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Bill Gross Cautious On Rate Hike In 2015: 2 Investment Grade Bond Funds To Buy

According to the ‘Bond King’ or bond investor extraordinaire William Hunt ‘Bill’ Gross, the good times may be over and many asset prices may drop in 2015. Record-low rates have failed to spur enough economic growth, according to Gross, and he believes the Fed may not be in a position to hike rates until late this year, if it at all does. “With the dollar strengthening and oil prices declining, it is hard to see even the Fed raising short rates until late in 2015, if at all,” said Gross, who is now in charge of the Janus Unconstrained Bond Fund. In an investment outlook for the Janus Capital Group, Inc. (NYSE: JNS ), Gross said investors would look for alternatives to risky assets. Gross Warns of ‘Minus Signs of Returns’ Gross seemed extremely cautious on 2015. Global economic growth is not enough even after years of low rates, and this may lead investors to seek alternatives to risky assets. The fact that borrowing costs are still stuck at near zero even after over half a decade of the end of the recession shows investors’ lack of confidence in the economic strength. “Be cautious and content with low positive returns in 2015. The time for risk taking has passed,” said Gross. He added, “At some future date … asset returns in many categories may turn negative.” This year has already begun on a dismal note for the benchmarks, registering their biggest declines to begin a year since 2008. The Dow, S&P 500 and Nasdaq are down 2.6%, 2.8% and 3.1%, respectively, year to date. However, 2014 too had begun with losses for these benchmarks. Gross however supports holding high-quality assets that have stable cash flows. He said that investors’ focus on “Treasury and high-quality corporate bonds, as well as equities of lightly levered corporations with attractive dividends and diversified revenues both operationally and geographically.” Debt Supercycle? Bill Gross warned of “minus signs in front of returns for many asset classes” at the end of 2015. The creation of cheap money by the central banks might face a troubled end. Gross believes that the realization of the debt supercycle approaching an end would show the markets’ gains as ‘debt-fueled sugar high,’ reported The Wall Street Journal. The recent years of the Bull Run was sparked by low rates and accelerated credit growth. Gross states that the central banks have countered challenges by rounds of credit creation and low rates. Gross said: The power of additional and cheaper credit to add to economic growth and financial-asset bull markets has been underappreciated by investors since 1981…Investors have continued to assume that monetary (and at times fiscal) policy could contain the long-term business cycle. However, Gross believes that the debt supercycle is nearing its end. It ends “when yields, asset prices and the increasing amount of credit place an unreasonable burden on the balancing scale of risk and return.” Growth Concerns Global economic growth concerns surfaced in 2015, with the Eurozone particularly posting dismal growth numbers. Japan too had entered a technical recession. Chinese economic data was shaky as well. However, the U.S. has outperformed these major economies and reported 5% growth in the third quarter of 2014. Gross believes that the growth rates in developed and developing nations are failing as a lot of capital is put into “risk-free” capital markets instead of the real economy. Now, there are concerns about Greek exiting the euro. The latest turmoil comes while the oil prices have slumped below $50 a barrel. These factors have combined to send the U.S. markets tumbling by the worst margins to start a year since 2008. Fed’s Stance In the Fed statement following the two-day policy meeting last month, the central bank sounded positive regarding economic growth and also mentioned that they will show some patience before hiking interest rates. The Fed stated: Based on its current assessment, the committee judges that it can be patient in beginning to normalize the stance of monetary policy. Investment Grade Bond Funds to Benefit A low interest rate environment is favorable for investments in bond funds. This stems from the fact that market value of a bond is inversely proportional to the interest rates. The primary forms of bond risk include default risk and the interest rate risk. The latter is obviously the most important these days. Meanwhile, global government bond yields dropped to a new low recently. 10-year U.S. Treasury note yield was down to 1.964% on Tuesday, the lowest since May 2013. Gross warns that investors “do not look, therefore, for economic growth to be the magic elixir for 2015.” He suggests, “Investors should be flexible and consider more liquid securities. Fixed income with shorter maturities is one starting place.” Investors agreeing with Gross’ views may thus look for investing in Investment Grade Bond funds. Bill Gross suggests “high-quality corporate bonds.” Here we will suggest 2 Investment Grade Bond Funds that carry a Zacks Mutual Fund Rank #1 (Strong Buy) as we expect the funds to outperform its peers in the future. The funds have decent 1-year return. They also have beta of less than 1. Funds having betas within this range will show less volatility than the broader markets. BlackRock Total Return Services (MUTF: MSHQX ) seeks total return that outperform Barclays Capital U.S. Aggregate Bond Index. Over 90% of the fund’s assets are invested in varied fixed-income securities such as corporate bonds and notes, mortgage-backed securities, asset-backed securities, convertible securities, preferred securities and government obligations. It mostly invests in investment grade fixed-income securities. It is a feeder fund, investing in a corresponding “master” portfolio. The fund has a one-year return of 8.3% and carries a Zacks Mutual Fund Rank #1 (Strong Buy). It has a one-year beta of 0.94. It carries an expense ratio of 0.76% as compared to category average of 0.86%. Nuveen Core Plus Bond A (MUTF: FAFIX ) seeks to provide current income along with limited risk to capital. It invests the majority of its assets in bonds. These include U.S. government securities that may include zero coupon securities, residential and commercial mortgage-backed securities, and corporate debt obligations among others. The fund has a one-year return of 5.2% and carries a Zacks Mutual Fund Rank #1 (Strong Buy). It has a one-year beta of 0.92. It carries an expense ratio of 0.77% as compared to category average of 0.86%.

