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Fund Manager Briefing: TwentyFour Corporate Bond

By Jake Moeller Lipper’s Jake Moeller reviews highlights of a meeting with Chris Bowie, Portfolio Manager, TwentyFour Corporate Bond Fund , on August 26, 2015. The new TwentyFour Corporate Bond Fund is the sister of the highly successful (and Lipper Award-winning ) TwentyFour Strategic Bond Fund . Launched only in January 2015, the fund is designed to perform against a relative benchmark (TwentyFour will shortly launch an absolute return bond fund) and is not slavishly devoted to maintaining a high yield. Mr. Bowie is a fund manager obsessed with liquidity. “You won’t find any private placements or unrated securities in this portfolio,” he stated. “I like quality and I want a small, compact portfolio.” Indeed, this fund is refreshingly compact. With only 70 securities, it is very small compared to some of the large corporate bond funds occupying the U.K. market, and Mr. Bowie doesn’t expect his fund will likely hold a significantly larger amount of holdings. In a credible move TwentyFour has recently stopped marketing its Strategic Bond Fund (at £750 million) to new clients in order to prevent pressure to increase the number of lines. TwentyFour has undertaken to similarly protect the Corporate Bond Fund from capacity constraints, should that need arise. The fund is designed along similar lines to Mr. Bowie’s previous Ignis Corporate Bond Fund , with an emphasis on delivering risk-adjusted returns across all sources of alpha, including duration and yield curve, stock selection and assets, country rating, and sector tilts. Mr. Bowie has an excellent pedigree in all aspects of corporate bond management and carries an enviable performance track record, once ranked by Citywire with the fourteenth best Sharpe ratio of all funds globally. Table 1. Composite Performance* of Chris Bowie from December 31, 2008 to Present within IA £Corporate Bond Sector Quartiles (click to enlarge) Source: Lipper for Investment Management. As a former computer programmer, Mr. Bowie has built his own system for examining risk/return that gives him some unique insights, particularly in constructing his credit buckets. “My system calculates a risk-adjusted return metric for every single bond,” he states. “This examines the last three-year cash price volatility for a bond and compares it to its current yield. If a bond is yielding 5%, but its three-year cash price volatility is 7%, that is quite a poor investment. If it is yielding 4% but has cash price volatility of 2%, this is much more attractive.” The fund has a very large position in BBB-rated securities at a whopping 44% (compared to the sector average of 38%) and a large component of BB-rated debt (16%), mainly around the five- to ten-year part of the curve. Mr. Bowie is also keen on corporate hybrids, with a 12% exposure there. “They’ve been good for us,” he states. “We have been selectively overweight for a while now.” Using his proprietary value system, Mr. Bowie cites the example of his preference for a Barclays Upper Tier 2 position that appears to have the wrong cash-price volatility for its rating. “It’s a no brainer!” he states. “If you buy the Barclays BBB on the same yield, you’ve increased your cash-price volatility three times for a single notch improvement in credit rating.” Table 2. Comparative Performance of Various Asset Class Proxies since 2000. (click to enlarge) Source: Lipper for Investment Management. Past performance does not guarantee future performance. For a fund manager whose week has just commenced with the “Black Monday” selloff in global markets, Mr. Bowie is strikingly calm and composed. “It’s not yet a solvency event,” he states. “This is a big question about growth.” While his tone is reassuring and his longer-term investment thesis is relatively intact, he does concede the crisis has warranted a few changes to his positions. He has just increased the duration of his portfolio from 7.1 years to 7.4 years (the sector average is 7.5 years) on the back of the selloff in Treasuries on Wednesday, August 26. This has created a partial hedge against the credit risk in some of his higher-beta names. He has also sold a small amount of his AT1 (additional Tier 1) bonds to further bring down his beta. “We expect further short-term volatility in equities markets,” he states, “and we don’t want to be selling bonds into the cash market. But we do want to mitigate some credit volatility.” While Black Monday hasn’t forced a redesign of Mr. Bowie’s overall strategy, it has placed emphasis on the outlook for inflation. “Until a week ago I thought the most likely thing was that the Fed would raise rates in September, the Bank of England following suit in Q1 next year, that we would have a normal recovery where inflation starts to gently rise, and we would see wage pressures elevate.” he states “But now, I’m wondering with what’s happened to oil and volatility and the noise out of China whether deflationary risk is more of a threat.” This concern comes despite