SWZ/Bought 50 of MFA at 8 in ROTH IRA/Closed End Fund Table/Bought 1 Hercules 6.5% Junior Bond Maturing on 6/30/29 at 86/What is Meant by Defensive in this Blog

The jobless claims number from last week, which got the market so excited last Thursday, was revised up yesterday morning to 420,000. I mentioned in last Thursday's post that the market's reaction was non-sensical. (introduction:  Stocks & Politics) For the W/E 6/18/2011, the seasonally adjusted, initial  unemployment claims rose to 429,000, compared to a consensus estimate of 415,000.   ETA Press Release: Unemployment Insurance Weekly Claims Report

Gold suffered a significant decline in value yesterday, which gives the "principal protected", senior, exchange traded, unsecured note MTY more breathing room. Stocks & Politics: MTY To avoid a reversion to the 3% minimum annual coupon, gold can not close above $1,576.80 at anytime during the current annual coupon period ending on 7/27/2011, based on the P.M. London Fix.  The starting value for gold during MTY's current coupon period is $1,168. Kitco Inc. - Past Historical London Fix Yesterday's P.M. fix was at $1523, down from $1541 at the A.M. fix. Still, I would be surprised to see MTY avoid what I call a maximum level violation.  Of course, the phrase "principal protected" means that par value will be paid at maturity, which is $10 per note, provided the issuer has survived to pay the note off, just like any other unsecured bond.

The U.S. Chamber of Commerce, a right wing partisan organization, criticized the release of 30 million barrels of oil from the U.S. strategic reserve, which will probably bring down gas prices for average working Americans.    UPDATE  That release was done in conjunction with the International Energy Agency that authorized the removal of 60 million barrels from strategic reserves worldwide.  The Chamber previously argued that the U.S. taxpayers need to pick up most of the tab from the BP oil spill:  ABC News  U.S. Chamber Statement on BP Oil Spill Cleanup | U.S. Chamber of Commerce  Taxpayers Pay

The market managed to recover somewhat from a downdraft yesterday morning after the EU and IMF announced their approval for the proposed 5 year Greek austerity plan.  Now, the Greek Parliament has to approve the plan.

1. Swiss Helvetia Fund (SWZ)(own): SWZ is a closed end fund (CEF) that invests in Swiss companies.  The Swiss Helvetia Fund  declared a net long term capital distribution of $.727 per share.  The ex dividend date is 7/21/2011.  I have been reinvesting the dividend to buy additional shares. This fund is classified by me as a core long term holding in my CEF portfolio, but only for shares held in a taxable account. I have traded  SWZ in retirement accounts.  I have not bought many shares in the open market. My last purchase in a taxable account was at $12.15 (December 2009 Post).  I own 263.902 shares as part of my international stock allocation in the CEF portfolio.  

Given the recent strength of the Swiss Franc against the USD, the net asset value of SWZ has had a strong tailwind behind it.  The fund has a large concentration in Nestle and Novartis, together representing about 29% of the funds' assets. Both of those companies would be viewed as "defensive" stock holdings. (see explanation in Item # 4 below)  The fund also has about a 7.55% weighting in Roche.  More information about the fund can be found at its website:  SWZ.com - Swiss Helvetia Fund  

One reason for reinvesting the dividend is that SWZ shares will typically trade at more than a 10% discount to net asset value per share. Morningstar shows the 3 year average discount at -14.45%. I would not be an open market buyer at less than a 10% discount.  Morningstar has a 4 star rating on this fund. 

The daily net asset value can be found at the sponsor's website or at the Closed-End Fund Association. 

This is a link to the dividend history: SWZ.com - Swiss Helvetia Fund

This is a link to the last filed SEC Form N-Q, listing the fund's portfolio holdings as of 3/31/2011: The Swiss Helvetia Fund, Inc.

This is a link to the last SEC filed shareholder report for the 2010 year: Swiss Helvetia Fund, Inc.

2. Bought 1 Hercules 6.5% Junior Subordinated Bond Maturing 6/30/29 at 86 on Thursday (Junk Bond Ladder Strategy)(see Disclaimer): Hercules was acquired by Ashland (ASH) on 12/13/2008. Form8k  According to FINRA, this bond is currently rated in junk territory S & P gives it a BB- and Moody's has it at Ba2.  Both of those ratings are better than most of the bonds in my junk bond basket. This debt is referenced in Note J to Ashland's last filed  Form10-Q at page 16.  

As I understand it, when this note was issued by Hercules, it would have been subordinated to all senior debt and later to a senior subordinated note. Form 10-Q, March 31, 2004 Prospectus for 6 3/4% Senior Subordinated Note due 2029.  