How Are Housing ETFs Poised For The New Year?

The housing construction market has recovered at a steady and gradual pace in the second half of 2014 after a slump at the beginning of the year. Overall economic growth, improving job numbers, growing consumer confidence, moderating home prices, stabilizing mortgage rates and a low level of housing inventory all led to the improvement. A string of housing data released lately portrays a mixed to slightly positive picture of the housing market. Existing home sales and new home sales rose in the month of October. Though housing starts declined in October and November, analysts in general believe the broader housing trends are stable to slightly positive and will pick up momentum in the New Year. Homebuilders are also turning more optimistic as demand for new homes rises with an improving job market and growing consumer confidence. Homebuilders’ confidence, as indicated by the National Association of Home Builders (NAHB)/Wells Fargo housing market index, rose 4 points to 58 in November. Though the index declined a point to 57 in December, it is still well above 50, which is the demarcating line between expanding and contracting activity levels. However, what keeps us concerned are the chances of a rise in short-term interest rates in 2015 as the Fed has already ended its six-year long quantitative easing program in October. Though the Fed had earlier promised to keep the key interest rate at record low for a ‘considerable time,’ investors are speculating about the timing of the planned rate hike. The robust job numbers might draw the Federal Reserve closer to raising interest rates. Higher interest/mortgage interest rates may have a moderating effect on housing demand and pricing. ETFs to Tap the Sector Given the improving fundamentals, the homebuilding sector deserves a closer look. For investors willing to play the space in a less risky way, an ETF approach can be a good idea. This technique can help to spread out assets among a wide variety of companies and reduce company specific risk at a very low cost. Below, we have highlighted three ETFs that are worth looking into. The SPDR Homebuilders ETF (NYSEARCA: XHB ) XHB is one of the more popular homebuilding ETFs in the market today with assets under management of around $1.48 billion and a trading volume of roughly 4.07 million shares a day. The fund has an expense ratio of 35 basis points. The fund holds 37 stocks in its basket, with 44% of the assets going to mid caps and 6% comprising large cap stocks. Despite the smaller holding pattern, the fund does not appear to be concentrated in the top 10 holdings. The fund has just 34.1% in the top 10 with Lowe’s Companies (NYSE: LOW ), Whirlpool Corporation (NYSE: WHR ) and Restoration Hardware Holdings (NYSE: RH ) occupying the top 3 positions with asset allocation of 3.64%, 3.63% and 3.56%, respectively. The fund’s assets include 33% homebuilders, 15% household appliances securities, 26% specialty retail stocks and the balance 26% building materials companies. The fund carries a Zacks Rank #3 (Hold) with a high level of risk. The iShares U.S. Home Construction ETF (NYSEARCA: ITB ) Another popular choice in the homebuilding sector is ITB, which tracks the Dow Jones U.S. Select Home Construction Index. It has $1.55 billion in assets with a trading volume of roughly 3.5 million shares a day, while its expense ratio is just 45 basis points. The fund holds 39 stocks in its basket, out of which only 12% are large cap securities. The fund has a concentrated approach in the top 10 holdings with 62.9% of the asset base invested in them. Among individual holdings, top stocks in the ETF include D.R. Horton, Inc. (NYSE: DHI ), Lennar (NYSE: LEN ) and Pulte (NYSE: PHM ) with asset allocation of 10.97%, 10.53% and 9.67%, respectively. Homebuilders accounts for around 64% of this fund. The fund carries a Zacks Rank #3 (Hold) with a high level of risk. The PowerShares Dynamic Building & Construction Portfolio ETF (NYSEARCA: PKB ) This ETF comprises around 30 housing companies and has its assets invested across all classes of the market spectrum. Engineering and construction stocks comprise 21% of the fund, followed by building materials companies that account for 17%. A look at the style pattern reveals that the fund has a preference for value stocks. The fund manages an asset base of $58.0 million and has an expense ratio of 63 basis points. The fund has only 16% in large cap securities and 46.1% in the top 10 holdings. The fund carries a Zacks Rank #3 (Hold) with a High level of risk. To Sum Up The housing market has improved dramatically from the trough year of 2009. Homebuilding activity is expected to take a cue from improving job numbers and a rebounding economy. Though the timing of a rise in interest rates creates uncertainty, homebuilders are increasingly optimistic of a pick up in sales in the New Year.