Europe’s supportive quantitative-easing program and increasing business confidence and is also reflected in the fund’s duration increase outlined earlier. Table 3. Proportion of IA Sterling Corporate Bond Sector by Fund Size Ranking Source: TwentyFour AM. Data as at April 2015. The fund currently holds 14% exposure to gilts and supranationals. Mr. Bowie is well aware of outflows from competitors’ funds in the sector and the potential for investors to undertake a broader rotation out of corporate bonds. The gilt position and the high level of highly rated names is protection for him, should this occur. He argues, however, that corporate bonds should be an ongoing component of investors’ portfolios, with the long-term performance profile (even including 2008 – see Table 2, above) measured by the iBoxx Non Gilts BBB Index since 2000 offering considerably better performance with lower volatility than equities. He notes also that there are some headwinds for the asset class, but an active fund that examines the drivers of volatility is best placed to protect capital. There are many things going for this new launch. TwentyFour is a vibrant fixed income specialist that has made a canny hire in Mr. Bowie. His pedigree is strong, and-although he is running what is currently a defensive portfolio-his unique processes bring a fresh dynamic. Furthermore, the concentration of flows in the sector (see Table 3, above), with 70% of the entire sector contained in the ten top funds, should be of concern to all investors. A small and nimble fund has much to offer. * The composite is constructed in the private asset module of Lipper for Investment Management as follows: Ignis Corporate Bond Fund from 31/12/2008 – 30/6/2014, IA £Corporate Bond sector from 1/7/2014 to 13/1/2015 & TwentyFour Corporate Bond from 14/1/2015 onwards.

Recent Volatility Providing Potential Buying Opportunity In The Biotechnology Space

Summary IBB was pulled back roughly 20% from its 52-week high this week with shares plunging from $400 to $320 per share during the recent market weakness. Persistently low oil prices, fear of an imminent rate hike and weakness in China have indiscriminately pulled down all indices over the past week. These external events are largely extraneous to the biotechnology sector and thus may present a buying opportunity throughout pullbacks if adding to a position or initiating a new position. Medical and prescription drug expenditures are projected to grow at an average rate of 5.8% and 6.3% annually through 2024, respectively. Taken together, this may present a potential buying opportunity especially given the recent market volatility. Introduction: The confluence of persistently lower oil prices, fear of an imminent rate hike and more notably weakness in China have indiscriminately plummeted all indices over the past week. These external events are largely extraneous to the biotechnology cohort yet this group has been taken along for the downhill ride with the broader indices. The biotechnology sector has been on an unprecedented performance streak in both annual and cumulative performance over the past 10 years and accentuated during the latest 5 year timeframe however lately this streak has been tested during the recent market volatility. The biotechnology sector can be highly volatile, however I posit that this cohort has not only established itself as a secular growth sector but these latest events are unrelated to the biotech sector and thus this recent pullback may provide a potential opportunity to add to a current position or initiate a position over time as this correction unfolds. Using The iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) as a proxy, based on annual and cumulative performance throughout both bear and bull markets, IBB may provide the opportunity investors have been waiting for in the face of the current market downturn. IBB is touched down to register a 20% decline from its 52-week high, shares have plunged from $400 to $320 at one point per share during the recent market weakness, presenting a potential buying opportunity. Growth expenditures as a rational for buying on major pullbacks: Per the Centers for Medical and Medicaid Services, medical expenditures are projected (from 2014 through 2024) to grow at an average rate of 5.8% per year. This translates into 1.1% faster than GDP throughout this time period thus the healthcare expenditures as a percentage of GDP are expected to rise from 17.4% in 2013 to 19.6% by 2024. Despite several years of growth below 5%, health spending is projected to have grown 5.5% in 2014. Faster health spending due mainly to ACA health insurance coverage and rapid growth in prescription drug spending. The domestically insured is projected to have increased from 86% in 2013 to 89% in 2014 as 8.4 million individuals are projected to have gained coverage. Post 2014, national health spending is projected to grow at a 5.3% clip in 2015 and peak at 6.3% in 2020. Given these projections, this scenario bodes well for the biotechnology sector as more individuals have