The history of this note was summarized by Hercules at page 60, footnote d, to its 2007 Form10-K. This junior was originally issued in 1999 to the Hercules Trust II that was liquidated in 2004, with the debentures held by the trust distributed to the owners of the trust preferred securities. According to that statement, the redemption value of the debentures is $1,000 per bond. As shown in this summary, this bond had an usual history before Hercules was acquired by Ashland. A possible reason for dissolution of the trust can be found in footnote g  at page 47 to the 2004 Hercules Annual Report. This history was sufficiently complicated that I almost passed on the 1 bond purchase, and would not purchase any more than 1 due to the legally complex history of this bond.    

When I went back and looked at the prospectus for the 1999 TP, I found that it was a normal trust preferred security. The underlying bond owned by the trust provides for quarterly payments:  www.sec.gov Interest may be deferred for up to five years provided no distributions are made on a junior security. The stopper provision is typical and is summarized at page S-11. 

This kind of security will be junior to all debt issues, other than other TPs if any, and senior only to pure equity securities, such as common stock and equity preferred or traditional preferred stock.  As a practical matter, for a company like Ashland, this would encompass only common stocks.  For many bank TPs there will often be a layer of equity preferred stocks sitting below the junior bond in the capital structure. 

Unlike Exchange Traded TPs, which trade flat, accrued interest will have to be paid by me to the seller of the 2029 Hercules bond. 

Ashland does pay a common stock dividend.  I am not currently concerned about the credit risk of this junior bond.  There is of course significant interest rate risk with any long term bond. 

For anyone unfamiliar with Ashland, this is a link to its profile page at Reuters and to the key developments page. As noted in the important developments, the company did recently increase its common dividend. 

Due to Ashland's proposed acquisition of International Specialty Products, S & P recently put Ashland's debt on credit watch with negative implications.  So, a downgrade in Ashland's debt by S & P may soon occur.  Reuters 

Usually, I could not buy this bond.  It will be difficult to buy or sell. Given the possible downgrade, a small number became available yesterday, undoubtedly from another small investor.  Since I am able to hold the bond to maturity, I do not care about its lack of liquidity.

My confirmation states that the current yield at my cost is 7.488% and the YTM is 7.878%. 

3. Bought 50 MFA at 8 in Roth IRA (see Disclaimer):  MFA Financial Inc. is a mortgage REIT that invests in both agency and non-agency mortgage securities. At a total cost of $8, and assuming a continuation of the current payout, the yield would be around 11.75%. The payout will fluctuate and will be dependent on a number of factors.  One important factor, common to all mortgage REITs, is the spread between their cost of borrowing and the yield on the securities bought with borrowed funds. Due to the FED's Jihad against savers, the cost of borrowing money is abnormally low at present. I would not want to own this type of security when interest rates are rising at any kind of rapid pace. The value of the assets bought with borrowed money might be declining and the cost of funds rising in that scenario, a double whammy for this kind of business. For now, the mortgage REITS are probably in close to their optimal operating environment, which is just my opinion. 

Unlike many Mortgage REITS which invest in only GSE mortgages, MFA ventures into the private mortgage market. I can only hope that the managers know what they are doing.  That is one reason for such a  small investment. There is no practical way for me to know the answer to that question.  My practical problem is that I have an excessive amount of cash building up in the IRAs due to bond redemptions.  

A discussion of MFA can be found in this Seeking Alpha article. 

I mentioned in yesterday's post that Randall Forsyth recently posted a column on the Mortgage REITs.  

I own an ETF that currently has about 67% of its assets in mortgage REITS, which went ex dividend for its quarterly distribution yesterday. iShares FTSE NAREIT Mortgage Plus Capped Index Fund (REM  MFA is one of the holdings, with a 4.58% weighting. 

This is a link to the MFA's last filed Form 10Q.  www.sec.gov This is a link to the  SEC Filed Press Release that is easier to digest.  In that document, the book value per share is shown at $7.86 as of 3/31/2011. 

4. What is Meant By "Defensive":  By defensive, I am not referring to a security that is "safe".  Many investors ask whether a common stock is "safe", which is never a question that I have asked anyone.  If I ask that question, then I will consent to having a conservator appointed to manage my assets.  "Maybe the LB already needs a conservator, being a Lame Brain and all", RB added with emphasis.   

There is a mind set among a certain class of individuals who want large returns for "safe" investments, something like greater than 10% annualized returns with the safety of a FDIC insured bank certificate of deposit. That mindset is just incredibly ludicrous to me.

Once an investor moves beyond relatively safe investments like a FDIC insured bank CD or a 3 month treasury bill, the proper question is not whether the investment is safe or not, but what are the risks and whether the risks outweigh the potential rewards?  Any investor who wants to know whether a security, which fluctuates in value, is "safe" needs to quit immediately making their own investment decisions. "LB needs to chill out", RB had to interject after that last comment, "go all in". I say relatively safe since I do not view anything as 100% safe, even a 3 month treasury bill issued by our destitute Uncle Sam. During the Dark Period, the government had to insure money market funds after a big fund broke the buck.  