Motiwala Capital Q4 2014 Letter

Summary 2014 Q4 Letter to investors. Winners and mistakes. Portfolio activity (buys, sells). Fourth Quarter 2014 Letter The year 2014 ended on a strong note with the US equity market as reflected by S&P 500 up ~14% The US markets are in an amazing six year bull market with the S&P 500 having tripled from the lows of March 2009. Motiwala Capital had a below average year with consolidated net return (after all fees and expenses) of ~4%. The consolidated number means some accounts performed below this number and some above it. See important notes at the end of the letter for more information. The performance information is shown in the table below: Year S&P 500 Motiwala Capital 2011* -1.7% 4.9% 2012 16.0% 20.3% 2013 31.9% 33.2% 2014 13.7% 3.9% 2014 Performance Overall our performance in 2014 was poor both on absolute and relative basis. There were more winners than losers but two large positions suffered large declines hurting overall performance. Positions detracting from performance included North Atlantic Drilling (NYSE: NADL ) (-80%), Prosafe ( OTCPK:PRSEY ) (-57%), CTC Media (NASDAQ: CTCM ) (-33%), Blucora (NASDAQ: BCOR ) (-27%) and International Housewares (-22%). Our biggest winners were Microcap H (+90%), Microcap L (+48%), Apple (NASDAQ: AAPL ) (+42%), Visteon (NYSE: VC ) (+40%), Microsoft (NASDAQ: MSFT ) (+25%) and Oracle (NYSE: ORCL ) (+20%). In addition, 14 of the 17 special situation investments during 2014 were profitable (or breakeven) and positively impacted our portfolio returns. We will continue to invest in this area and believe it distinguishes our management style. Discussion on winners Microcaps H and L were purchased at low valuations. Both exhibited strong earnings growth and were rewarded with higher valuations resulting in superb gains. Apple had a fantastic year, releasing exciting new products and continuing to return capital to shareholders via share buybacks and dividends. Investors were more optimistic and the share price headed higher. Visteon continued to divest non-core businesses and investors were happy. Recently, the company announced the sale of its majority stake in publicly traded Halla-Visteon for $3.6 billion. Visteon will be left with only one business segment and could be potentially acquired. Microsoft and Oracle reported business as usual generating solid free cash flow and continued buybacks and dividends. Discussion on mistakes High leverage, capex and high dividend payout The positions in North Atlantic Drilling and Prosafe hurt the portfolio returns by 6%. These were the biggest mistakes since 2011. Both companies are in the energy service industry, cyclical in nature and dependent on capital spending by large oil producers, which in turn depends on crude oil pricing. NADL and PRSEY had significant capital expenditures and high levels of debt. To add fuel to the fire, they had a high (75-100%) dividend payout policy. The combination of these three factors in a cyclical business is too risky. I will guard against this in the future. Prosafe warned about weakening demand and potential dividend cuts in its Q2 earnings. The stock price fell and I felt that the bad news was priced in. In the case of NADL, its agreement with Rosneft ( OTC:RNFTF ) did not close due to sanctions against Russian entities. NADL suspended its dividend given the weak outlook. From mid September, crude oil prices started declining and there was a meltdown in late November. Most energy related stocks including NADL and PRSEY declined sharply as result. When the situation changes I purchased shares of Russian media company CTCM Media in March 2014. My argument then was “CTCM has a solid balance sheet and produces attractive free cash flows. CTCM was purchased for 10%+ FCF yield. When Russia moves out of the front-page news, I hope the stock would be higher.” After purchase, the stock appreciated by 25% despite Russia continuing to be in the headlines. The stock was still cheap and I continued to hold. However, in late September Russia passed a law restricting ownership of Russian media companies to 20% from the prior 50%. This was unexpected and the stock price took a 20% hit. Later the stock was also hurt by the rapid depreciation of the Rubble, which was caused by the rapid decline in crude oil prices. CTCM indirectly became linked to energy prices. My mistake here was not selling immediately after the media law change, which would have reduced our losses. Portfolio Composition Our portfolios are divided into two sections. The ‘Generals’ are generally undervalued equity