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Market Neutral Funds: The Best And Worst Of October

By DailyAlts Staff Morningstar’s aggregated Market Neutral category returned +0.67% in October, besting September’s returns of +0.12%. Invesco’s All Cap Market Neutral Fund (MUTF: CPNAX ) was the category’s top performer for an impressive second-straight month, adding 3.03% gains in October to the prior month’s +7.03%. But, while the top funds generally posted lighter gains in October than they did in September, the worst performers sustained even steeper losses. (click to enlarge) Top Performing Funds in October As stated above, the Invesco All Cap Market Neutral Fund was the Market Neutral category’s top performer for the second straight month. Through October 31, the fund had year-to-date returns of +10.88%, and even more impressive three-month and one-year gains of 13.42% and 11.40%, respectively. The fund, which debuted in December of 2013 and has $35 million in assets under management (“AUM”), is available in A (CPNAX), C (MUTF: CPNCX ), R (MUTF: CPNRX ), and Y (MUTF: CPNYX ) shares. The other top performers last month were the Nuveen Equity Market Neutral Fund (MUTF: NIMEX ) and the Zacks Market Neutral Fund (MUTF: ZMNAX ), which posted respective one-month gains of 2.72% and 2.58%. NIMEX, which debuted in June of 2013 and has $55.7 million AUM, had one-year returns of +2.97% through October 31. ZMNAX, which has been around since July 2008 but has just $9.8 million in AUM, was up 7.67% for the year ending on Halloween, ranking in the top 8% of the Morningstar category. All three of October’s top performers had positive returns over the past one, three, ten, and twelve months ending October 31. The Zacks Market Neutral Fund also had positive returns over the past three and five years ending October 31, as well. (click to enlarge) Worst Performing Funds in October The Hussman Strategic Growth Fund (MUTF: HSGFX ) was October’s very worst market-neutral fund to own, losing 6.53%. This is quite a bit worse than last month’s biggest loser, the Castlerigg Event Driven and Arbitrage Fund (MUTF: EVNTX ), which fell just 4.72% in September. HSGFX was down 9.58% for the year ending on October 31. The fund has been around since 2005, producing annualized three- and five-year losses of 7.96% and 7.93%, respectively, though the end of October. The fund has a one-star “negative” rating from Morningstar. The PSI All Asset Fund (MUTF: FXMAX ) and the BlackRock Emerging Market Long/Short Equity Fund (MUTF: BLSIX ) were the next worst performers in October, posting respective losses of 4.77% and 3.01% for the month. FXMAX launched in 2010 and has gone on to generate negative returns across the one-, three-, and ten-month periods ending October 31, in addition to three- and five-year annualized returns of -6.05% and -5.14%, respectively. BLSIX launched in 2011 and also has negative returns across all of Morningstar’s default time frames, including respective one- and three-year annualized losses of 7.01% and 2.54% for the periods ending October 31. (click to enlarge) September’s Best and Worst: Follow-Up Invesco’s All Cap Market Neutral Fund held on to its crown as the best-performing market-neutral fund for a second straight month, but what happened to September’s other top performers? The AQR Equity Market Neutral Fund (MUTF: QMNIX ), which posted a 5.79% gain in September, added just 0.09% in October, ranking in the bottom 38% of the category despite the modest gains. The Vanguard Market Neutral Fund (MUTF: VMNIX ), which returned +5.11% in September, lost 0.85% in October, putting it in the bottom 15% of all market-neutral funds for the month. And what about September’s worst performers? The previously mentioned Castlerigg Event Driven and Arbitrage Fund lost 4.72% in September, but bounced back (a bit) with a 0.62% gain in October. September’s other bottom-three funds in the category – the Visium Event Driven Fund (MUTF: VIDIX ) and the Arbitrage Event-Driven Fund (MUTF: AEDNX ) – which posted respective declines of 4.70% and 3.73% in September, improved with returns of +0.11% and +0.55% in October. Past performance does not necessarily predict future results. 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.

CenterPoint Energy: Investors Have Nothing To Fear

Summary The stock continued to decline after Q3. Equity investment write-down doesn’t reflect the investment’s true value. Results from core operations improved from last year. The market continues to be bearish about CenterPoint Energy (NYSE: CNP ). Given the company’s performance in 2015, it would seem that investors are doubting the stability of the utility company. After falling 20% from $23.43 at the beginning of the year to $18.68 before Q3 earnings, shares have since dropped another 8% to $17.10. Do the fundamentals support this rapid decline? Revenue continued to fall. Following Q2’s 19% drop, Q3 revenue decreased by 10% ($1.8 billion to $1.6 billion) as well, primarily as the result of lowering natural gas prices. However, this was offset by the drop in natural gas expense, which decreased from $702 million to $527 million. Due to various cost reductions, the company was able to decrease its operating expense from $493 million to $479 million. This impact may seem small, but this allowed the company to increase its operating income by 14% when compared to Q3 2014. This rise in operating profit is the first time the company achieved growth in 2015. Q1 and Q2 operating profit decreased by 13% quarter on quarter, and Q3 operating profit was flat. Isn’t this evidence that the company is improving? What are investors worried about? Possible Concern One thing that could trouble investors is the loss from equity investment ($794 million), which is the biggest reason that the company delivered a $900 million loss before taxes. The equity investment consisted solely of Enable Midstream (NYSE: ENBL ), a stock that I’ve talked about before. You can read my previous articles ( here and here ) to learn more about the company. Enable Midstream Partners is a midstream company that is suffering from industry headwinds. However, the company continues to deliver good cash flows due to its fee-based contracts. Furthermore, it is well capitalized with a good interest rate coverage ratio. Enable’s transported volume continued to grow in Q3, offsetting declining prices that negatively impacted product sales. Going forward, I believe Enable will come out on top even if natural gas prices don’t improve. What does all of this mean? I believe that the write-off of equity investment is not representative of Enable Midstream Partners’ true value. Core Operation Remains Stable Enough about Enable, what about CenterPoint’s existing operation? In my last article , I talked about the company’s stability. The Electric segment is not directly affected by commodity movements since it is not involved in power generation activities. The Natural Gas Distribution segment does have some exposure to commodity movements due to a time lag between purchases and deliveries, but the company actively uses derivatives to hedge any uncertainty. So overall, I would expect profit to be stable over the long term. CenterPoint’s stability is once again evident in Q3. Every single segment improved quarter on quarter. Operating income for the Electric segment rose 5%, Natural Gas Distribution’s operating income recovered from last year’s volatility, improving from a loss of -$8 million to a gain of $11 million, and Energy Services’ operating income increased by 17%. Takeaway I believe there’s nothing in the third quarter that was particularly alarming. The company continued to deliver stable profits amid a volatile commodity environment. Unfortunately, investors have been focusing on the wrong things. In particular, the Enable Midstream fear is overblown. Results from core operations should continue to improve, and that is what will really support the company as a whole.

