Tag Archives: seeking-alpha

Closed-End Target Date Muni Bond Funds Have A Good Yield And Low Interest Rate Risk

Blackrock and Nuveen target date funds pay back upon maturity. These funds hold pretty safe municipal bonds. These fund have decent yields. Blackrock (NYSE: BLK ) and Nuveen have a series of closed-end municipal bond funds that have a target date maturity. These funds have a nice yield and pay back principal in just a few years. We will look at the Blackrock Municipal 2018 Term Trust (NYSE: BPK ). As of today, it is trading at $15.50 and is almost at par with its net asset value (NAV). That means that the underlying portfolio of cash and bonds are worth what the market capitalization is. The portfolio holds 124 different issues of municipal bonds. They appear to be revenue bonds with names like: New York State Dormitory, California Waste, and Maryland Transportation. Revenue bonds are backed by the revenues generated from a certain project like a toll road or student housing. The bonds are rated: 6.9% AAA, 21.4% AA, 41% A, 18.9% BBB, 5.2% BB, 3.3% not rated, and 3.3% cash. The portfolio is only 1.5% leveraged, meaning that in a closed-end fund, that is all that has been borrowed. The fund has returned 5.8% since it was taken public in October 2001. Most of the time, it trades at par to NAV except when the markets went crazy in ’08 and then recovered. The trust yield 4.7¢ a month, so the total yield is 56.4¢ a year divided by today’s market price of $15.50 for a yield of 3.64%. The bonds will be liquidated or will have matured by December 31, 2018. That’s a pretty good yield for a bond that matures in about three years. The maturity price is $15. I assume that there could be some cash left over. The internal fee is 0.64%. It does not appear that there are many funky bonds that could go under. These include Detroit, Illinois, and Puerto Rico government obligations. As the bonds in the portfolio are backed by specific projects, they appear to be pretty safe. I must say, it’s seems like a pretty good investment for certain circumstances. As bonds are sold in $1,000 increments and the minimum that most bond brokers require is to buy in a $5,000 a lot, an investor must have quite a bit of money to hold a diversified portfolio. These Blackrock funds are good to hold smaller amounts of cash that are low risk, provided that the trade fees don’t negate the returns. These funds are traded like stocks. Other funds that fit in this category include: the Blackrock Municipal 2020 Term Trust (NYSE: BKK ), the BlackRock New York Municipal 2018 Term Trust (NYSE: BLH ), the Nuveen Intermediate Duration Quality Muni (NYSE: NIQ ), and another Nuveen Intermediate Duration Municipal Term Fund (NYSE: NID ). I have not done the research on these as I have on the Blackrock listed above. I have also not looked at the prospectus and just looked at the fact sheet. The particular closed-end fund seems to have a decent return and should do well in a rising interest rate environment. It would be nice if the fees were a little lower but what can you do? A yield of over 3% with a maturing of three years is pretty good in this environment.

Illiquid Securities Could Bite Mutual Fund Shareholders In The Rear

Increasingly mutual funds are buying into startups before they are public. That sounds great as you read about the valuations afforded non-traded startups. But look at the 2000 tech stock bubble, startups don’t always work out as planned. There has been a series of articles lately spattered across The Wall Street Journal, the New York Times, and Forbes discussing the issue of mutual funds and illiquid securities. It isn’t that this is a huge problem, but it’s one that’s worth understanding because it could have a notable impact on you if you happen to own a fund like , say, the Fidelity Contrafund Fund (MUTF: FCNTX ). How much is Airbnb worth? Around the middle of 2015 , Airbnb raised $1.5 billion worth of money by selling non-public shares. That gave the company a valuation of roughly $25.5 billion. Just for reference, Marriott International’s market cap is around $20 billion. Airbnb is a hot tech startup that helps people rent out their guest rooms over the internet. (Marriott is just a lowly public company that’s been doing the whole hotel thing for decades.) Airbnb is such a hot investment because it’s part of the “sharing economy” theme that’s big right now, including names like Uber. Uber is pretty much an online taxi service that allows every day folks to hire themselves out for rides. These are exciting ideas, to be sure, though I’m not a big fan myself. The idea of having strangers stay in my home or of staying in a stranger’s home doesn’t appeal to me. I’ll just pay for a room at a hotel, thanks. But the sharing society theme is really changing the world as we know it. Uber, for example, has prompted taxi drivers around the world to revolt . (And why not, taxi drivers generally have to go through hoops to get their hack licenses, anyone with a car and an Internet connection could potentially become an Uber driver.) But here’s the thing, Uber and Airbnb are private companies. Mom and pop investors can’t buy into them. But as the Airbnb example above shows, sophisticated and wealthy investors can and do. The list of well-heeled investors looking to