Friday, April 30, 2010

Revised Closed End Fund Table/Bought 200 SFH at 10.18/Added 75 GDO at 18.47/Bought 50 ADM at 28.05/ XOM GLW COP T UN /Pared BCF at 13.62/VIX/GS

The preceding table reflects transactions in the Closed End Fund strategy since I lasted posted the table. It has to be clicked in order to read it. This is basically a balanced portfolio of CEFs. It contains both stock & bond funds, domestic and foreign. Then, this mini-portfolio has sectors within those broad classifications such as TIPs, natural resources and real estate stocks, buy-write option income funds, and high yield bonds. In effect, I am trying to achieve a balanced portfolio, similar to what Powershares is attempting to do with a recently launched ETF of CEFs: PowerShares CEF Income Composite Portfolio (PCEF). I do not have to charge myself a fee, however, for assembling this portfolio. PCEF has a .5% management fee, which is on top off the expenses for the owned funds. I would not have a problem owning PCEF as an alternative to what I am doing, but I prefer to select my own CEFs, and to follow a different strategy. There is some overlap in my holdings and the current ones for PCEF: Holdings While I own bond and buy-write funds, I prefer to emphasize more plain vanilla stock funds, both internationally and domestically.

I have been investing in CEFs since around 1983. When I started, there were just a few of them. Some of the more prominent ones back in the early 1980s were started during the 1920s, such as Adams Express and Tri-Continental, and managed to survive the Great Depression and the stock market crash. The ones that failed used leverage, and the owners of those leveraged funds found out the hard way that leverage works both ways.

I started only recently to add bond CEFs. This was in part based on the realization, based on what appeared to be overwhelming evidence, except to the LB, that I was no longer a 16 year old Stock Stud. I am emphasizing bond funds that have a term date, which lessens in my view the interest rate risk inherent in bond funds. Bond funds do not have a maturity date. This is a very important and obvious point, which many individuals will learn the hard way when interest rates start to rise.

1. HF Financial (HFFC) (own Regional Bank Strategy): This is one of the smaller banks in the basket of regional banks, and apparently only one analyst covers it. HF Financial Corp reported earnings of 1.8 million for its 3rd fiscal quarter (3/31/10) or 26 cents per share. The tangible book value was $12.79, or greater than the current share price. The total risk-based capital to risk-weighted assets was 11.72%. Tangible common equity to tangible assets was 7.22%. Net interest margin was 3.32%.

2. Corning (GLW)(owned-2010 Speculative Strategy): Corning reported 1st quarter earnings of 52 cents on sales of 1.55 billion. This beat the consensus estimate by 10 cents. Gross margin improved to 47% from 42% in the previous quarter.

3. BNC Bancorp (BNCN)(Regional Bank Stocks strategy): BNC Bancorp reported first quarter earnings of 12 cents per share. NPLs as a percentage of total loans was 2.04%. This bank recently completed an FDIC assisted acquisition that extended its geographic service territory in Eastern North Carolina into the coastal region of South Carolina, primarily in the Myrtle Beach area.

4. ConocoPhillips (COP)(own)(Natural Resource Overweight Strategy): ConocoPhillips reported 1st quarter earnings of 2.1 billion or $1.4 per share (adjusted at $1.47). Cash from operations for the 1st quarter was 3 billion. The consensus estimate was $1.36. Downstream operations recorded a loss of 16 million.

5. Exxon (XOM)(own)(Natural Resource Overweight Strategy): Exxon reported earnings of $1.33 per share, missing expectations by 8 cents, and significantly missed the revenue estimate of 96.41 billion by reporting "just" 90.25 billion. Six billion to the U.S. government is not even a rounding error. Chemical earnings increased 257% from the year ago quarter. U.S. refining continues to be a drag, recording another loss.

6. Currency Risk of Foreign Stocks and Bonds: This article from Morningstar explains the currency risks in owning foreign securities.