Valuation Dashboard: Energy And Materials

Summary Four key fundamental factors are reported across industries in Energy and Basic Materials. They give a valuation status of an industry relative to its historical average. They give a reference for picking stocks in each industry. This is part of a monthly series of articles giving a valuation dashboard in sectors and industries. The idea is to follow up a certain number of fundamental factors for every sector, to compare them to historical averages. This article covers Energy and Basic Materials. The choice of the fundamental ratios used in this study has been justified here and here . You can find in this article numbers that may be useful in a top-down approach. There is no analysis of individual stocks. You can refine your research reading articles by industry experts here . A link to a list of stocks to consider is provided in the conclusion. Methodology Four industry factors calculated by Portfolio123 are extracted from the database: price/earnings (P/E), price to sales (P/S), price to free cash flow (P/FCF), return on equity (ROE). They are compared with their own historical averages, “Avg.” The difference is named with a prefix “D” before the factor’s name (for example D-P/E for the price/earnings ratio). It is measured in percentage for valuation ratios and in absolute for ROE. The methodology is quite different from the S&P 500 dashboard. In some industries, S&P 500 companies are very few, so mid- and small caps are included here. Also, the fundamental industry factors are not median values, but proprietary data from the platform. The calculation aims at eliminating extreme values and size biases, which is necessary when going out of a large-cap universe. The drawback is that these factors are not representative of capital-weighted indices. They may be very useful as reference values for picking stocks in an industry, but are less relevant for ETF investors. Industry valuation table on 10/26/2015 The next table reports the four industry factors. For each factor, the next “Avg.” column gives its average between January 1999 and October 2015, taken as an arbitrary reference of fair valuation. The next “D-xxx” column is the difference between the historical average and the current value, in percentage. So there are three columns relative to P/E, and also three for each ratio. P/E Avg. D- P/E P/S Avg. D- P/S P/FCF Avg. D- P/FCF ROE Avg D-ROE Energy Equipment & Services 21.25 24.2 12.19% 0.81 1.73 53.18% 7.86 35.34 77.76% -10.59 7.34 -17.93 Oil/Gas/Fuel 17.27 18.53 6.80% 1.95 3.35 41.79% 14.22 29.03 51.02% -13.51 4.47 -17.98 Chemicals 20.04 18.48 -8.44% 1.44 1.21 -19.01% 35.4 25.37 -39.53% 9.17 6.74 2.43 Construction Materials 53.65 21.44 -150.23% 1.34 1.16 -15.52% 52 40.5 -28.40% 10.61 5.77 4.84 Packaging 21.91 17.96 -21.99% 0.92 0.61 -50.82% 21.92 20.09 -9.11% 18.58 8.34 10.24 Metals & Mining 20.74 19.83 -4.59% 1.27 2.65 52.08% 15.18 25.53 40.54% -19.81 -8.6 -11.21 Paper & Wood 31.74 21.27 -49.22% 0.77 0.72 -6.94% 21.78 22.81 4.52% 8.41 4.99 3.42 The following charts give an idea of the current valuation status of Energy and Materials industries relative to their historical average. In all cases, the higher the better. Price/Earnings Price/Sales Price/Free Cash Flow Quality (ROE) Relative Momentum The next chart compares the price action of the SPDR Select Sector ETF in Materials (NYSEARCA: XLB ) and energy (NYSEARCA: XLE ) with SPY (chart from freestockcharts.com). (click to enlarge) Conclusion Since last month, XLB has outperformed SPY by 1%, and XLE has lagged by 3%. Both have been widely underperforming the broad index in the last six months. At the industry level, Energy Equipment & Services, Oil/Fuel/Gas and Metals/Mining look undervalued relative to their historical averages, but they are in negative territory for quality. Oil/Fuel/Gas and Metals/Mining have improved since last month in valuation due to the sharp decline in oil, metal and stock prices. Oil/Fuel/Gas deteriorated in quality, but Metals/Mining is stable. Chemicals, Construction Materials and Packaging are above their historical average in quality, but overpriced for the three valuation factors. Valuation factors have deteriorated for Construction Materials since last month because of a few outliers and the relatively small number of companies in this industry. No industry in these two sectors looks globally very attractive. However, comparing individual fundamental factors to the industry factors provided in the table may help find quality stocks at a reasonable price. A list of stocks in energy and basic materials beating their industry factors is provided on this page . If you want to stay informed of my updates on this topic and other articles, click the “Follow” tab at the top of this article.