get in on the next big thing before it goes public, however, is increasingly including mutual funds. The kind of funds that mom and pop investors actually own. That’s some list Take, for example, the Fidelity Contrafund. A quick look at the fund’s June 2015 semi-annual report shows that it’s invested in Airbnb and Uber. But that’s not the end of the list, it’s also invested in 23andme, Blue Apron, Dropbox, and Pinterest, among others. If you’ve never heard of some of these companies don’t feel bad, they are private placement darlings. But if you own Contrafund, you own a tiny slice of these startups. To be fair, they are just a small portion of Contrafund’s portfolio, but I’m not sure that these are the types of companies investors were thinking about when they gave Fidelity Contrafund their hard-earned money to invest. Contrafund, by the way, is hardly alone. For example, the T. Rowe Price Media & Telecommunications Fund (MUTF: PRMTX ) also owned Uber, Dropbox, and Airbnb, among many other private placements at the mid-point of the year . (Just to be clear, I’m not sure Uber or Airbnb count as media or telecom, and I’ll give a leery pass on Dropbox.) Forbes , meanwhile, recently highlighted the Hartford Growth Opportunities Fund (MUTF: HGOIX ) as having as much as 6% of assets in such investments with the Davis Global Fund (MUTF: DGFYX ) at 4%, those are getting to notable numbers percentage wise. And, obviously, This isn’t unique to one fund sponsor or one fund. So my first big concern is really about fund companies living up to their fiduciary duty. Are these the types of investments that should be in a portfolio meant for small investors? You could argue that the funds are providing access to an area from which investors would be otherwise excluded. Moreover, compared to the total portfolio, these investments are relatively small and could have a big payoff. These are true statements and I can see the validity of the arguments. But I remember how shocking it was to watch the tech bubble implode. It was exactly these types of companies that did the imploding once they came public. Is that risk reward tradeoff a good one for a retiree? I’m not sure it is. And if the excitement fades before these private placements list on a public exchange, these investments could turn sour and leave the funds that own them with no way out. Is that a real number? So the appropriateness of private placements in mutual funds is my first concern. But that leads to other issues. For example, it can be hard, if not contractually impossible, to sell private placements since there’s no public market. That means these are illiquid securities that could weigh down the fund in a bear market. The manager will have no choice but to sell more liquid, and potentially better, companies to meet redemptions if investors start pulling money out of the fund. That’s true even if the private companies are still doing OK operationally. And valuations are tricky, too. To give you an example, in PRMTX’s June semi-annual report it’s investment in Airbnb is listed as worth twice what it was purchased for in April of 2014. But there’s no public market so it basically had to make that number up. That’s why there’s a little number 3 footnote next to the position. That footnote tells you that its a level 3 security for valuation purposes. Note 2 to the semi-annual report explains that level 3 prices are based on “unobservable inputs.” (If that wording isn’t ominous, I don’t know what is.) In other words, T. Rowe Price didn’t have a whole lot to go on when assigning Airbnb and its other private placements a valuation. I’m going to believe that they did the best they could to come up with a reasonable valuation, but there’s a problem here. A recent Wall Street Journal article listed the per share price that was used for Uber at four different mutual funds. The difference between the highest and lowest valuations varied by nearly $7 a share. The low end was Contrafund at $33.32 a share. The high end was the BlackRock Global Allocation Fund (MUTF: MDLOX ) at $40.02 a share. On an absolute dollar basis that doesn’t seem so bad, but it’s a strikingly large 20% difference. Interestingly, the Vanguard U.S. Growth Fund (MUTF: VWUSX ) was toward the high-end at $39.64. (Yes, even Vanguard is doing it!) Now here’s an awkward questions that you can’t help but ask: Are some fund families inflating the valuation of private placement investments to boost performance? I don’t want to believe that’s true, but a 20% difference is pretty large. How could these supposedly smart people be so far apart? You have to admit that there’s a lot of temptation there, even if it turns out that everything is on the up and up. Knowing is half the battle This isn’t a reason to sell all your mutual funds. But it is a warning that you should take a moment to review the list of securities that your mutual funds own. You might be surprised at what you find. And while the exposure to these securities might seem small today, don’t underestimate the risk this could pose to the fund and your wealth. That’s particularly true if the impressive valuations that private placements are being afforded today turn out to be nothing more than wishful thinking-just like the Internet darlings that fell of a cliff in the tech crash.