7. Unilever (own): I still own shares in Unilever bought at 18.05 on 3/23/2009. I have no intention of selling them, viewing that price as a good long term entry point. Unilever (UN, UL) reported a net profit of €1.055 billion on a 6.7% in sales. pdf Earnings per share came to €34 cents up from €25 cents in the year earlier period. Net cash flow was €666 million. The second quarter's dividend will be increased by 6.7% over the first quarter. Excluding currency fluctuations and acquisition, sales increased 4.1% year-over-year. A discussion of this report can be found at MarketWatch.

8. AT & T (own senior bonds and common): I believe the IPhone was introduced around June 2007. AT & T was selected by Apple to be the exclusive service provider in the U.S. While I do not want to be unfair to AT & T, or to be excessively judgmental, I think that it would be fair to say that the IPhone has been more important to Apple than to AT & T. RB just said that the LB is both overly judgmental and critical. Lighten up Dude, the RB purred.

I bought some AT & T bonds during the meltdown phase at very favorable prices, and have recently purchased the common stock when it fell below $25. The common has had a relatively small move during the tremendous bull run since March 6, 2009. The stock closed on 3/6/2009 at $22.58: T: Historical Prices for AT&T. It is meandering now around $26, or about a 15% increase since 3/6/09. The S & P 500, as of 4/28/10, had increased a stunning 75% off the March low. ( see charts at

On June 29, 2007, AT & T closed at $41.5 or about a 37% decline in the stock price since the IPhone introduction.

AT&T's first-quarter results were okay. Excluding a 17 cent charge related to the health care legislation, the adjusted E.P.S. was 59 cents compared to 53 cents a year ago. AT & T added 1.9 million net new wireless subscribers. The postpaid adds were relatively weak, however, at 512,000, representing a 40% decrease from a year ago. The company used some excess cash to pay down debt during the quarter.

9. Bought 50 ADM at $28.05 (See Disclaimer): ADM almost qualifies for the dividend growth strategy. I looked at the historical data at VL which starts in 1994 for ADM. The dividend has been increased in every year except for 1999. The current annual rate is 60 cents per share, up from 32 cents in 2005 and 16 cents in 1997. The payout ratio is low, hovering around 20% to net profits, so there is room for better dividend growth.

The current dividend yield is, however, too low as the starting point for stocks in the dividend growth strategy. This simply means that I am not likely to be a long term holder of ADM. I placed it in a satellite account where the primary focus is capital preservation by investing in CDs. I will therefore sell the shares on a pop.

Price to sales is .29 and price to book is 1.22. The five year expected PEG ratio is less than 1. ADM: Key Statistics for Archer-Daniels-Midland Company The current consensus estimate is for an E.P.S. of 3.01 for the F/Y ending June 2011. ADM: Analyst Estimates

10. Bought 200 SFH in the ROTH IRA at 10.18 (see Disclaimer): This is sort of a principal protected note, with some downside protection as explained below. The issuer is Bank of America and it matures on 12/5/2011. It is automatically callable on an observation date if the S & P 500 closes at or above the starting value of 1105.65 on any of the three observations days. The S & P 500 closed yesterday at 1206.78 ( ^GSPC) The next observation date is 11/29/2010. If the S & P 500 closes on that date at or above 1105.65, Bank of America has to call the note and pay me $10.955. So, this is hopefully going to happen. I would call this attempting to get on base with a bunt or possibly refusing to move when the fastball is about to graze the jersey.

The next observation date after 11/29/2010 is 5/25/2011. And if the index is above the starting value on that date, Bank of America will have to pay $11.433. The last observation date is 11/28/2011. If the index is above the starting value at that time, BAC has to pay $11.91.

I said that this was sort of a principal protected note. What happens if the S & P 500 index does not close on any of the three observation dates above the starting value of 1105.65? Then, I will receive on the maturity date $10 provided the S & P 500 closes above the "threshold value" of 995.09. So, this security is principal protected above the Threshold Value. I start to lose the par value with lower closes on a 1 to 1 basis. The example given in the prospectus is an ending value in the S & P 500 at 939.8, a 5% decline from the Threshold value, which would result in a payment of just $9.5 at maturity.