There is more risk involved with owning just one stock rather than an ETF for the entire stock market {e.g. Vanguard Total Stock Market ETF (VTI) or iShares Dow Jones U.S. Index Fund (IYY)} The total stock market ETF is not risk free or safe, as that term is normally used by an investor seeking safety. An investor could buy a VTI in October 2007 and still be trying to breakeven on that purchase.  During a long term secular bear market in stocks, an investment in a broad market average like the S & P 500 will decline in value after inflation even with the dividends reinvested to buy additional shares.  The Roller Coaster Ride of the Long Term Secular Bear Market   Does that sound safe to anyone?

And it could be made worse by the individual's situational risk, such as having to withdraw money during retirement when the asset has declined a lot in value or when the asset's value has lost ground to inflation.   

An individual stock may at times outperform the total market index. Apple's shares would be a recent example. I would view the diversification provided by the total stock market ETFs to be "more safe" than owning a handful of stocks for most individual investors.  I will own the total stock market ETFs from time to time, but I try to outperform the broad market indexes with a large, diversified selection of stocks, moving my allocation up and down based on my macro views.  My stock allocation was decreased substantially in 2007, increased substantially in March-July 2009 as noted in these Posts, and has recently been decreased significantly this year back to about where it was in March 2009.   So, I try to outperform based on the allocation to stocks and the selection.  If the market skyrockets from yesterday's close, I will underperform the averages.  Otherwise, I will most likely outperform based on security selection and the increased cash allocation.  

When I started to increase my allocation in March 2009, I was buying a lot of stocks that I viewed as "defensive". This would include stocks like Coca Cola, Unilever, Heinz, Pepsico, Sysco, Campbell Soup, Kraft, and Proctor & Gamble.  If an investor looks at the charts for those kind of stocks, over any short period of time, the word "safe" does not come to mind.  A long term chart, say twenty or thirty years, looks better and more safe, provided the investor has the wherewithal to ride the down periods. 

One characteristic of consumer staple stocks is that many of them continued to increase both their profits and dividends during the Near Depression period. They were, however, clearly vulnerable to downdrafts in their stock prices.  If an investor panicked and sold the stocks, it would have been easy to lose money. Or an investor could have purchased one or more of those stocks when the P/Es were over 20, with the share price returning now to near where the purchase was made, and that investor might not believe that KO is a good investment or a defensive one, when the shares were bought at $80 and over a 40 P/E many years ago.  As the stock price moves up, so does the risk. KO was less risky when I bought shares in the spring of 2009 at $38.72 than at $65 now. 

These stocks, whose businesses are not dependent so much on the ebb and flow of the business cycles, are defensive in that sense. They are not defensive in the sense of being immune to downdrafts in their stock prices which will likely occur in bear markets. Maybe they will decline less than other stocks, where the company is more directly exposed to unfavorable economic conditions.

The consumer staples and other "defensive" names, which would include pharmaceutical companies who are not suffering from a patent cliff,  can become more defensive when the entry price has been impacted downward by a recession and/or bear market. A catastrophic bear market will periodically come along, based on historical precedent, and most stocks will hit the crapper. The catastrophic phase is one where prices fall more than 50%, usually in a relatively brief period of time. That type of event culminated in March 2009 and in October 1974, for example, with both of those catastrophic declines occurring in the context of a long term secular bear market in stocks, usually lasting 15 years or so.    

So, buy defensive, I do not mean a lack of vulnerability to stock market downdrafts or to any possible meaning of the word "safe".  Instead, I am referring to the following:

A. A company whose business is less subject to the ups and downs of the business cycle compared to the vast majority of companies. 

B. A company with a long history of raising its dividends and increasing its earnings, in both good and bad times. While I would allow for a minor dip in earnings during a severe recession, I would prefer to see no earnings retreat at all.  

C.  Whose stock is currently valued at less than 15 times forward earnings and at less than a 2 P.E.G.  I would not view buying KO at 40 times earnings to be a defensive stock selection.  So, items 1 and 2 above have to be put in some kind of context relating to price and earnings.

5. Closed End Fund Table:  I periodically post a table of the CEFs that I own. The primary purpose of this portfolio is to receive a constant stream of income distributions, which will then be grouped with other distributions to buy more income generating securities.  This is a balanced world portfolio. Some of the distributions will be from capital gains, especially from the stock funds.  I am currently reinvesting dividends to buy additional shares SWZ, JQC, RMT, RVT, CSQ, SGL and ADX, plus only the GDO and BTZ shares owned in a taxable account. I will soon receive shares purchased with monthly dividends paid by CSQ, BTZ, SGL and GDO, plus the quarterly distribution for JQC, which are not yet reflected in the following table.

I take everything in cash in the retirement accounts, which are bond heavy.  I own 220 shares of GDO in the Roth and 200 of BTZ.

I look at this table at least once a day. I am interested in how the portfolio, as a whole reacts, to volatility and to down moves in the market.  The portfolio lost $4.64 yesterday: