Monday, January 19, 2015

Added 300 of the Bond CEF ACG at $7.5-Roth IRA/Added 100 of the Stock ETF EWS at $12.8/Bought 50 BMLPRJ at $20.25

Stable Vix Pattern (Bullish):

Recent Developments: 

The Shanghai Index declined -260.14 or -7.70% on Monday. That index had the largest 2014 percentage gain among major markets and had risen about 40% in 90 days. The total gain in 2014 was 53%. The purported precipitating event was a crackdown on illegal margin lending. WSJ

I published a long introduction to my discussion about ACG at SA: Generating Tax Free Income In The Roth IRA: Bought Back ACG - South Gent | Seeking Alpha

1. Bought 300 ACG at $7.5-Roth IRA (see Disclaimer): This purchase brings me up to 600 shares.

Snapshot of Trade:

2015 Roth IRA Bought 300 ACG at $7.5+

Security Description The AllianceBernstein Income Fund (ACG) is a leveraged closed end bond fund that is weighted in investment grade rated bonds, and has close to a 60% portfolio weighting in U.S. treasuries as noted below. This fund also has a significant weighting in junk rated bonds.

Sponsor's Website: AllianceBernstein Income Fund, Inc.

The sponsor claims that the effective duration was 5.65 years as of 12/31/14.

The general rule of thumb is that the securities owned by a bond fund with a 5.65 year duration will decline 5.65% for each 1% rise in interest rates.

Bond Fund Duration: Vanguard Publication

Interest Rate Risk and Bonds: FINRA Publication

A 2% rise in interest rates would offset approximately 2 years of dividend payments. Interest rate risk is material.

Data on Date of Trade 1/15/15: 
Closing Net Asset Value Per Share: $8.46
Closing Market Price: $7.49
Discount: -11.47%
Average Discounts:
1 Year:  -10.68%
3 Year:  -10.4%
5 Year:  - 9.87

Sourced: CEFConnect Page for ACG

Last SEC Filed N-Q: AllianceBernstein Income Fund (holdings as of 9/30/14; cost of investments=$2.912+B with a market value of $2.995+B)

The largest weighting will be in U.S. Treasury securities:

U.S. Treasury Holdings as of 9/30/14 
The unrealized gain in the fund's U.S. treasury holdings represented about 48% of the total unrealized gains as of 9/30/14.

Credit Quality as of 12/31/14:

While the fund in weighted in "AAA" due to the treasury holdings, there is a significant exposure to junk rated securities that provide more yield but also exposes the fund to credit risks.

The fund also assumes some foreign currency risks with foreign bonds priced in local currencies.

Leverage is high at 36.68% as of 12/31/14. The fund does not specifically state whether or not its duration number is adjusted for leverage which increases duration.

When looking at those historical average discount numbers, the only conclusion to draw is that this fund sells at a persistent discount close to 10%. This pricing may of course change. A continued consistent trend removes the potential of a market price gain due to a significant narrowing of the discount after purchase.

A common trading technique is to buy a closed end fund when it is selling at a substantially larger discount than the historical averages for the past 1, 3 and 5 years and then to consider selling or paring the position when the discount narrows to the historical range. Hopefully, the net asset value per share has also materially increased adjusted for the dividend payments. In that kind of optimal scenario, the investor makes money in three ways: (1) the narrowing of the discount to net asset value after purchase; (2) dividend payments; and (3) an increase in net asset value per share which hopefully will be reflected entirely in the market price.

ACG Filings with the SEC

Last SEC Filed Shareholder Report: AllianceBernstein Income Fund (semi-annual for the period ending 6/30/14)

Last Monthly Update: AllianceBernstein Income Fund Releases Monthly Portfolio Update

ACG is rated 1 star by Morningstar even though the analyst refers to the fund as a "solid core option".
The expense ratio is .63% according to Morningstar.

Prior Trades: I purchased another 300 share a few weeks ago: Bought  300 ACG at $7.53 (10/17/14 Post)

Item # 6 Sold 150 ACG at $7.54-Regular IRA (1/28/14 Post)(profit snapshot= $68.83)-Item # 2 Bought 150 ACG-$6.975-Regular IRA (10/9/13 Post)

Item # 3 Sold 400 ACG at $8.44 (8/21/12 Post)(profit snapshot=+$85.62)-Bought 400 of the Bond CEF ACG at $8.19 (5/31/13 Post);

Item # 1 Sold 400 ACG at $8.122 (12/2/2011)(snapshot of profit +$59.28)-Item # 4 Added 200 of the Bond CEF ACG at $7.98 (10/4/11 Post) and Item # 4 Bought 200 ACG at $7.85 (8/8/11 Post);

Item # 3 Sold 300 of the Bond CEF ACG at 7.82 (5/26/11 Post) (snapshot profit=$41.65-preceding linked post)-Item # 3 Bought 300 of the Bond CEF ACG at $7.63 (4/11/11 Post)

Item # 4 Sold 200 ACG $8.45-Roth IRA (8/26/10 Post)(profit snapshot $104.27)-Bought 200 ACG at $7.85 (5/6/10 Post)

Sold 200 ACG at $8.35 (8/17/10 Post)(Snapshot of profit $58.27)-Added 200 ACG at 7.98 (5/6/10 Post)

Total Trading Profits: $417.92

Distributions: The fund is currently paying a monthly dividend of $.03455 per share. AllianceBernstein Income Fund, Inc. Monthly And Special Distributions There was a slight addition to the December distribution that brought the total up to $.03679 per share.


Assuming a continuation of that rate, which is in no way assured, the dividend yield would be about 5.53% at a $7.5 total cost per share.

ACG cut its monthly dividend rate to .0346 from $.04 effective for the August 2013 distribution.

There was apparently a significant capital gain distribution of $.5687 per share in December 2012.

Provided a fund desires to avoid supporting a dividend with a return of capital, it is to be expected that a bond fund will cut its dividend during a prolonged period of declining interest rates. As vintage bonds mature or redeemed by the issuer before maturity, the reinvestment opportunities will generally have lower coupons, possibly even with the assumption of more credit risk, and new bond purchases will consequently produce lower amounts of income.

Rationale: With this type of purchase, I am playing what I call the Japan Scenario, which the Bond Ghouls view as certain for Europe and highly probable for the U.S. The current bond yields in Europe, with the 10 year bonds of several countries priced below 1% and at least 3 below .5%, would be irrational unless investors believed that Europe will be facing a long period of stagnation burdened by periodic bouts of deflation possibly alternating with periods of abnormally low inflation. Global Government

Current 10 year yields below .5% include the following:

Germany 10Y Yield-Bloomberg

Netherlands 10 Yr Bond - Bloomberg

Switzerland 10 Year Note Generic Yield- Bloomberg

The Swiss 10 year government is below a zero yield.

Just stunning in the future economic assumptions underlying those yields.

The bond investors in the U.S. are not as pessimistic but are moving in that direction in what appears in an inexorable march to a 1% ten year treasury yield.

I am not about to lend the U.S. government money for 10 years at 1.8%. I am barely able to tolerate ACG's yield of 5.5% even with its large exposure to U.S. treasuries and consequently fitting somewhat into a portfolio design for the Japan Scenario.

The 30 year U.S. treasury hit an all time low last week.

Risks: Personally, I think the Bond Ghouls have lost their marbles.

Sure, deflation is likely for several months in Europe.

A forecast of a persistent Japan Scenario taking root is not supported by the current evidence.

Europe slipped into a mild Y-O-Y deflation number last December after the huge decline in crude prices.

The strength of the Euro until recently has contributed to deflationary pressures, but that issue is no longer applicable. There is always a time lag for exports to perk up after a currency devaluation.

When crude prices bottom and start to tick up, inflationary pressures will ensue due to the higher price and the slide in the EUR/USD conversion rate.

And, it is important to recognize that it will not take much of an uptick in inflation and inflation expectations for the current low intermediate and long term yields to look ridiculous.

So, while the Bond Ghouls are pessimistic now, and recognizing that it usually takes them a long time to recognize their severe shortcomings as forecasters even after being confronted with years of data inconsistent with their future forecasts, the risk is still to the downside for leveraged bond funds, particularly when the FED starts to raise the federal funds rate that will increase their borrowing costs.

But, just in case the bond investors are become prescient in their long term predictions, I will play along with them some in my security selections.

As I have noted in earlier commentary, stock investors recognized quickly in August 1982 that the Federal Reserve had strangled problematic inflation out of the system. It took bond investors over a decade to quit mis-pricing inflation in 10 to 30 year bond yields. That fact can be easily confirmed by comparing the actual inflation rates starting in 1983 and the yields for 10 and 30 year treasury bonds. The real rate of returns were extremely high to the persistent mis-pricing due to a continuous erroneous inflation forecast which was being contradicted by an array of current factual information including the CPI reports and productivity gains due to technological advancements and other innovations.

