Tuesday, June 5, 2012

Volatility and Asset Allocation/Bought 50 PRY at $23.58/BOUGHT 100 FPCPRA at $25.35

This is a link to a WSJ article discussing asset allocation based on volatility. According this paper, a mutual fund follows this approach, the Invesco Balanced-Risk Allocation Class A. This is link to the top 25 holdings of ABRZX. I have argued that volatility needs to play an important role, particularly in the stock allocation, for about five years now. The Vix Asset Allocation Model bases stock allocation decisions, at least in part, on the movement of the VIX. Mark Hulbert and the Use of the VIX as a Timing ModelTrading and Asset Allocation in Stable and Unstable VIX Patterns. The most important signal given by that model is the Trigger Event, which requires a mandatory reduction in the stock allocation. That event occurred in August 2007 which marked the formation of an Unstable VIX Pattern which is still in effect. VIX Chart from 2007: Alerts and Triggers Major Disruption of Cyclical Stable Bull VIX Pattern

It is more difficult to set volatility parameters for other assets such as gold. If I was going to base a decision now on whether to buy gold based on its volatility, which I would not do, I would buy when the volatility of gold price increases, which is counter-intuitive. Gold prices last spiked when the CBOE/COMEX Gold Volatility Index spiked from under 20 (July 2011) to 37.13 (9/23/11). Gold prices went down as volatility decreased and finally hitting a bottom at 16.89 on 4/27/12. Last Friday, gold had a big up day and volatility rose from 23.26 to 25.24. In other words, gold prices may be asset class benefiting from increased volatility. That would conform to my previous observations that gold tends to rise during an elevated spike in the VIX associated with an ongoing and signifiant stock market decline. {GVZ, the gold "VIX", measures "the market's expectation of 30-day volatility of gold prices by applying the VIX methodology to options on" GLD, CBOE}

An article in the WSJ found that there was inconsistent correlations between gold prices and two other assets, the S & P 500 and the 10 year treasury. It is not unusual for correlations of certain asset class to be volatile, a topic that I explored briefly in a 2009 post: Instability & Volatility in Asset Correlations For example, a ten year treasury may rise in value with stocks for a time, and then be negatively correlated in other periods. An investor really needs to drive down to the causes for positive and negative correlations, and then determine which cause is present in the real world.

It should not come as any surprise that Bank of America hid the anticipated losses from acquiring Merrill Lynch from its shareholders before its shareholders voted on that acquisition. NYT

Bernstein started Facebook (FB) with a sell rating and a $25 price target. (see also discussion at  Bloomberg) It would be unsual for me to buy a large capitalization company at more than 20 times forward earnings. The current consensus estimate for FB's calendar 2013 E.P.S. is $.65. If I slap a 20 P/E on that estimate, the price would have to be about $13.

Reuters' poll found that 4 out of 5 Facebook users have never bought a product or a service as a result of advertising or comments on Facebook.

Finance Ministers and central bank governors from the G-7 will hold an emergency conference call today to discuss Europe. Something major needs to be done soon to restore confidence in the European banks. There is some hope that Germany will come around and do whatever is necessary to keep the EU from collapsing.  MarketWatch

I have several stocks fall into my buy range, where I sold a partial share position at higher prices. For many of my stock positions, I will trade small lots, selling an odd lot on a pop and then buy back those shares at lower prices, hopefully realizing a gain while at the same time lowering my average cost per share using FIFO accounting. This is a normal trading strategy during an Unstable Vix Pattern.

1. Bought 50 PRY at $23.58 Last Friday-Roth IRA (see Disclaimer): PRY is a new exchange traded senior unsecured bond issued by Prospect Capital (PSEC). The bond has a 6.95% coupon on a $25 maturity. It is scheduled to mature on 11/15/2022. Interest payments will be made quarterly on the 15th day of February, May, August and November. Prospect has the option to redeem this bond at par value, plus accrued interest, after May 15, 2015. This is a senior unsecured note.

This note started to trade last Thursday and the price has been volatile since the start of trading, with a downside bias. Possibly, some investors have become unnerved by a significant percentage decline since the IPO and have sold without regard to price. The price action for PRY after its IPO is notably different than the price for HTGZ and ARN, two recent exchange traded bond offerings from the BDCs Hercules Capital and Ares Capital. While I was able to pick up 200 shares of HTGZ at a small discount to its par value, that 7% senior bond is now trading at or slightly over its $25 par value. Ares Capital Corp. 7% Sr. Notes 2022 (ARN) has not traded below its par value after its recent IPO. Yesterday, Prospect Capital Corp. 6.95% Senior Notes Due 2022 (PRY) traded in a $22.18 to $23.85 range. This is not what I would call rational for this type of security. The shares closed at $23.25, down 4.25% for the day.

As noted in the prospectus, the company  had $461.5 million in senior unsecured debt and PRY will rank equally with that debt. (page S-6) Importantly, the prospectus does not contain financial or operating covenants. 

The aggregate value of PSEC's portfolio was $1.691+ billion as of 3/31/12, page 53

PSEC's debt in existence as of 3/31/12, prior to the issuance of PRY, is discussed in note 4, starting at page 41 of Form 10-Q for the Q/E3/31/12. 

