB ). When the holdings are similar and the strategy is passive it is difficult to find any reason to expect the underlying portfolios to have materially different returns. IYR on the other hand did offer some different allocations. The second allocation there is American Tower Corp. (NYSE: AMT ) which is a REIT that operates cell phone towers. They are working in an oligopoly as there are only a few major cell phone tower REITs and the leasing structure on their facilities results in enormous economies of scale when they are able to increase the number of customers for each location. AMT is not in the top 10 holdings for either of the other REIT ETFs. Conclusion I tend to favor very passive management which is the trend for each of these ETFs. Without a compelling reason to pick either of the ETFs with a higher expense ratio, I see VNQ as the strongest REIT ETF in this batch. If IYR or FRI were to outperform VNQ over the longer term, I would expect it to be IYR because there appears to be a larger difference in the selection of securities which should reduce the correlation in the long run returns of the ETFs.

Terraform Power’s Recent Moves Support Dividend Growth Of At Least 15% In 2016

Summary Terraform Power closed the first part of their planned transaction with Invenergy, 832MW of net wind power plants, increasing their current portfolio from 1.9GW to 2.8GW. I found it interesting that the company ended up changing the financing package for this transaction, which is expected to deliver unlevered CAFD of $139mil in 2016. Terraform also recently updated their purchase agreement with SunEdison for the producing assets of SunEdison’s deal to buy Vivint Solar. The updated deal projects that Terraform will pay $799mil to purchase 470MW of producing assets. These assets should produce annual CAFD of around $73-75mil. Both transactions support an increased dividend in 2016. The actual amount will depend on the timing of the transactions, but I expect 2016 exit rate of at least $1.60/share. Terraform Power (NASDAQ: TERP ) has had a pretty busy last couple of weeks. The company completed a large part of their planned transaction with Invenergy on Wednesday, buying 832MW of wind assets. This comes on the heels of the announcement last week of a renegotiation of the terms of SunEdison’s (NYSE: SUNE ) purchase of Vivint Solar (NYSE: VSLR ). The updates have removed many of the concerns investors have had with TERP, and the stock has responded in kind, as it has almost doubled from its late November lows. As I explain below, these transaction also support a continued dividend increase in 2016. TERP data by YCharts TERP came out with solid 3rd Quarter results in early November, but management’s unwillingness to confirm their previously estimated 2016 dividend increase to $1.75, and liquidity concerns at sponsor SUNE, led to the stock plunging over the next two weeks $6.73. At that point, the current yield was 20%. The market finally came to its senses when David Tepper announced a large stake and sent an open letter to management. Invenergy Transaction: Sources/Uses of Fund Changed One of the interesting takeaways from TERP’s announcement of the Invenergy transaction is the fact that they changed the way they ended up financing it. Back in July when the deal was made, the plan (see page 17) was to place half the MW into TERP immediately, and hold the other half in a SUNE warehouse. From August thru the 3Q earnings call in November, the plan (see page 18) was to only drop down 265MW and place the rest in a structured warehouse. Now it seems that management has decided to place all of the projects directly into TERP immediately. Sources of Cash   Uses of Cash   Non-Recourse Project Debt assumed or incurred with respect to transaction $801m 832MW of Wind Assets located in US and Canada $1,962m Pro-rata portion of $500mil new non-recourse term loan $417m     Cash on Hand (incld proceeds from TERP $300mil senior note offering in July 2015) $744m       $1,962m   $1,962m The press release notes that, “once all projects are operational, the first year adjusted EBITDA (before minority ownership) is expected to be $147 million, and unlevered CAFD (before all project and HoldCo debt payments) is expected to be $139 million.” Unfortunately, this doesn’t clarify how much we should expect the project and HoldCo debt payments to be, so it’s tough to predict how much of the unlevered CAFD will actually be available for dividend payments. My best estimate is to use the initially projected cash on cash yield of 8.4%, which equates to about $62mil (8.4% x $744mil cash on hand). We’ll have to wait for TERPs 4Q results for more details. The new $500mil term loan charges LIBOR + 5.5%, with a 1% LIBOR floor, meaning that TERP is currently paying 6.5%. It matures in 2019 and can be prepaid anytime, so it’s very likely that TERP will refinance this as soon as they can organize something with better terms. Vivint Transaction Terms Improve Last week TERP and SUNE announced that they had improved the terms of the Vivint transaction. TERP was able to reduce their initial purchase commitment from $922mil down to $799mil, by only paying for completed installations, and paying a reduced fee of $1.70/MW. The final total will depend on the actual number of producing MW transferred when the Vivint deal closes sometime during Q1 2016. In their Q2 earnings presentation, management noted that they expected the 523MW to generate average unlevered CAFD of $81 annually, so I project that the 470MW delivered at close will generate $70-75mil annualized unlevered CAFD. Considering the fact that TERP used substantially all of their cash on hand at the end of Q3 to fund the Invenergy transaction, it’s likely that they will be drawing on their revolver for much of the $799mil. The revolver’s rates are currently under 3%, so the annual interest would be about $24mil. Thus, I expect final CAFD to be about $50mil. 2016 Updated CAFD Projection Based on their 3Q presentation, TERP expected to generate CAFD of about $208mil before taking into account the Invenergy and Vivint transactions. If we assume that the Vivint transaction closes by the end of Q1, we should see annualized CAFD at the following levels next year: Quarter End Q1 Q2 Q3 Q4 Annualized CAFD $270m $320m $320m $320m CAFD distributed (85%) $230m $272m $272m $272m Per Share Quarterly Distribution $.35 $.40 $.40 $.40 The quarterly distribution estimates include the effect of SUNEs IDRs. I don’t expect TERP to actually increase the dividend to $.40 for Q2, even though it seems that operations would allow this. Rather, it’s likely that they will prefer to show steady quarterly increases up to $.40/share in Q4. This confirms my view that these transactions will cause TERP to increase their dividend by at least 15% over the next year.