The sponsor discusses risks starting at page 4 of its last SEC filed shareholder report. AllianceBernstein Income Fund, Inc.

Future Buys and Sells: I am in a trading mode for this leveraged, low yielding bond CEF, as shown by my trades noted above.

I am more likely to sell the 300 shares bought in the taxable account first. The non-qualified dividends paid by ACG become tax free when that fund is owned in the Roth.

2. Bought 50 BMLPRJ at $20.25 (see Disclaimer):

Snapshot of Trade:

Security Description: The Bank of America  Floating Rate Non-Cumulative Preferred Series 4 (BML.PJ) is an equity preferred stock that pays qualified and non-cumulative dividends at the greater of 4% or .75% above the 3 month Libor rate on a $25 par value.

There are five BAC equity preferred floaters that pay the greater of a guarantee or a spread over the 3 month Libor rate. These equity preferred stocks are functionally equivalent. All have $25 par values and pay quarterly non-cumulative and qualified dividends.  

BACPRE 4% or .35% above the 3 month Libor Bank of America Corporation
BMLPRG 3% or .75% above the 3 month Libor  Prospectus Supplement
BMLPRH 3% or .64% above the 3 month Libor Final Prospectus Supplement
BMLPRJ 4% or .75% above the 3 month Libor Final Prospectus Supplement
BMLPRL 4% or .5% above the 3 month Libor Term Sheet

Chart: 3-Month London Interbank Offered Rate (LIBOR) St. Louis Fed

The securities starting with the prefix BML were originally issued by Merrill Lynch, which was later acquired by Bank of America.  

When I placed the trade, the following snapshots show the prices and yields for the functionally equivalent BMLPRJ and BMLPRL:

BMLPRJ $20.25: Yield 5.05%

BMLPRL $20.15: 5.07% Yield
So, why would I buy the BMLPRJ with a .02% lower yield-because it was only .02%. I did one prior paired trade when the spread was larger: Item # 4 Paired Trade: Sold 100 BMLPRL at $19.14 & Bought 100 BMLPRJ @ $19.32/ (2/17/11)

While I know that it is difficult to think ahead, particularly way ahead, there will be a time when short term interest rates rise sufficiently to trigger the 3 month Libor float. BMLPRJ has a .25% higher float rate than BMLRPL's .5%.

If the three month Libor rose to 6% during the relevant computation period, the coupon for BMLPRJ would become 6.75% and BMLPRL would be 6.5%. The BMLPRJ effective yield at a $20.25 total cost per share becomes 8.333%. The BMLPRL effective yield at a $20.15 total cost per share becomes  becomes 7.75% or .583% less.

For a negligible give back now in yield, I have the potential to earn substantially more when the 3 month Libor rises sufficiently to trigger the Libor float provisions. It would not thereafter take long to recoup that .02% differential.

Prior Trades:

2014 BMLPRJ 50 Shares +$40.08 
2012 BMLPRJ 50 Shares +$90.98
2010 BMLPRJ 100 Shares +$50.16 
Total Trading Gains BMLPRJ: $181.22

Some Related BAC Preferred Floater Trades:

2011 BMLPRG, BMLPRH and BMLPRL +$221.87

2010 BMLPRH 100 Shares +$363.48
2009 BMLPRG 50 Shares +$166.48
2009 BACPRE 40 Shares +$137.18
Total Related Trades: $889.01

Links to discussions of those transactions can be found in Floaters: Links in One Post.

Rationale: The floaters that pay the greater of a guarantee or some percentage over a short term rate are part of my Inflation or Deflation strategy, confined to a narrow group of securities that can swing both ways, irrespective of whether there is deflation or inflation. The main issues are credit and volatility risks.

These securities have been discussed since the earliest days of this blog, when their pricing presented what may end up being a once in a lifetime opportunity: Item # 4 LIBOR AND THE MET LIFE FLOATING RATE PREFERRED STOCK (October 2008); LIBOR AND THE AEGON FLOATING RATE PREFERRED STOCK (October 2008). I was able to buy the Aegon hybrid at below $5. The Met Life floater METPRA was bought as low as the single digits.

The current coupon is the minimum 4% and that is likely to remain the applicable coupon for several years. Based on that coupon, and assuming a total cost of $20.25 per share, the current yield is about 4.94%.