investments that fit the value framework. The rest of the portfolio is invested in special situations (short term investments with a specific event that unlocks value) or cash. Average cash balance at the end of 2013 was 45%. The top 5 positions add up to 25% of the portfolio. We have 16 regular positions (Generals) in our portfolio. This makes up ~45% of the portfolio. The rest of the portfolio is currently in special situations (10%) and cash (45%). Cash is 30% higher over last quarter end due to heavy selling as explained later. Portfolio Characteristics Weighted average P/E = 12 (P/E is based on 12-month trailing earnings) Portfolio dividend yield = 2.4% Weighted average Market Cap = $55 billion Price to Value (P/V) For every stock we purchase, we estimate a range of fair values. We compute a ratio of current market price (price) to estimated value (value). Price to value on the invested portfolio was 0.83. Lower P/V means better upside and limited downside. A higher P/V points to lower future upside potential for the portfolio. We will continue to look for attractive investments that will help to lower the P/V at the portfolio level. Top 7 Positions (some clients will not have all the positions and in the same weights) Company name (Ticker) % of portfolio B/S Div FCF ROIC Val Visteon (Equity and Warrants) 7.5% Y Y Microcap H 5.6% Y Y Y Y Y Outerwall (NASDAQ: OUTR ) 5.4% Y Y Y Oracle 3.6% Y Y Y Y Y Blucora 3.3% Y Y Y Y Qualcomm (NASDAQ: QCOM ) 3.1% Y Y Y Y Y Conrad Industries ( OTCPK:CNRD ) 3.1% Y Y Y Y Y For the above stocks, we have provided information about which characteristics they satisfy B/S = strong balance sheet Div = pays a dividend FCF = solid free cash flow ROIC = solid Return on Invested Capital (NASDAQ: ROIC ) Val = low/reasonable valuation Portfolio by Market Cap Micro cap 18% less than $250m Small Cap 15% $250m to $2billion Mid Cap 9% $2 billion to $10 billion Large Cap 8% $10 billion to $200 billion Mega Cap 5% $200 billion + We have invested across the market cap spectrum and are market cap agnostic. Portfolio by Sector Sector Weight Technology 12% Consumer Discretionary 12% Financials 7% Energy 6% Telecom 3% Consumer Staples 3% Industrials 1% Special Situations 11% Cash 45% We do not seek investments by sector. We make our investments one stock at a time. However, as part of risk management, we want to make sure that our investments are across multiple sectors. Portfolio Activity Special Situations: Share tenders We participated in two special situations in the quarter that were profitable. Generals: Portfolio exits: We sold out of seven positions in the quarter. Some positions were sold as they hit our price targets, while some were sold when I was concerned about the business or the situation had changed. Microsoft ( MSFT ): We purchased shares of Microsoft in early 2011 around $26. During our 3+ years holding period, Microsoft has continued to be very profitable, generate lot of free cash flow, paid dividends and buyback shares. A new CEO has come in and the market perception has improved. We sold our shares around $46 as the stock price appreciated to our price target. Vodafone (NASDAQ: VOD ): Vodafone shares were also purchased in early 2011. It owned 45% of Verizon wireless back then. After the sale of its stake in Verizon wireless, VOD made some acquisitions in Europe and decided to invest heavily in its network. The major part of its business is in Europe and has been struggling for several years. The negatives from Europe are greater than the positives from the rest of its business in Asia and Africa. Finally, VOD has gone from net cash to net debt on its balance sheet to finance the dividend and capex. These combined factors swayed us to sell the position. Amcon Distributing (NYSEMKT: DIT ): DIT was purchased in the second quarter of 2013. DIT is a wholesale distributor of consumer products to convenience stores. Since our purchase, business results have been soft with declining earnings and ROE on increasing competition. Despite this, the stock price appreciated, seemed fairly valued and we sold. Hess Corp (NYSE: HES ): We sold our remaining shares of HES. HES was purchased as a special situation when it was selling assets, paying down debt and buying back shares. HES has now become a pure play E&P company. I had no interest to own HES beyond the asset sales. I was holding on for the announced spinoff of an MLP. However, with declining crude oil prices, it made sense to close the position. National Oilwell Varco (NYSE: NOV ): NOV was another energy services company in the portfolio. It