Low Volatility Bond Strategy Using Momentum With Short Timing Periods

Summary Most momentum strategies utilize long timing periods, but because of inherently shorter latencies, shorter timing periods would in principle be preferable if whipsaws could be kept within acceptable limits. Shorter timing periods are more likely to work well with low volatility funds. A basket of four funds with daily standard deviations A relative strength tactical strategy named LVS is presented with a 10-day look-back period and 10-day simple moving average cash filter. One fund or two funds are selected each month. Backtested to 1988, the one fund version (LVS-1) has CAGR = 11.6% and MaxDD = -6.6%. The two fund version (LVS-2) has CAGR = 9.4% and MaxDD = -3.4%. LVS implementation is addressed by selecting NTF funds from both Fidelity and Schwab brokerages, and backtesting from 2000 – 2015 with these funds. Monthly win rates over 81% are observed. Tactical momentum strategies rely on look-back periods to establish the ranking of a basket of funds, and then select the best fund(s) to be held each month. The best funds are then filtered by absolute momentum or moving averages. If the funds do not pass their filter, then the money is diverted to a cash fund (usually a money market fund). There are a number of possible momentum strategies that can be used, such as 1) relative strength momentum with cash filters based on absolute momentum. This is commonly called dual momentum; 2) relative strength momentum with cash filters based on moving averages; and 3) a basket of funds with cash filters on each fund based on moving averages. The length of time periods, both for relative strength and for moving averages, is a parameter selected by the developer of a tactical strategy. Developers choose different lengths or combination of lengths based on extensive (or not so extensive) backtesting and/or the research literature. For relative strength, look-back periods ranging from 3-months to 6-months are commonly used. For moving averages, even longer time periods are typically used, e.g. 10-months or 12-months. For moving averages, it is well-known that the optimal moving average can change between asset groups, and can be substantially different under various market conditions. So picking a timing period is not a simple task. In my recent development of momentum strategies (e.g. see here , here , and here ), I have found that shorter timing periods are generally preferred in order to respond quickly to market trends. But short timing periods usually result in whipsaw and poor performance. So the big question is how can we effectively use short timing periods and avoid whipsaw. My answer is that we need to select low volatility funds in our basket of assets, funds with daily standard deviations [DSDs] of 0.35% or less. I arrived at this DSD number after studying what DSD level is needed for effective use of short duration timing periods in tactical strategies. In other words, I determined what DSD level is needed in order for short duration SMAs to produce returns higher than buy & hold, and for maximum drawdowns to be 33% or less of the maximum drawdown of buy & hold. In reality, a DSD of 0.35% is a rather arbitrary number, but it is in the right ball park. To get a feel for DSD numbers for various assets, I have listed DSD numbers for various ETFs and mutual funds from 2009 – 2015: SPDR S&P 500 ETF (NYSEARCA: SPY ): 1.02% Vanguard S&P 500 Index Fund (MUTF: VFINX ): 1.03% PowerShares Nasdaq-100 Index ETF (NASDAQ: QQQ ): 1.11% Vanguard Small Cap Index Fund (MUTF: NAESX ): 1.33% iShares Barclays Long-Term Treasury ETF – 20+ Years (NYSEARCA: TLT ): 0.98% Vanguard Long-Term Treasury Fund – 15+ Years (MUTF: VUSTX ): 0.84% SPDR Barclays Convertible Bond ETF (NYSEARCA: CWB ): 0.69% Vanguard Convertible Securities Fund (MUTF: VCVSX ): 0.59% Vanguard High Yield Corporate Bond Fund (MUTF: VWEHX ): 0.26% Dreyfus U.S. Treasury Intermediate Term Fund (MUTF: DRGIX ): 0.19% Barclays Low Duration Treasury ETF (NYSEARCA: SHY ): 0.06%. All equity assets have DSDs that are substantially greater than 0.35%, and so they can be eliminated from consideration. Some bond assets also have DSD numbers that are too high for use, including long-term treasuries and convertible securities. But there are some bond asset classes that meet the DSD requirement, and also have reasonably high returns. We do not want a fund to have low DSD at