While many are now predicting the imminent onset of a long term bear market in bonds, with egotistical certitude in their ability to predict the future, I will admit to more than a small measure of uncertainty about the future. I exchanged the following email with a reader about the current bond sell-off:
" Cramer seems to think that the bond bear market has already started as I noted in today's post. We are most likely near the end of a long term secular bull market in bonds that started in 1982.
I do not share his confidence, however, that the current moment marks the demarcation line in the long term secular patterns given the powerful deflationary forces still at work in developed economies, and the likelihood that China and other emerging market nations will have to tighten monetary policy to curb their own inflation problems.
So, it may be more probable than not that the end is upon us already, or soon will be, but I would not rate that as 100% or even at 80%. More like 60-70%.
If the other scenario unfolds, a CEF like HPF will do find, where there is some GDP growth, but not enough to make a dent in unemployment, which is the case now. This is the Japan type scenario, where after multiple bubble bursts, particularly in stocks and real estate ending in 1989, Japan entered into a long period of stagnation, anemic growth and low to declining inflation, making long term Japanese government bonds a good investment for the home crowd at 1989 prices. One proponent of this view is Gary Shilling, We're Turning Japanese: Deal With It - Forbes.com, and I would not regard that scenario now as out of the question. I am actually gradually increasing my positions in leverage bond CEFs during this recent downdraft in a typical contrarian move, but only in very small amounts. "
If Cramer is right, I will suffer share losses on all of my recent bond CEF purchases, possibly even exceeding over the next several years the total amount of dividends paid by those funds. And, I will incur unrealized losses in some of my individual long term corporate bonds. In both cases, I can use my prodigious cash flow to buy bonds and bond funds at lower prices than prevailing today, and sell some to offset taxable gains. I can always hold my short and intermediate term bonds until maturity to avoid a capital loss.
The problem is that I do not know what the future will bring, which is why I have a balanced portfolio that includes bonds. At times, I will change my asset allocations based on my beliefs about the more probable than not future scenarios. If Shilling is right, then I will want to have bonds. If Cramer proves to be right, then I still have my stocks and those stocks are mostly those that pay high dividends.
1. Bought Back 50 of the bond CEF NBB at $18.4 in the Regular IRA on Thursday (see Disclaimer): At the moment, buying bond funds is clearly a contrarian move. Buying leveraged bond CEFs is a contrarian move on steroids. Due to the expiration of the Build America Bond program at the end of this year, and the current uncertainty above its extension, a flood of new issues under this program is hitting the market, and that supply is driving up yields and lowering prices on vintage issues. The decline in BABs is being aggravated by the significant correction in treasuries, particularly in the 10 to 30 year range. Most BABs are long term bonds. So, under the circumstances, it may very well be foolish to buy back the fifty shares of NBB that I sold a few days ago in the regular IRA @ 19.24. Those shares were bought @ 18.4 in mid November, so I placed a limit order to buy those 50 shares back at $18.4 which was filled yesterday as the price shot through that limit order on its way down to $18.22, as the price went from $18.46 to the next trade at $18.22.
I have discussed NBB in several posts. It is a leveraged CEF that invests in taxable municipal bonds issued under the Build America Bond program. Dividends are paid monthly at the current rate of $.117. If that monthly dividend rate is continued for an entire year, then the yield at a total cost of $18.4 would be about 7.63%. If the BABs program is not extended, which is possible, NBB will be liquidated in 2020 provided there are no BABS or similar U.S. treasury subsidized taxable bond sold for any 24 month period prior to 12/31/2014. NBB - Nuveen Build America Bond Fund So, it is possible that NBB may turn into a term bond CEF, which is preferable from my point of view.
This fund closed on Wednesday with a net asset value per share of $18.62 and at a -.27 discount to that NAV. WSJ.com Yesterday the net asset value actually rose 1 cent to $18.63, creating a discount of -.32 to the closing price of $18.57.
NBB had a wild day yesterday for a bond fund, trading in a range between $18.22 and $18.66 before closing unchanged at $18.57. Needless to say, the bond CEFs are very volatile now, and the leveraged bond CEFs are even more so. Obviously, the trading yesterday had nothing to do with the performance of the fund on Thursday.
During a correction in bond prices, I would expect leveraged bond CEFs to decline more than comparable non-leveraged ones. NBB is a leveraged bond CEF.
3. Bought Back 50 of the TC PJL at $25.3 in the Roth IRA (see Disclaimer): PJL is a trust certificate (TC). The TC represents an undivided beneficial interest in the assets own by the trust. For PJL, the trust owns senior bonds issued by Verizon Global Funding, an investment grade bond currently rated A3 by Moody's and "A" by S & P. The TC has a $25 par value, a 7.625% coupon, and matures on 12/01/2030.
This is a link to the prospectus for PJL: www.sec.gov As noted in the prospectus, Verizon, the parent company of Verizon Global Funding, has agreed to support this bond as provided in the prospectus.
Trades of the underlying bond can be found at the FINRA site. The underlying bond is trading at a significant premium to its par value, so it would make economic sense for the owner of the call warrant to exercise it. If that happened within the next month or so, I would lose a few bucks. But I sold 50 shares of PJL in the Roth IRA at 26.5 in late September based on my belief that an exercise of the call warrant could happen at anytime based on the pricing of the individual bond. I decided to keep 100 shares owned in a taxable account. So I in effect lowered my cost some in PJL by selling at $26.5 and then buying back those shares closer to par value.
This TC has a call warrant attached to it, and I am surprised that it has not yet been exercised by the owner of the call warrant. As previously discussed, the owner of the call warrant has the option to acquire the bonds owned by the trust by paying the owners of PJL the $25 par value per certificate, plus accrued interest. Since the TC and the underlying bond just made their semi-annual interest payment, there is not much accrued interest now. The TC price has been falling since that ex interest date closer to its par value, suggesting the possibility of an imminent call by the warrant owner. The TC XFL, containing this same VZ bond, was called several months ago by the owner of the call warrant Call Warrants and Trust Certificates: XFL CALLED More on the Call Warrant in TCs Call Warrants and Trust Certificates
I first started to discuss these TCs containing the Verizon Global Funding bond when I started this blog in October 2008: Trust Certificates PJL and XFL: Verizon Bond (10/8/2008 post); TRUST CERTIFICATES JZJ AND PJL (10/8/2008 post). At that time both XFL and PJL were selling at below $20.
I am comfortable with the credit risk of this bond. PJL presents a better value than purchasing its underlying bond at current prices in the bond market. I have both a higher yield with PJL and a better YTM. The problem is the existence of the call warrant.
At a total cost of $25.3, the yield is around 7.6% for PJL. In the Roth IRA, I look at that yield in the same way as I would a municipal bond in a taxable account. But, as we all know, there are no "A" rated municipal bonds with current yields of 7.6%.
4. Bought Back 300 of the Bond CEF WIW at $12.14 (see Disclaimer): I clipped a profit on an earlier round trip on this bond CEF, which invests mostly in inflation protected securities. Bought 300 of the CEF WIW at $11.94; SOLD 200 of 300 WIW at $12.5; Bought 200 WIW at 12.29; Sold 300 WIW at $12.53 Judging from this trading activity, I do not expect much price (if any) appreciation in the shares.
I do have a big hole in my portfolio, having sold virtually all of my inflation protected bond funds, including the ETF TIP. I still own a few 10 year TIPs in the Roth IRA bought at two separate treasury auctions in July and October 2009 which have done well, and I intend to hold those until maturity on 7/15/2019. 10 Year TIP Auction 10 Year TIP Auction They are up about 10% plus the interest payments. I am underweighted this asset class based on my view that the TIPs are overvalued at current prices. Notwithstanding that belief, which appears to be rational to me, the TIP has risen in value since I sold out of my TIP ETF position. Sold All Shares TIP ETF iShares Barclays TIPS Bond Fund (TIP): Overview I have also kept the Vanguard inflation protected mutual fund (VIPSX) and have been reinvesting its meager dividends.
