Tag Archives: seeking-alpha

Smart Beta, Dumb Money And EMH

Someone asked me about Smart Beta in the forum the other day and I got to thinking about this. Indexers are all basically chasing some form of beta. But some indexers chase beta in stupid ways and some indexers chase beta in smart ways. An increasingly common example of this is the many forms of factor investing that have become popular in recent years (in case you haven’t noticed, I don’t like factor investing – see here and here ). I am generalizing, but I tend to believe that factor investing is just a new clever way to get people to pay higher fees for owning index funds. Now, this particular reader asked about the profit factor so I went exploring. It turns out that there are more than a few ETFs that track this profit factor. The largest one is the WisdomTree MidCap Earnings ETF ( EZM), which has 770 million in assets and “seeks to track the investment results of earnings-generating mid-cap companies in the U.S. equity market.” So, I go and compare this fund to the Russell Mid-Cap Index. It actually appears to be beating the index since inception, but it has a 99% correlation. Something doesn’t smell right about that. So, I look under the hood and find that it actually deviates from the Mid-Cap Index quite a bit. While the Mid-Cap Index has an average market cap of 10.5B this fund has a market cap of just 4.2B. Ah, so there’s the outperformance. It’s not profits, it’s just higher risk smaller cap stocks. And if you layer on the Russell 2,000 Small Cap Index, whose market cap is 1.5B, you get a near perfect replica of EZM. This is precisely what I expected given that I’ve run some version of this experiment almost every day for the last few years when assessing people’s portfolios. The kicker is, this fund isn’t “smart” at all. The only thing that’s smart about it is that it deviates from the Russell Mid-Cap Index giving it the appearance of better performance. And so what we have here is a sort of sad case of dumb money chasing market inefficiency and proving that the only thing inefficient here is their factor chasing charade. And in doing so they’re paying 0.38% per year for a fund that costs as low as 0.07% elsewhere. That’s almost $2.5 million in annual fees being flushed down the drain there. And that’s just one fund out of a growing list of hundreds and maybe thousands. I’d laugh if it didn’t make me sad. Share this article with a colleague

3 Sector Funds To Gain On Oil Slump

The slump in oil prices has now continued for over a year. There was relief this year in March when crude prices moved up seemed a blip, as they are back near $40 mark now. Last Friday, prices of WTI crude oil declined 2.2% to $40.45 per barrel on Friday. WTI crude oil also registered its eighth straight weekly loss, its longest weekly losing streak since 1986. Additionally, the Brent crude oil declined 2.6% to $45.46 per barrel. Oil prices took a beating after Baker Hughes Incorporated (NYSE: BHI ) reported that oil rig counts increased to 674 as of Aug 21. On Monday, price of WTI crude oil tanked 5.8% to $38.24 per barrel. The price of WTI crude oil finished below $39 a barrel for the first time since Feb 2009. Additionally, the Brent crude oil declined 6.5% to $42.69 per barrel. The price of Brent crude oil fell below the $43 mark for the first time since Mar 2009. However, certain sectors seem to enjoy a blessing in disguise amidst the oil market rout. These sectors benefit from the oil slide in certain ways. While auto and transportation are direct beneficiaries, sectors such as retail, consumer discretionary and consumer staples also gain from low oil prices. Thus, to buy certain favorably ranked stocks from these sectors will be a prudent move. Recent Oil Slide WTI crude oil prices plunged around 21% in July, witnessing its biggest monthly decline since Oct 2008. Meanwhile, the price of Brent crude oil is close to going below the $40 level now. Both the crude prices are trading at multi-month low levels. Very recently, the weakening Chinese economy and the weekly rig count report showing another increase in the number of drilling rigs operating in the U.S were responsible for the ugly slip. Recently released economic data indicated that China, the second biggest economy of the world, is suffering from a sluggish growth environment. This has curbed the demand for oil by a significant proportion. Some analysts opine that China’s economic activity may fall below 7% in the third quarter. This will hamper oil demand from the world’s second-largest consumer. In the US, news that oil producers increased their rig count for five straight weeks shocked an already over-supplied market. The demand and supply imbalance is striking and with little hope of a steady rebound. Until China recovers and producers put a lid on volumes, crude is fated to fall. And if market predictions hold any truth, there is hardly any reason for investors in this space to rejoice. Auto & Transportation: Direct Beneficiaries Recently released auto sales data indicates the benefits from the low oil price environment. U.S. auto sales came ahead of expectations in July, fueled by demand for light trucks and sport-utility vehicles rather than fuel-efficient cars. The seasonally adjusted annual sales rate (SAAR) climbed 3.2% from June to 17.6 million in July, its second highest tally in a decade. Meanwhile, domestic vehicle sales rose 5.2% to an annualized rate of 14.2 million in July, which exceeded the consensus estimate of 13.5 million. Meanwhile, the Dow Jones Transportation Average (DJT) has gained while oil prices slumped. Airlines industry, included in this sector, is a major gainer from this situation. In the second quarter, the aviation industry is said to have amassed record quarterly profit of more than $5 billion. Plunge in fuel prices coupled with strategic investments to bring in more passengers on board have buoyed profit margins. Fund to Buy Fidelity Select Automotive Portfolio (MUTF: FSAVX ) invests a majority of its assets in companies that manufacture, market and sell automobiles, trucks, specialty vehicles, parts, tires, and related services. The non-diversified fund invests in both US and non-US companies, primarily in common stocks. Fidelity Select Automotive Portfolio carries a Zacks Mutual Fund Rank #1 (Strong Buy) . FSAVX’s 3 and 5 year annualized returns are 18.2% and 13%. The expense ratio of 0.85% is lower compared to category average of 1.46%. Retail: Indirect Beneficiary Along with strong labor market conditions, decline in oil prices has played an important role in increasing consumer spending in recent times. According to the “advance estimate” released by the U.S. Department of Commerce, Real Personal Consumption Expenditure rose 2.9% during the second quarter, higher than the first quarter’s growth rate of 1.8%. Funds to Buy Putnam Global Consumer Fund (MUTF: PGCOX ) invests in mid to large companies that are involved in the manufacture, sale or distribution of consumer staples and consumer discretionary products and services. Putnam Global Consumer A currently carries a Zacks Mutual Fund Rank #1. PGCOX boasts year-to-date return of 4.4% and has returned nearly 4.9% over the past 1 year. The 3 and 5 year annualized returns are 13.9% and 14.5%. The expense ratio of 1.29% is however higher compared to category average of 1.27%. Rydex Retailing Fund (MUTF: RYRIX ) seeks growth of capital. RYRIX invests almost all its assets in equities of US-traded retail companies. Apart from investing in small to mid-cap retailing companies, RYRIX may also buy ADRs to get exposure to foreign retailers. RYRIX may also invest in derivatives and US government securities. RYRIX currently carries a Zacks Mutual Fund Rank #2 (Buy) . RYRIX’s 3 and 5 year annualized gains stand at 14.7% and 18.5%. The annual expense ratio of 1.33% is lower than category average of 1.46% Link to the original article on Zacks.com

Tax-Free Income From Municipal-Bond CEFs: A Closer Look

Summary Municipal-bond closed-end funds offer excellent opportunities for high levels of tax-free income. This category is the largest in the closed-end fund space. Here I look in some detail at funds that rose to the top in an earlier filtering of the entire municipal bond CEF universse. A Closer Look at Top-Scoring Municipal Bond CEFs I recently discussed tax-free, municipal-bond, closed-end funds ( here ). Tax-free munis comprise the largest category of closed-end funds. Two sites ( Cefanalyzer and cefconnect ) were the primary sources for the previous report. They list 99 funds covering tax-free national municipal bonds with over $45 T in AUM, so narrowing down that lot to a manageable number of candidates to research can be daunting. I identified several that looked to be potentially appealing based primarily on criteria set out by Eli Mintz using the relationship between return on NAV and discount as a filter. Briefly, Mintz noted a modest linear relationship between the two metrics and argued that funds falling well below the linear trend line were most worth exploring when making new purchases. I received some excellent feedback in the comments to that article. In particular, several readers pointed to two Eaton-Vance funds as being among today’s best opportunities in tax-free CEFs. In this article I want to expand in greater detail some of the funds previously noted plus the two Eaton-Vance offerings. The funds I’ll discuss are: MFS High Yield Municipal Trust (NYSE: CMU ) Dreyfus Municipal Bond Infrastructure Fund, Inc. (NYSE: DMB ) Eaton Vance Municipal Bond Fund (NYSEMKT: EIM ) Eaton Vance Municipal Bond Fund Ii (NYSEMKT: EIV ) MFS Municipal Income Trust (NYSE: MFM ) Nuveen Municipal Advantage Fund Inc (NYSE: NMA ) Nuveen Municipal Market Opportunity Fund Inc (NYSE: NMO ) Nuveen Select Quality Municipal Fund Inc (NYSE: NQS ) Nuveen Dividend Advantage Municipal Fund 2 (NYSEMKT: NXZ ) Nuveen Dividend Advantage Municipal Fund 3 (NYSEMKT: NZF ) Invesco Trust For Investment Grade Municipals (NYSE: VGM ) Invesco Advantage Municipal Income Trust II (NYSEMKT: VKI ) Invesco Municipal Opportunity Trust (NYSE: VMO ) This is a mixed group with some focused on high yield, others on credit quality, others on duration. The funds that appeared most interesting using Mintz’s criteria, which emphasizes high NAV return and deep discounts tend to push further out on the credit-quality scale, have longer durations, and relative high percentages of their portfolios subject to AMT. As the appeal of these funds is tax-free income, the AMT issue can be a deal breaker for some investors. Here is a heat-map table summarizing Discount, Distributions, Net Investment Income, Average Portfolio Maturity and Leverage. (click to enlarge) The next chart compares credit quality among the funds. On the horizontal axis, I’ve listed the funds and, in parentheses, their average portfolio credit rating based on number of bonds (data from Morningstar ). (click to enlarge) The superior credit quality of the two Eaton-Vance funds (EIM, EIV) is clearly evident in this chart. The percentage of each portfolio’s bonds that is subject to AMT shows a wide range as seen in the next chart. EIM and EIV are zero-AMT funds. The MFS funds (CMU and MFM) carry the highest AMT liabilities at 24% for MFM and 22% for CMU. The Nuveen funds (NMA, NMO, NQS, NXZ and NZF) are lowest of the non-zero group with the Invesco funds (VGM, VKI and VMO) intermediate. EIM and EIV are zero-AMT funds. The MFS funds (CMU and MFM) carry the highest AMT liabilities at 24% for MFM and 22% for CMU. The Nuveen funds (NMA, NMO, NQS, NXZ and NZF) are lowest of the non-zero group with the Invesco funds (VGM, VKI and VMO) intermediate. The next table shows effective durations, unadjusted and adjusted for leverage: Effective Duration Unadjusted Adjusted for Leverage CMU 6.56 10.20 DMB 6.49 9.40 EIM 4.86 8.00 EIV 2.86 4.70 MFM 7.00 10.00 NMA 7.10 10.88 NMO 7.72 12.10 NQS 7.76 12.32 NXZ 7.47 11.31 NZF 8.29 12.80 VGM 7.97 13.44 VKI 7.71 12.97 VMO 7.82 13.11 Again, the Eaton-Vance funds, especially EIV, stand out from the pack. Summary The Drefus fund made this list on the basis of its deep discount (ranking 