1. Bought 200 of the CEF Alliancebernstein Income Fund (ACG) at $8.12 in ROTH Friday (see Disclaimer): When looking at PCEF, the new ETF from Powershares that owns CEFs, I noticed that its top bond holding was ACG, as of 4/30/2010, at 4.84% of the fund. Holdings I remember looking at this fund a few years ago, but did not buy it. I looked at it again on Friday, and decided to do a nibble in the ROTH.
I face two distinct kinds of interest rate risks with a fund like ACG. First, the fund is leveraged. With a rise in rates, the spread between the borrowing cost which is now low and the interest earned by ACG on the bonds bought with borrowed funds will narrow or even turn negative. The second interest rate risk is applicable to any bond fund, particularly when there is a prolonged period of rising rates and no term date for the bond fund. This form of interest rate risk has been discussed many times in this blog (see e.g. Item # 2 Interest Rate Risks- Bonds). I have referenced in the past several articles that discuss the impact of rising rates on bond investments: Rising Rates and Your Investments & FINRA - Investor Information - Smart Bond Investing & Fixed Income – Bond Funds vs. Bonds)
Another risk with a CEF is that the price will fluctuate based on investor demand. ACG closed on Friday at $8.13 which represented a 5.79% discount to its NAV. WSJ.com This discount may narrow or expand in the coming days or weeks. If it narrows when the NAV is also going up, then I can make money in two ways. The reverse can also happen. The discount can expand at the same time the value of ACG's assets are falling. This is called a double whammy. There will be a triple whammy if the fund uses borrowed money to buy assets falling in value. And, if you want to worry about something, what if the price of those borrowed funds is rising at the time the discount is expanding and the assets are declining in price, then I would characterize that phenomenon as a quadruple whammy. Even the RB knows to avoid quadruple whammies.
The problems and the opportunities with CEFs were drastically highlighted during the Near Depression period, particularly for leveraged funds that invested in securities that were pummeled by 50% or more. Many of those funds had to sell in order to reduce leverage at the most inopportune time. The discounts on many CEFs expanded to over 30% as the value of their assets fell dramatically during the catastrophic phase of the bear market, which I define as starting with the Lehman failure in September 2008 and ending on March 6, 2009. The lessons that I drew from those events is to jettison most, if not all of my CEFs soon after receiving a Trigger Event in the Vix Asset Allocation Model. And, the second lesson was to look for opportunities to buy them back when the double, triple and quadruple whammies work their magic and the prices plummet in value. Another lesson is to avoid leverage funds altogether during a bear market.
So, I just did a nibble on ACG. It is a leveraged fund which invests in bonds. This is fine for now. It will not be good when interest rates start to rise in an appreciable manner. Having identified the risk of ACG, I can now turn to why I bought a small number of shares.
One reason is that the leverage is working for ACG now. It will generate a higher payout to me than a fund investing in the same securities without using leverage, though the unleveraged fund would be viewed as safer.
Dividends are paid monthly, always preferred here at HQ, and the distribution is currently at a 4 cent per month rate. This was just reduced from $.043. The rate was 5 cents in December 2009. The annualized yield at a total cost of $8.12, assuming a continuation of the 4 cent monthly distribution, would be 5.91%. ACG is doing what it is supposed to do, aligning the dividend payment with the income being earned. I receive nothing of value when a CEF maintains a high dividend by returning part of my capital to me in the form of a dividend.
Another important feature of this fund is that it tilts toward AAA credits, with significant holdings in U.S. government debt. So, the quality of the bonds means that the yield will be lower than an investment grade bond fund.
Morningstar rates it five stars. The Morningstar page also has a chart that shows historical prices in relation to net asset value. I view that as material information, since it gives me an idea of a normal range for this fund's price in relation to its NAV.
This is a link to the fund's web site: AllianceBernstein Income Fund, Inc. (formerly ACM Income Fund, Inc.) A breakdown of the holdings shows almost 77% in AAA rated credits as of 3/31/2010: Overview
This is the SEC link for the 2009 Annual Report for the AllianceBernstein Income Fund, Inc.
Page 53 of that report shows a gross expense ratio of .91%. Excluding interest expense due to the leverage the expense ratio is .69%.
2. Euro (short-own EUO): I thought this was an interesting article in MarketWatch attempting to fathom why the EURO has not fallen further than $1.33 given the problems in the Eurozone. One explanation is that Asian money is still flowing into the EURO as an alternative currency to the U.S. Dollar, which has its own set of long term problems. Another possible contribution to the EURO stabilizing is a flight to German bonds as a safe haven. And, lastly, the market may simply believe that all of the problems are going to be solved. The Europeans at least kick the can down the road a ways over the weekend by agreeing to bail out the Greek government. NYTimes.com
3. Mahamed El-Erian interview in Barrons.com: Mohamed El-Erian believes the market is betting now that Germany will end up financing the bailout. He explains what will happen in the event this does not materialize. The "risk market" will be shocked, the problem will rapidly spread to other European countries and banks, and "reduce liquidity in the system"
He likes credit exposure in both Canada and Australia. I have recently increased by exposure to Canadian bonds by buying ETFs on the Toronto exchange: Bought 100 of ETF CLF:TO at 20.10 CAD (1-5 Canadian government bonds); Bought 100 CBO:TO at 20.4 (1 to 5 year Canadian corporate bonds); and 100 CPD:TO at 16.09 (Canadian preferred stocks)
El-Erian's analysis is similar to one offered by Bill Gross in one of his newsletters, discussed in Item # 1 Bill Gross:The New Normal/ (article found at PIMCO - February 2010 Gross Ring of Fire). This is a quote from that newsletter: "Of all of the developed countries, three broad fixed-income observations stand out: 1) given enough liquidity and current yields I would prefer to invest money in Canada"
El-Erian also believes inflation will decrease during the remainder of 2010 before increasing. He opines that this may give investors an opportunity to buy TIPs at more favorable prices. I would agree with him that investors are not positioned in their portfolios for a return of significant inflation. The massive flow of funds into bond funds over the past year or so has been into funds buying fixed coupon bonds, which will not hold up well during a rising inflation/interest rate scenario.