PSEC is a business development corporation, which like a REIT, must pay out most of its net income (at least 90%) to the common shareholders in order to maintain its tax status. That tax status allows the company to avoid taxation at the corporate level for the amounts so distributed, thereby avoiding double taxation. Distributing that much money to the common shareholder deprives the corporation of a cash cushion that bond owners would like to have. On the other hand, the income payable to the common shareholders makes it easier to sell common stock, which PSEC has accomplished with regularity and some consternation to me as a common shareholder. The most recent equity offerings are listed in note 7 at page 44. 

I placed a limit order to buy 50 in the ROTH IRA last Friday at $23.81. If I had place a round lot order, it would have probably been filled at that price. Instead, the security underwent a downdraft soon after I placed the order and was filled at $23.58:

That is not uncommon for odd lot limit orders. The downside is that I might receive a fill, at the limit price, for less than 50 shares, which is a known trading hazard for thinly traded securities. On at least one occasion, I had a fill for just 1 share with a 50 share odd lot limit order. I placed the PRY limit order about 40 cents below where it was trading at the time of my order entry. When done in that manner, I would not be thrilled with a partial fill of an odd lot, but I would not be bothered by it either.  In this particular case, it worked in my favor by filling the entire odd lot at below my limit price. 

At a total cost of $23.58, the yield is approximately 7.37%. Using the Morningstar Bond Calculator, the YTM would be 7.8% at a total cost of $23.58. 

Prospect Capital Corp. 6.95% Senior Notes Due 2022 (PRY) closed at $23.25 in trading yesterday. 

I sold 100 shares of the common in the Roth earlier last week. I mention then that I might substitute the PSEC senior bond, trading less income for a higher priority security. Sold 100 PSEC at $10.83-Roth IRA

2. Bought 100 FPCPRA at $25.35 Last Friday (see Disclaimer): I have bought and sold this Trust Preferred Security. In addition to the 100 shares purchased last Friday in a taxable account, I currently own 50 shares in the ROTH IRA. Bought 50 FPCPRA at 25.59 (July 2011)

FPCPRA is a typical trust preferred security. It originates from FPC Capital II, a Delaware Trust, who used the proceeds from the sell of TPs to buy junior bonds issued by Florida Progress, an electric utility operating in Florida that was later acquired by Progress Energy (PGN).

Duke Energy is in the process of acquiring PGN. If that merger is completed, then the underlying bond in FPCPRA will become a Duke Energy obligation.

As noted earlier, I fully anticipate that FPCPRA will be called at its $25 par value plus accrued interest. I have not seen any notice of a call yet. The market expects a call in my opinion, given the small premium to par value. The coupon is 7.1% on a $25 par value.  The TP and the underlying junior bond mature on 5/152039. While a bond maturing in almost 27 years would have a considerable amount of interest rate risk, I am not concerned about it for this bond given the likelihood of a call which could happen at anytime.

If it is called, I will lose $42 on the security which includes the purchase commission.

According to QuantumOnline, FPCPRA is rated investment grade at Baa2 and BBB-. Since the interest payments may not be deferred unless PGN eliminates the common dividend and any equity preferred dividends, I feel more secure with this security than a BBB- rating would suggest. I would feel even better if Duke completes the merger, though that would probably increase the likelihood of a call.

The merge is not a done deal as the parties await action by the Federal Energy Regulatory Commission. The FERC is concerned about competition issues in the Carolinas' wholesale power market (e.g. power sales to rural cooperatives for resale to their customers). The combined entity would dominate that market in both North Carolina and to a lesser extent South Carolina, due to the presence in SC of Scana and Santee Cooper.

There is a typical stopper clause that would prohibit PGN from deferring the interest payment while continuing to make distributions on a junior security, which is what one would expect to see:


This kind of purchase is a placeholder in a taxable account. While I do not expect to make much, if anything, on the security, I hope to avoid losing anything either, while collecting one or more interest payments. The goal is therefore very modest, sell the security for a few a bucks in profit after collecting at least 1 interest payment. Collecting four interest payments and harvesting a $1 profit would be satisfactory. This kind of purchase can be financed without dipping much into the substantial cash allocation, given the interest and dividend cash flow into the taxable accounts:

Buy of 100 FPCPRA at $25.35 + Some 6/1/12 Cash Flow One  Account
On the day of my purchase (6/1/12), FPC Capital I 7.10% Cum. QUIPS Series A (FPC.PA) closed at $25.48, down 2 cents for the day. The S & P 500 declined 2.46% last Friday.

The yield at a total cost of $25.35 is approximately 7%.

Duke Energy has a 6.05% mortgage note, rated at A1 by Moody's, that matures in 2038 that closed last Friday at over 130, with a YTM slightly over 4%  (FINRA and Prospectus-  Duke Energy Carolinas, LLC). A 6.1% Duke senior bond maturing in 2037 closed last Friday at over 127, giving it a 4.3% YTM at a A3 Moody's rating (FINRA and Prospectus) Progress Energy has a 6% senior note maturing in 2039 that last closed over 127, giving it a YTM of 4.59% at a Baa2 Moody's rating (FINRA and Prospectus) I suspect that Progress is waiting for the Duke acquisition to be completed and then Duke would have the option of redeeming this junior bond. Refinancing the junior bond with a senior bond would save some money.

FPCPRA is discussed in note 23, starting at page 224, of the 2011 Progress Energy Annual Report ($300 million in principal amount outstanding)

FPC Capital I 7.10% Cum. QUIPS Series A closed up 1 cent at $25.49 yesterday. 

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