access to health coverage and prescription drugs. In terms of prescription drug expenditures, spending is projected to have grown 12.6 percent in 2014 to $305.1 billion. Driving growth were new specialty drugs and increased prescription drug use among people who were newly insured. Prescription drug spending growth is projected to average 6.3% annual growth from 2015 through 2024. Taken together, as the biotechnology sector continues its innovation and continuous supply of medications to treat and cure many different diseases coupled with the growth in overall medical spending may present an investment opportunity especially given the recent market volatility. Secular growth case for buying on major pullbacks: In addition to case outlined above (e.g. highlighting the disconnect between the events bringing down the broader indices and the biotechnology sector on a whole) the biotech sector has displayed its resilience in both bear and bull markets with secular growth. The returns for IBB have been very impressive in both annual and cumulative performance, unparalleled by any major index. Over the past 10 and 5 year time frames, IBB has posted cumulative returns of over 360% and 325%, respectively. These results are unrivaled by any major index, outperforming on a 10 year cumulative basis of 295%, 240% and 300% for the S&P 500, Nasdaq, and Dow Jones respectively (Figure 1). These returns are accentuated during the previous 5 years. IBB notched cumulative returns of 325%, outperforming the S&P 500, Nasdaq and Dow Jones by 245%, 215% and 265%, respectively (Figure 2). IBB has cumulatively outperformed all indices by roughly 3-fold and 2.5-fold over the 10 year and 5 year time frames, respectively (Figures 1 and 2). (click to enlarge) Figure 1 – Google Finance comparison of IBB returns relative to the S&P 500, Nasdaq, Dow Jones over the previous 10 years (click to enlarge) Figure 2 – Google Finance comparison of IBB returns relative to the S&P 500, Nasdaq, Dow Jones over the previous 5 years IBB has displayed impressive resilience in the face of the market crash in 2008, the bear markets of 2011 and the very volatile market thus far in 2015. During the market crash of 2008, IBB posted an annual return of -12.2% while the S&P 500, Nasdaq and Dow Jones posted returns of -37.0%, -40.0% and -31.9%, respectively (Figure 3). During the bear market of 2011, IBB posted an annual return of 11.7% while the S&P 500, Nasdaq and Dow Jones posted returns of 2.1%, -0.8% and 8.4%, respectively (Figure 3). Thus far during the highly volatile market of 2015, IBB posted an annual return of 13% while the S&P 500, Nasdaq and Dow Jones posted returns of -5.8%, -0.8% and -8.6%, respectively (Figure 4). These data suggest that IBB outperforms during bear markets and thus has established itself as a secular growth sector and in the face of unrelated economic events may provide a buying opportunity. (click to enlarge) Figure 3 – Morningstar comparison of IBB annual returns relative to the Nasdaq over the previous 10 years (click to enlarge) Figure 4 – Google Finance comparison of IBB annual performance thus far in 2015 relative to the S&P 500, Nasdaq and Dow Jones Conclusion: As the confluence of these economic events seemingly disconnected in bringing down the biotechnology sector coupled with expenditure growth in overall health and prescription drug spending, it may be a good time to consider capitalizing on this correction via adding to existing positions or initiating a new position in this cohort given this opportunity. Being opportunistic and capitalizing on the recent volatility on pullbacks to slowly add to or initiate a position may be the opportunity investors have been waiting on to pounce on IBB. Data suggests, provided a long-term position that volatility within the biotech sector is negated by its long-term performance that is unparalleled by any major index. This sector provides high returns unrivaled by any major index with moderate risk (based on its resilience during the bear markets of 2008 and 2011 and thus far in 2015) and volatility. IBB may be providing investors with a great opportunity to add or initiate a position for any long portfolio desiring exposure to the biotechnology sector with a long-term time horizon given the recent market conditions. References: CMS.gov Statistics Trends and Reports Disclosure: The author currently holds shares of IBB and is long IBB. The author has no business relationship with any companies mentioned in this article. I am not a professional financial advisor or tax professional. I wrote this article myself and it reflects my own opinions. This article is not intended to be a recommendation to buy or sell any stock or ETF mentioned. I am an individual investor who analyzes investment strategies and disseminates my analyses. I encourage all investors to conduct their own research and due diligence prior to investing. Please feel free to comment and provide feedback, I value all responses. Disclosure: I am/we are long IBB. (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.