Buffett is concerned about government's triggering inflation as an outgrowth of their efforts to stabilize the financial system. MarketWatch
4. Favorable Cover Story on JNJ in Barrons.com (own): Most investors who own funds or just the S & P 500 index would have some exposure to JNJ. I own a number of funds that have significant positions in JNJ, generally meaning 1 to 3% of fund assets. I have increased my exposure to JNJ in two ways last month. First, I bought a few days ago 50 shares of JNJ at 64.44. This was in part a response to JNJ raising its dividend by 10.2%. JNJ is a member of the dividend aristocrats, reserved for firms that have increased their dividends every year for the past 25 years. In the post discussing this purchase, I mention other factors that make JNJ a good candidate for investors pursuing a dividend growth strategy. The second way that I increased my exposure was to purchase 100 shares of the PPH. For every 100 shares of PPH, I in effect own 26 shares of JNJ, bringing my total to 76 shares. Item # 6 Bought 100 PPH at 65.42 I also pick up a fixed number of shares in other pharmaceutical companies such as PFE, BMY, LLY, ABT and MRK by buying PPH.
The article in Barron's goes into more detail than I will normally do in this blog. One reason for my shorter version is that I am spread out very broadly and do not have the inclination to discuss every detail which enters into a decision to buy or sell a security. Instead, I will just focus on the primary reasons for buying a stock like JNJ, which would not include an evaluation of each drug in its pipeline for example. I would simply highlight the rock solid finances of the company, its ability to generate large amounts of cash flow, its commitment to shareholder value exemplified by a long history of buying back stock and increasing the dividend, and the stability and reliability of its earnings.
5. Greece: There was an article in the NYT that highlights just one of the Greece's many problems. While there is considerable wealth in Greece, only a few thousand of its citizens declared income in excess of $132,000. Tax evasion is estimated to cost the Greek government 30 billion a year. In one wealthy neighborhood, only 324 checked a box on their tax forms claiming to own pools. A satellite photograph revealed 16,674 pools in the area. It is understandable given where the tax money would go, to line the pockets of a bloated government work force enjoying wages and benefits far greater than the nation can afford. It is just one part of a wider cultural problem that includes entrenched corruption and bribery. Based on reports that I have read over the past several months, the only apt description for Greece is a Kleptocracy. No wonder there is widespread opposition in Germany and elsewhere to bailing the Greeks out.
Reuters provides some examples of an entitlement society run amok. There are tens of thousands of daughters collecting their dead parent's pensions. Civil servants can retire with a full pension in their 40s. They can receive a bonus for knowing how to work a computer or for showing up for work on time. Civil servants receive bonuses for Easter and Christmas. The Greeks regularly form committees, employing ten thousand people at a cost of €220 million a year and no one knows what they do. The NYT recently reported that civil servant salaries and pension benefits took up 51% of Greece's budget. The new government came into office and hired 2000 more employees in the energy department and handed out 1.6 billion EUROs to low income families. And if there is an effort to cut back on these benefits, including being paid for no work, when the government has no money, the populace goes on strike demanding their rights. The rot appears to be very deep and widespread.
If Europe could avoid a contagion effect by allowing Greece to suffer the consequences of its policies, then that would be the best and moral course. Unfortunately, there is little doubt in my mind that the ability of other PIIGS to refinance their maturing debt would become extremely problematic in the event of a sovereign default in Greece. So, no matter how distasteful it may be, bailing out the Greeks is probably the least undesirable alternative, sort of like the U.S. having to bail out the Masters of Disaster at Citigroup and AIG.
6. GM Ad (never owned): It is comical to see GM's Chief Executive crow in a TV ad claiming that it has paid back the taxpayers' loan with interest and ahead of schedule. Gretchen Morgenson points out in her column in the NYT that GM used another account with taxpayer funds to make that payment. The current estimate is that the government will end of losing 30 billion trying to salvage GM.
The use of taxpayer money to pay back the loan is acknowledged by the treasury in a letter to Senator Grassley (R): grassley.senate.gov/.pdf
7. 132 Billion in Losses from Synthetic CDOs Created by the Masters of Disaster: One of the many innovations cooked up by the Masters of Disaster to enrich themselves was the synthetic CDO which allowed institutions to places "bets" on subprime mortgages. WSJ estimates that all of those creations quickly went to a zero value, losing 132 billion really fast for those who bet wrong, and helped to undermine the financial system on a worldwide basis. The Masters of Disaster just saw it as a product to line their own pockets, and the ratings agencies blessed the toxic trash with AAA ratings initially at least, to give the Masters of Disaster time to complete the deals.
Another article in WSJ shows how the Masters of Disaster magnified the losses from subprime mortgages. For example, one 38 million subprime mortgage pool created in June 2006 found its way into 30 other debt pools that ended up causing 280 million in damage.
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