The Specter Of Risk In The Derivatives Of Bond Mutual Funds

By Fabio Cortes, Economist in the IMF’s Monetary and Capital Markets Department Current regulations only require U.S. and European bond mutual funds to disclose a limited amount of information about the risks they have taken using financial instruments called derivatives. This leaves investors and policymakers in the dark on a key issue for financial stability. Our new research in the October 2015 Global Financial Stability Report looks at just how much is at stake. A number of large bond mutual funds use derivatives-contracts that permit investors to bet on the future direction of interest rates. However, unlike bonds, most derivatives only require a small deposit to make the investment, which amplifies their potential gains through leverage, or borrowed money. For this reason, leveraged investments are potentially more profitable, as the gains on invested capital can be larger. For the same reason, losses can be much larger. Derivatives offer mutual fund managers a flexible and less capital intensive alternative to bonds when managing their portfolios. When used to insure against potential changes in interest rates, they are a useful tool. When used to speculate, they can be bad news given the potential for big losses when bets go wrong. Strong growth in the assets of bond mutual funds active in derivatives The assets of large bond mutual funds that use derivatives have increased significantly since the global financial crisis. As you can see below in Chart 1, we now estimate they amount to more than $900 billion, or about 13 percent of the world’s bond mutual fund sector. While existing regulations in the United States and the European Union on mutual funds impose clear limits on cash borrowing levels, the amount of leverage that can be achieved through derivatives exposure is potentially large, often multiples of the market value of their portfolios. This may explain why mutual funds accounting for about 2/3 of the assets in our sample disclose derivatives leverage ranging from 100 percent to 1000 percent of net asset value in their annual reports. This range may be also conservative as these are the notional exposures of derivatives adjusted for hedging and netting at the fund manager’s discretion. What makes them sensitive to higher rates and volatile financial markets Although these leveraged bond mutual funds have not performed differently to benchmarks over the past three years, their relative performance has occurred in a period of both low interest rates and low volatility, which may mask the risks of leverage. This is because the market value of a number of speculative derivatives positions could have been unaffected by the relatively small changes in the price of fixed income assets. In addition, limited investor withdrawals from leveraged bond mutual funds may have also masked the risks of fund managers having to sell-off illiquid derivatives to pay for investor redemptions. In our analysis we find that a portion of leveraged bond mutual funds exhibit both relatively high leverage and sensitivity to the returns of U.S. fixed-income benchmarks, depicted in Chart 2 below. This combination raises a risk that losses from highly leveraged derivatives could accelerate in a scenario where market volatility and U.S. bond yields suddenly rise. Investors in leveraged bond mutual funds, when faced with a rapid deterioration in the value of their investments, may rush to cash in, particularly if this results in greater than expected losses relative to benchmarks (and the historical performance of their investments). This could then reinforce a vicious cycle of fire sales by mutual fund managers, further investor losses and redemptions, and more volatility. Improve disclosure: regulators need to act Making a comprehensive assessment of these risks is problematic due to insufficient data; lack of oversight by regulators compounds the risks. The latest proposals by the U.S. Securities and Exchange Commission to enhance regulations and improve disclosure on the derivatives of mutual funds is a welcome step. There is currently no requirement for disclosing leverage data in the United States (and only on a selected basis in some European Union countries). Implementing detailed and globally consistent reporting standards across the asset management industry would give regulators the data necessary to locate and measure the extent of leverage risks. Reporting standards should include enough leverage information (level of cash, assets, and derivatives) to show mutual funds’ sensitivity to large market moves-for example, bond funds should report their sensitivity to rate and credit market moves-and to facilitate meaningful analysis of risks across the financial sector.