the expense of having low annualized return. Thus, a short-term treasury like SHY is not a viable candidate. I have shown previously that a strategy that employs short duration moving averages can be quite effective when used on a low volatility asset. One example is to use the crossover of 3-day and 25-day simple moving averages [SMAs] on the high yield mutual fund VWEHX. If the 3-day SMA is greater than the 25-day SMA, the strategy holds VWEHX. If not, then the strategy is in cash. Total returns and drawdown for this strategy from 2000 – 2014 can be found here . The strategy is quite effective. The DSD of VWEHX over this timespan is 0.25%. In comparison, another high yield asset that is commonly used in tactical bond strategies, SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ), has a much higher DSD of 0.58% from 2009 – present, and short duration SMAs do not seem to work as well on it as they do for VWEHX. So if my hypothesis is correct, then we need to find a basket of funds that: 1) are non-correlated, 2) have DSDs less than 0.35%, and 3) have relatively high annualized return (> 5%). It turns out that mutual funds are our best option (rather than ETFs) to meet these criteria, and only certain bond classes of mutual funds are suitable. I have found four classes of bond mutual funds that meet the stated criteria. The asset categories are listed below: 1) High yield municipal bond, 2) High yield corporate bond, 3) Mortgage securities, and 4) Intermediate-term treasuries. To show the viability of this approach, I selected four funds that meet the criteria (one from each category). They all have early inception dates. The four funds that I selected are: 1. Oppenheimer Rochester AMT-Free Municipals Fund (MUTF: OPTAX ), 2. Federated High Yield Trust Fund (MUTF: FHYTX ), 3. Fidelity Mortgage Securities Fund (MUTF: FMSFX ), and 4. Dreyfus U.S. Treasury Intermediate Term Fund . The correlations of the funds, together with various forms of standard deviations and annualized returns, are shown below for the timeframe 3/27/1987 to present. These results are taken from Portfolio Visualizer, a commercially-free software package. It can be seen that the funds have relatively low correlation to each other except for FMSFX and DRGIX that have a correlation of 0.74. Notice that all of the funds essentially meet the DSD and annualized return criteria; the only exception is the annualized return of OPTAX that is slightly less than 5%. FHYTX has the highest DSD (0.33%) along with the highest annualized return (7.62%). (click to enlarge) The total returns of the funds from 1999 – present are shown below in a composite figure from StockCharts.com. Please note that the funds complement each other well, i.e. when one or more funds have a downtrend, one or more of the funds have a corresponding uptrend. And, of course, when all funds are trending down, the strategy should put the portfolio money into a money market fund. When all of the funds are trending up, the strategy will select the fund(s) with the greatest momentum. (click to enlarge) I was able to backtest these funds to 1988. I was hoping to go back to 1987, but I could not find an intermediate term treasury fund that had an inception date before 1987. I used the relative strength approach with a SMA as a cash filter. The safe harbor was a money market fund, i.e. CASHX in PV. Because of the low volatility of the funds, a 10-day look-back period for ranking could be used, and a 10-day SMA could be used as a cash filter. These are, obviously, much shorter timing periods than are commonly used in tactical strategies. They can only be used because of the low volatility of the funds. The top-ranked fund was selected at the end of each month. The results of the Low Volatility Strategy selecting one fund each month (LVS-1) are shown below. Portfolio Visualizer [PV] was used to calculate the results. In addition to LVS-1, results are also presented for a buy & hold strategy (updated annually) and for the S&P 500. The S&P 500 was used as a benchmark only because PV did not have a bond benchmark. LVS-1 Using OPTAX, FHYTX, FMSFX, and DRGIX: Total Return, 1988 – 2015 (click to enlarge) LVS-1 Using OPTAX, FHYTX, FMSFX, DRGIX: Annual Returns, 1988 – 2015 (click to enlarge) LVS-1 Using OPTAX, FHYTX, FMSFX, DRGIX: Summary, 1988 – 2015 (click to enlarge) It can be seen that LVS-1 has a Compounded Annual Growth Rate [CAGR] of 11.6%, an annualized