So, this one has limited principal protection and a capped upside. The main benefit now is the S & P is well above the starting value of 1105.65. If it stays above that value on the first observation date, which is what I hope, I will receive about a 7.5% return even if the S & P 500 declines 100 points from its close yesterday at 1206.78 by the first observation date in November 2010. And that return would be realized under those circumstances in about 7 months.

Given the small profit spread, I would not pay anymore than $10.18 for this security. If I miss the first two observation dates and hit the third and last one, the return would increase to about 16.8% but the holding period would be 1 year and seven months. So, I would be happy with the 7.5% in seven months.

This is a link to the prospectus: Final Term Sheet 202 I personally would not hold this security in a taxable account given the uncertainties set forth in prospectus about the tax treatment.

There were several similar notes that I was considering to buy. SFH was the only one that had some volume yesterday.

And, I would caution that the elevator on the way down is a lot faster than the one going up.

This security would be more interesting to me if it missed the first two observation dates, but not by much. Then, if I could buy at a price near par value, then I would have only to wait about 6 months before conceivably receiving the highest amount on the final observation date.

These notes are unsecured obligations of the issuer. Anyone who buys them is subject to the credit risk of the issuer, as the owner of similar securities issued by Lehman found out the hard way. While I sympathize with their plight, it is impossible for me to understand their arguments, made in some lawsuits brought against brokers who sold them the Lehman notes, that they were unaware of the credit risk. If they were unaware, then they were negligent. It only takes a second to review the prospectus before you see language that these types of securities are unsecured obligations of the issuer. They are not CDs covered by FDIC insurance. (some banks do offer CDs whose interest is linked to an index: Index Linked CDs) If BAC is seized by the FDIC, I would become just another unsecured creditor in bankruptcy court as the owner of SFH, though I believe that I would be senior to the owners of the trust preferred issues which might get me a few cents on the dollar in a worse case scenario.

11. Sold 100 of the 457 shares of the CEF BCF (Natural Resource Overweight & CEF Strategy) (See Disclaimer): I like this CEF, but it is another one whose price is currently at a premium to its net asset value. I therefore sold 100 shares of BCF in the Roth IRA. My strategy for CEFs has always been to buy at discounts to NAV, mostly over 10% for stock funds, and to sell or pare when the discount narrows or rises to a premium to net asset value, when that phenomenon occurs in a rising market for stocks. Then, I would be making money in two ways: a reduction in the discount and the rise in the NAV due to a bull market in stocks. BCF closed yesterday at a 2.02% premium to its NAV on 4/29/2010: Some of these natural resource funds have been dinged, particularly yesterday, by owing BP and Transocean, both involved in that oil spill in the Gulf of Mexico.

12. VIX: The ^VIX recovered yesterday from its brief foray above the 20 demarcation line and fell 12.52% yesterday to close at 18.44. The recent dominant trend still suggests that a Stable Vix Pattern may be forming and I am continuing my 3 month count as if there was no brief excursion above 20. Again, my primary use of the Vix Asset Allocation Model is to alert me to change my allocation to stocks when there is a Trigger Event that disrupts a long-standing Stable Vix Pattern. I am now using it to make an estimation of the likelihood of the sustainability of the current bull move for several more years. Under the model, this requires the formation of a Stable Vix Pattern at the end of the Unstable Vix Pattern. We have been in an Unstable Pattern since August 2007. Once the VIX moves for 3 months ( call it 66 trading days) below 20 without a significant disruption of that pattern, then I would declare the formation of a Stable Vix Pattern, which historically would mean a continuation of the bull move for several years, though the time period is mushy. The bull move as defined in the model continued for about 6 years after the formation of the Stable Vix Pattern in 1991 and almost 4 after the 2003 Stable Vix Pattern formation.

12. Goldman Sachs-Investigation of Possible Criminal Charges: The WSJ and the NYT are reporting that Federal prosecutors are conducting a criminal investigation of Goldman Sachs. The matter was referred by the SEC and involves mortgage trading. This may result in nothing happening. It is not unexpected, though the market will probably act surprised today by the news. Needless to say, the phrases "investment bank" and "criminal investigation" do not go well together. The matter was referred to the Justice Department by the SEC one day after 62 House lawmakers forwarded a petition to Justice requesting a criminal investigation. This continues the political theme of the investigation.