is a high quality albeit cyclical business with a solid balance sheet and generates good free cash flow. NOV was sold in response to the sharp decline in crude oil prices. A major part of NOV business is providing equipment and parts for rig systems. I do not know how this business will perform 2016 onwards given the excess supply of deep-water rigs. CTC Media : We sold our shares as explained earlier. Generals: New Positions: GameStop (NYSE: GME ) makes a second appearance to our portfolio. GME is the largest video game retailer in the world and sells new and used video game software, hardware, accessories for video game systems from Sony (NYSE: SNE ), Nintendo ( OTCPK:NTDOY ) and Microsoft. Recently, GME has diversified into other concepts such as Cricket wireless stores and Simply Mac stores. GME has generated annual free cash flow of $450 million. The capital allocation policy is impressive and allows for the distribution of up to 100% of free cash flow to share holders. We purchased shares at a dividend yield of 4% and 10x P/E. Last time we purchased shares of GME, the video game console cycle was long in its tooth. The new consoles from Sony and Microsoft were released in 2013. Sales of games for the older consoles have declined faster than the increase in sales for new consoles. This is weighing on recent results. Once software sales for newer consoles pick up, I feel the shares should get re-rated higher. Generals: Reduced positions: We reduced our large position in Conrad Industries as we grew concerned about the demand for new barges that CNRD builds. The stock appears cheap on a trailing basis but this is a cyclical business and we wanted to be a bit cautious after a superb multiyear run. We sold half of our remaining position in Apple) after the stock doubled since our investment in Q2 2013. We sold half of our position in Franklin Resources (NYSE: BEN ) as it traded close to our conservative price target. My initial assessment on the valuation was higher due to the large net cash of $8 billion (25% of market cap). However, this cash is held overseas and is unlikely to be returned to shareholders. Also, recent asset flows have stagnated at this asset management firm. Generals: Increased positions During the quarter we increased our positions in Visteon warrants (VSTOW) and International Housewares (1373) as they were attractively priced. High Cash levels Cash in the portfolio grew to an all time high of 45%. The reason for this is simply because we sold (33%) a lot more than what we bought (5%) in this quarter. It has become increasingly difficult to find attractive investments as markets overall have run up. However, I continue to look for investments to deploy some of the cash. Often investors question when there are high cash levels as it can detract from performance in a period of rising markets. The value of cash is twofold: it acts as a buffer in declining markets and the optionality it provides to make purchases. Special dividends : Once again Conrad gave us a Christmas gift and declared a special dividend of $1/share. On our original purchase price of $15, we have already received $5/share in dividends. Conrad also instituted a regular quarter dividend of $0.25/share. Asset manager Franklin resources declared a $0.5/share special dividend and raised its dividend. Other news : I am happy to report that I have moved into my new office. At year-end, our AUM was $5.4 million. We wish everyone a prosperous and happy new year 2015. Please contact me if you are interested in our managed account services. This commentary candidly discusses a number of individual companies. These opinions are current as of the date of this commentary but are subject to change. All information provided is for information purposes only and should not be considered as investment advice or a recommendation to purchase or sell any specific security. While the information presented herein is believed to be reliable, no representations or warranty is made concerning the accuracy of any data presented. This communication may not be reproduced without prior written permission from us. Past performance is no guarantee of future results. Motiwala Capital performance is computed on a before-tax time weighted return (TWR) basis and is net of all paid management fees and brokerage costs. Performance figures are unaudited. Performance of individual accounts may vary depending on the timing of their investment, the effects of additions, and the impact of withdrawals from their account. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.