4th of the 99 funds screened) and a return on NAV near the median (51/99) which place it very high using the qualitative Mintz criteria. Leverage (10.39%) is low for this category (12/99), which helps to moderate risk for the fund. Duration is shorter than all but the Eaton-Vance funds, which reduces interest-rate risk relative to the rest of the pool. On the negative side, credit quality is low, averaging BBB- for the portfolio. Unfortunately, it has the highest negative net investment income in the field (99/99); the fund’s payout yield is 6.47%, but its actual yield is only 4.84%. One might reasonably expect a distribution cut soon. As the funds primary appeal is its high yield for low leverage, the specter of a dividend cut takes it out of my consideration. For investors primarily interested in high levels of tax-free income, the Invesco funds (VKI, VGM and VMO) might be most appealing. Next would come the MFS funds (CMU and MFM). VKI pays a tax-free 7.01% (2/99); excess NII is a negative -0.25%. The other two offer similar results. But these three funds use the highest levels of leverage to achieve those returns. For the entire universe of national tax-free CEFs, only 5 exceed 40% leverage, these three Invesco funds are among those five. For VKI, leverage is 40.54% (97/99) with VGM and VMO (96 and 95/99) only slightly behind. The MFS funds also offer high yields. CMU is paying 6.77% (11/99) and MFM pays 6.31% (47/99). Unlike the Invesco funds, they do so without paying shareholders more than they are taking in. CMU’s excess NII of 0.72% ranks 3/99 for the tax-free muni-bond CEF universe and MFM’s 0.49% ranks 6/99. It would appear their yields are safe for the near term. Leverage is moderate, CMU carries 35.56% (55/99) and MFM carries 30.04% (25/99). CMU’s average portfolio credit rating of BBB- is low, but not out of line with the Invesco funds. MFM is much better at BB+. None of these high-yielding funds would appeal to investors who place a high priority on minimizing AMT, however, as they are among the highest for this metric. The Nuveen funds carry deep discounts, which drive moderately high yields from less risky portfolios. Those discount range from the mid -13%s to the mid -14%s. and rank 5, 7, 8 and 13 of all 99 funds. This generates yield near 6% (5.93 to 6.09%) from moderate leverage (32.13 to 33.98%), which clusters the fund near the lower mid-range of leverage for all funds. Credit quality is intermediate for the group (all BBB average rated except NXZ at BBB-). I’ll close with the Eaton-Vance funds. These are clearly the best for a more conservative investor who is more interested in credit quality (A- for EIM and AA for EIV) than yield (6.28% for EIV, ranking 49/99 and 5.91% for EIV, 68/99). For investors subject to AMT, the fact that they are AMT free can enhance those yields on a tax-equivalent basis as well. Leverage is high, however; both fall into the top 10% of all funds. These funds did not make the cut in my initial analysis because that exercise depended heavily on Mintz’s relationships between NAV return and discount. From that point of view EIV falls directly on the trend line and EIM, with its greater discount, falls moderately below it. As respondents to my last article, especially wiseone123 and Johan2003 , point out these funds have strong portfolio, attractive yields and discounts and should be considered strong candidates by anyone looking for entries into muni-bond CEFs at this time. Thanks to the commenters on the previous article for their excellent feedback, especially with regard to the Eaton-Vance funds, which certainly appear to be the choice of the lot. If one were to follow Mintz’s lead, then EIM would probably be the better choice of the two, but this comes at the cost of reduced portfolio credit quality. The most conservative investor would likely choose EIV with its high credit quality, low duration and reasonably high yield. Even using Mintz’s criteria, the fund is a reasonable buy as it is not in the more problematic space above the trend line. (For discussion of the NAV distribution/discount relationship with a summary of all 99 funds, see my earlier article, linked above.) 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.