Still, even with the purchase of 300 shares of WIW on Thursday, I am considerably underweight TIPs and would have to buy at least another 20 grand to arrive at what I would consider a normal weighting in my portfolio. I do regard these securities as primarily a hedge against unexpected inflation, and they do have value in my balanced portfolio as a non-correlated asset class. Treasury Inflation Protected Securities as a Non-Correlated Asset I just do not view them as good value at current prices, but I am negative on all treasury securities at prevailing market prices and yields.
Back to WIW, the fund recently cut its monthly distribution from 4 cents to 3.65 cents. WIW - Western Asset/Claymore Inflation-Linked Opportunities & Income Fund - Distributions. I support that dividend cut for the reasons given by the fund: "The monthly dividend amounts for WIA and WIW were modified in an effort to better align the Funds’ current earnings rates with current dividends, while also considering the relatively benign near-term outlook for inflation. While the benefit from inflation accretion in the coming months may be minimal, the Funds’ management believes inflation remains a long-term concern." guggenheimfunds.com div_pr_12_2010_1.pdf Inflation protected securities are simply not going to produce much current income now.
At the reduced rate, and assuming no further changes, the dividend yield at a total cost of $12.14 would be about 3.6%.
I was drawn back to WIW due to its discount to net asset value at the current price, which will give me hopefully a trading opportunity when and if the negativity toward treasuries reverses. WIW closed on Wednesday at $12.24 and had a net asset value at that time of $13.24, creating a discount of -7.55. The net asset value fell 4 cents on Thursday and the discount expanded to a -8.18%. The WSJ.com classifies this fund as an "investment grade" bond fund.
This is a link to the last filed shareholder report: www.sec.gov
WIW traded in a range between $12.09 and $12.23 yesterday and closed at $12.12, down 12 cents or .98%. The TIP ETF was down .12%.
I have also bought and sold a similar fund: Bought 300 CEF IMF at 16.51 Sold: 300 IMF @ 17.23
I have omitted discussions of a few securities bought on Wednesday and Thursday due to time constraints, and will discuss only one more trade from Thursday in the next post.
look @ the unleveraged HIO under $6.
ReplyDelete$5.90 is some support. Bought a little @ 5.95.
If you look at TIP, it is still going lower, I think WIW goes lower.
Besides, dividend cut .004 so it's about 3.5% yield is all.
PUK-A near $24 worth a look. Rarely dips.
ReplyDeleteHIO is a junk bond CEF selling at a 2.75% discount to its net asset value as of 12/9 which makes it eligible for purchase here at HQ. As of 9/30, 23.29% of its portfolio was in "CCC" rated securities which would give me pause.
ReplyDeletehttp://www.leggmason.com/individualinvestors
/products/closed-end/characteristics/HIO.aspx
Anything below a B rating gives the OG heartburn.
I generally prefer picking my own junk securities, mostly in the 2014 to 2020 range and at below their par values and then simply hold until maturity. My other preference is to trade the junk bond CEFs.
My longer term junk securities are mostly in TCs. Some of my best performing bonds from 2008 to present have been the junk rated exchange traded bonds with one up over 300% plus interest payments before it was called by the call warrant owner. (DKR)
Overall, however, HIO is okay from my point of view. The expense ratio shown on the last shareholder report is 1.2% which is okay for this kind of fund, and it does not use leverage, which will add to the devastation when junk bonds have one of their periodic deep selloffs. I would also prefer HIO to HIX, another high yield bond CEF from Western Asset that uses leverage and sells at a small premium. I also would note that Morningstar rates HIO at 4 stars and HIX at 3 stars.
I noted the small dividend cut in WIW in my post today. Still even after that cut and at a 3.5% yield, it will have a current yield higher than the alternatives such as an unleveraged TIP mutual fund or an individual TIP bought in the bond market.
As to whether WIW goes up or down, it is down some today and who knows about tomorrow. A rally in treasuries could bring it back up to around $12.5 which has been my sell point on prior trades.