Best And Worst Q3’15: Small Cap Blend ETFs, Mutual Funds And Key Holdings

Summary The Small Cap Blend style ranks last in Q3’15. Based on an aggregation of ratings of 30 ETFs and 659 mutual funds. FNDA is our top-rated Small Cap Blend ETF and PXQSX is our top-rated Small Cap Blend mutual fund. The Small Cap Blend style ranks last out of the 12 fund styles as detailed in our Q3’15 Style Ratings for ETFs and Mutual Funds report. It gets our Dangerous rating, which is based on an aggregation of ratings of 30 ETFs and 659 mutual funds in the Small Cap Blend style as of July 20, 2015. See a recap of our Q2’15 Style Ratings here. Figures 1 and 2 show the five best and worst-rated ETFs and mutual funds in the style. Not all Small Cap Blend style ETFs and mutual funds are created the same. The number of holdings varies widely (from 24 to 2526). This variation creates drastically different investment implications and, therefore, ratings. Investors seeking exposure to the Small Cap Blend style should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2. Figure 1: ETFs with the Best & Worst Ratings – Top 5 (click to enlarge) * Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings Eight ETFs are excluded from Figure 1 because their total net assets are below $100 million and do not meet our liquidity minimums. Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5 (click to enlarge) * Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings Four mutual funds are excluded from Figure 2 because their total net assets are below $100 million and do not meet our liquidity minimums. The Schwab Fundamental U.S. Small Company Index ETF (NYSEARCA: FNDA ) is the top-rated Small Cap Blend ETF and the Virtus Quality Small-Cap Fund (MUTF: PXQSX ) is the top-rated Small Cap Blend mutual fund. FNDA earns a Dangerous rating and PXQSX earns an Attractive rating. The Global X Guru Small Cap Index ETF (NYSEARCA: GURX ) is the worst-rated Small Cap Blend ETF and the Investment Managers Chartwell Small Cap Value Fund (MUTF: CWSVX ) is the worst-rated Small Cap Blend mutual fund. Both earn a Very Dangerous rating. Escalade (NASDAQ: ESCA ) is one of our favorite stocks held by Small Cap Blend funds and earns our Very Attractive rating. Since bottoming out in 2008, Escalade’s after-tax profit ( NOPAT ) has grown by an impressive 55% compounded annually. NOPAT margin has increased tenfold to 10% over the same timeframe. Return on invested capital ( ROIC ) has also improved to 10% from 1% in 2009. Despite the strong turnaround since the economic recession, ESCA remains undervalued. At the current price of $18/share, ESCA has a price to economic book value ( PEBV ) ratio of 0.9. This ratio implies that the market expects the company’s profits to permanently decline by 10%. If Escalade can grow NOPAT by just 6% compounded annually for the next five years , the stock is worth $22/share – a 22% upside. Alon USA Energy (NYSE: ALJ ) is one of our least favorite stocks held by Small Cap Blend funds and earns our Very Dangerous rating. Since 2011, NOPAT has declined by 28% compounded annually. Alon currently earns a 5% ROIC, which is less than a quarter of the 22% earned in 2005. Investors have overlooked the deterioration of Alon’s fundamentals, and the stock is overvalued. To justify the current price of $18/share, Alon must grow NOPAT by 12% compounded annually for the 15 years . For a company that has struggled with earning consistent profits for years, this expectation appears to be overly optimistic. Figures 3 and 4 show the rating landscape of all Small Cap Blend ETFs and mutual funds. Figure 3: Separating the Best ETFs From the Worst Funds (click to enlarge) Sources: New Constructs, LLC and company filings Figure 4: Separating the Best Mutual Funds From the Worst Funds (click to enlarge) Sources: New Constructs, LLC and company filings D isclosure: David Trainer and Max Lee receive no compensation to write about any specific stock, style, style or theme. 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. I have no business relationship with any company whose stock is mentioned in this article.