Standard Deviation [SD] of 6.3%, a worst year of +0.5%, and a Maximum Drawdown [MaxDD] of -6.6%. In terms of growth/risk, the Sharpe Ratio is 1.2, the Sortino Ratio is 2.7, and MAR (CAGR/MaxDD) is 1.8. Comparison of these numbers to those obtained with a buy & hold strategy and the S&P 500 can be seen in the summary table. Notice that the LVS-1 has the highest CAGR and the lowest MaxDD of the three scenarios. And the MAR of LVS-1 is 1.8 versus 0.5 for buy & hold and 0.2 for the S&P 500. The results for LVS when the two highest-ranked funds are selected (LVS-2) are presented below. From the summary table we see that CAGR drops to 9.4%, but the risk is significantly reduced: SD = 4.5% and MaxDD = -3.4%. The MAR is increased to 2.8. LVS-2 Using OPTAX,FHYTX,FMSFX,DRGIX: Total Return, 1988 – 2015 (click to enlarge) LVS-2 Using OPTAX,FHYTX,FMSFX,DRGIX: Annual Returns, 1988 – 2015 (click to enlarge) LVS-2 Using OPTAX,FHYTX,FMSFX,DRGIX: Summary, 1988 – 2015 (click to enlarge) I will now present a way to practically implement the LVS on Fidelity or Schwab platforms. This requires finding mutual funds with No Transaction Fees [NTF] on Fidelity and Schwab that mimic the funds that have longer historical data (that we have just discussed). I have tried to select NTF funds that do not have any redemption fees, can be traded every 30 days, and have favorable round-trip restrictions per their prospectus. I also tried to find funds that Morningstar rated four stars or higher. The basket is composed of: 1. Nuveen High Yield Municipal Bond Fund (MUTF: NHMAX ), 2. Principal Fields Inc High Yield Fund (MUTF: CPHYX ), 3. PIMCO Mortgage-Back Securities Fund (MUTF: PTMDX ), and 4. Dreyfus U.S. Treasury Intermediate Term Fund . I ran the LVS-1 and LVS-2 with this basket of funds. The backtesting is limited to 2000 – 2015 for this basket because of the limited historical data of NHMAX. The results of LVS-1 are shown below. LVS-1 Using NHMAX, CPHYX, PTMDX, DRGIX: Total Returns, 2000 – 2015 (click to enlarge) LVS-1 Using NHMAX, CPHYX, PTMDX, DRGIX: Annual Returns, 2000 – 2015 (click to enlarge) LVS-1 Using NHMAX, CPHYX, PTMDX, DRGIX: Summary, 2000 – 2015 (click to enlarge) It can be seen that CAGR = 11.7%, SD = 6.0%, Worst Year = +4.0%, MaxDD = -6.5%, and MAR = 1.8. The monthly win rate is 81%; this win rate should be compared with a 60% – 65% monthly win rate for most backtested strategies I have seen. The results compare well with the results using OPTAX, FHYTX, FMSFX, and DRGIX backtested from 1988 – 2015. This strategy is good for an investor who wants high growth and low risk. The results of LVS-2 for NHMAX, CPHYX, PTMDX and DRGIX are presented below. LVS-2 Using NHMAX, CPHYX, PTMDX, DRGIX: Total Returns, 2000 – 2015 (click to enlarge) LVS-2 Using NHMAX, CPHYX, PTMDX, DRGIX: Annual Returns, 2000 – 2015 (click to enlarge) LVS-2 Using NHMAX, CPHYX, PTMDX, DRGIX: Summary, 2000 – 2015 (click to enlarge) It can be seen that CAGR = 9.9%, SD = 4.2%, Worst Year = +3.6%, MaxDD = -2.6%, and MAR = 3.8. The monthly win rate is 83%, an exceptionally high number in a tactical strategy. There are only 33 months with negative returns, out of a total of 190 months. These results also compare well with LVS-2 results using OPTAX, FHYTX, FMSFX, and DRGIX backtested from 1988 – 2015. This strategy is good for an investor who desires moderate growth and very low risk. In summary, a new approach has been conceived that allows the use of short timing periods in tactical strategies without seeing the associated whipsaw effects. To enable the use of short timing periods, each mutual fund in the basket of funds must have a daily standard deviation less than 0.35%. To maximize return, each fund must have adjusted annualized returns over 5%. A tactical strategy named Low Volatility Strategy [LVS] is presented that uses relative strength ranking based on total returns of the last 10 trade days, and a 10-day SMA to filter the top-ranked fund(s). After backtesting LVS to 1988 by using mutual funds with early inception dates, the implementation of the strategy was addressed. NTF mutual funds were selected for use on Fidelity or Schwab platforms. LVS-1 and LVS-2 backtest results from 2000 – 2015 showed monthly win rates over 81%. LVS-1 had a CAGR of 11.7%, a MaxDD of -6.5%, and a MAR of 1.8. LVS-2 had a CAGR of 9.9%, a MaxDD of -2.6%, and a MAR of 3.8. There were no losing years for LVS-1 or LVS-2, with either set of mutual funds.