I may need to decide whether GYB and PYT, two synthetic floaters tied to a GS TP and held in retirement accounts, are currently consistent with the conservative management strategy for those accounts, at least until the smoke clears. One factor that helps in the decision making process is that no taxes have to paid on gains in those accounts. I do not have a problem holding JBK and PJI in the taxable account where I am willing to assume more risk. I do not believe that I will ever need the funds in the retirement accounts. If I ever do, then those funds will certainly need to be there. I have good unrealized profits in most of GS bond positions in the IRAs.

I had more trades which I will try to remember to summarize in the next post. This post is long enough already. The buys included 50 shares of a bank TP at $23.2 and a foreign pharmaceutical stock. Some sells were made in some securities that had not moved, and LB ran out of patience. Actually, RB just said that the LB has no patience, so it could not run out of something that it has never had. RB's explanation is that Mr. Tunnel Vision is at its core a trader that just kicks up a lot of dust. The LB replied that Mr. Lame Brain may have a point. LB is not know for its patience. Instead, those sells were made as part of a dynamic allocation process of Headknocker's capital, moving from one group of stocks that had not shown the desired movement to other securities, which at least pay income, such as the TP and foreign pharmaceutical stock.


  1. I have been considering selling a lot of my CEF's and just go with PCEF. I agree with most of your reasons for making your own portfolio except I don't think that .5% management fee is a valid reason. I suspect if you figure up all of your trading fees it would add up to at least .5% or more. Unless you trade for free that is. Not to mention the time you put into choosing them.

  2. Rick: It will be interesting to me to see whether I outperform PCEF over time. I tend to manage my CEF position. I would not buy or continue to hold some of the PCEF positions due to their prices in relation to NAV.

    I am not likely to hold a large number of bond funds like PCEF. While PCEF has small positions in a couple of term bond funds, most of its large bond position is in bond funds with no term dates. Since I am concerned about interest rate risk, I am wary of bond funds in general, but I am willing to add to term bond funds like GDO and IGI. As mentioned in prior posts, I view the interest rate risk to be less in term bond funds than the regular ones that dominate PCEF. Also, I am generally picking up more yield with my bond fund selections which pay monthly.

    I would agree that my trading fees are relevant to the analysis, but those fees would be less over time. I could incur almost $500 in trading fees in a year and the cost would be less than that .5%. I suspect that my trading fees are less than $150 per year. A number of these positions are static with nothing added or subtracted to them. I probably have engaged in an abnormal of transactions recently due to the slow uptake in adding to GDO.

    I would add that there is a CEF that contains other CEFs. The symbol is FOF and the sponsor is Cohen and Steers.

    While it is more expensive than PCEF, I do view it as more balanced and it is less bond fund heavy.

  3. Ironically I held FOF for a while and dropped it as it was underperforming the rest of my portfolio (stocks and funds) and it contained some funds that I considered really bad investments.

    Good discussion and follow up post! I have been tracking PCEF for about a month now to see how it holds up against my own portfolio. If it is close then I will probably just add it along side the rest and increase the position as I close others.

    I often have a equity fund that I use as a place to put cash for a while if either I can't find anything better to buy or I don't have the time to look. I can see PCEF filling that role for CEF's...

  4. Rick: Another thing to consider, which would be in favor of a CEF fund of funds is discussed in the Morningstar article which I referenced. The tax reporting issues for my bevy of CEFs can be daunting unless your broker keeps track of dividends classified as returns of capital, which requires a tax cost basis adjustment. Owing one fund simplifies that accounting headache.

    Another issue for me is that PCEF will have a very large overlap in bond investments given the large number of funds. It seems that you could pick two or three of the bond CEFs and come close to what is being held in PCEF on a performance basis. ACG was their top bond holding and it has a lot of diversity with a strong lean toward upper tier investment grade.