The 3 month Libor rate would have to rise above 3.25% to trigger any increase in the coupon. The market may be wrong in forecasting future inflation and the FED's federal funds rate which is one reason to own some securities whose coupons can increase in response to problematic and unexpected inflation and the FED's response thereto.

I view the 3 month Libor float provision as a kind of insurance policy for unexpected inflation. In effect, I am paying an insurance premium for every quarterly payment representing the difference between the BMLPRJ yield and yield of fixed coupon BAC equity preferred stocks.

I can price that insurance premium at the time of purchase. I will just take one of the fixed coupon BAC preferred stocks to compute that premium.

The Bank of America 6.625% Non-Cumulative Preferred Series I closed at $26.43, or a significant premium to its $25 par value. BAC has the option to redeem this security on or after 10/1/ 2017, Bank of America Corporation. At a total cost of $26.43, the current yield would be about 6.27%. The YTM would be lower in the event BAC exercises its optimal redemption right in 2017. A redemption of BACPRJ, which is not going to happen in the foreseeable future, would result in a $4.75 per share gain based on a $20.25 total cost and would add to its YTM.

Just taking the current yield numbers, the inflation insurance premium is a bit expensive at 1.33% per annum lower current yield. When I started trading these floaters, the premium was closer to 2%, but then inflation was running hotter than now. Bond investors believe that inflation is as good as dead until the end of days now, just like they believed back in the 1980s that problematic inflation would last for 30 years even after it was clear that this prediction was profoundly erroneous and embarrassingly so.

If BAC calls BACPRI on 10/1/2017 at its $25 par value, the difference shrinks to .19%, using the Morningstar Bond Calculator to calculate that YTM. (YTM becomes just 5.13%)

Risks: I have discussed the many risks relating to non-cumulative equity preferred stocks in my Gateway Post on this subject: Stocks, Bonds & Politics: Advantages and Disadvantages of Equity Preferred Floating Rate Securities

I have also repeatedly discussed the risks in several recents posts here and at SA:

Equity Preferred Floating Rate Stocks: Added 50 Goldman Sachs Group Preferred Series C At $19.63 - Goldman Sachs Group Inc. (NYSE:GS) | Seeking Alpha

Equity Preferred Floating Rate Stocks: Added To MSPRA At $19.87 - South Gent | Seeking Alpha

These securities were smashed down into the single digits during the Near Depression period and its immediate aftermath. Stock charts highlight their risks. In 2007, BMLPRJ was selling at over its $25 par value with a peak price around $27.25 (January 2007). By late February 2009, it had collapsed to just above $3: Bank of America Corp. PRFD 'J': NYSE:BML-J  That had to hurt. Fortunately, I did not start buying these securities until Lehman collapsed and their prices tanked. There is nothing like fear of a price going to zero to shake out the weak hands. And, just for emphasis, an equity preferred stock issued by a leveraged financial institution would have the same value as used toilet paper after a BK.

3. Added 100 of the Stock ETF EWS at $12.8 (see Disclaimer):

Snapshot of Trade:

Security Description: The iShares MSCI Singapore Index Fund (EWS) is an ETF that owns stocks in a Singapore stock index.

Sponsor's webpage: iShares MSCI Singapore ETF | EWS (expense ratio .47% as of 6/30/14; 30 holdings as of 10/3/14; 5 year total annualized returns of 8.37% and 11.21% over ten years through 9/30/14)

EWS Page at Morningstar

This purchase is an average down from an October 2014 buy: Bought Back 100 EWS at $13.27 (10/11/14 Post) The fund did pay a $.2474 semi-annual dividend after my purchase. Adjusted for that dividend, the previous purchase price was $13.02.

Prior Trades: Item # 2 Sold Taxable 100 EWS at $13.69(7/26/14 Post)-Bought Back 100 EWS at $13.1 (12/17/13 Post)(realized gain $44.25); Bought 100 EWS at $12.96 (September 2012)-Sold EWS @ $13.91 (April 2013)(realized gain +$79.22)BOUGHT 100 ETF EWS AT $10.9 February 2010-Sold EWS at $11.55 June 2010 (realized gain +$47.15)

Total Trading Gains: $170.82

I have not yet caught the wave on this yet. I really can not say that keeping those shares bought at $10.9 back in February 2010 would have been worthwhile, given the almost five year time elapse since that purchase and comparing the return with a U.S. stock index ETF like SPY.

EWS has had some stellar years. I want count the +67.47% total return in 2009 after the disastrous 2008. The fund did have recent total returns of +24.58 (2010) and +31.79% (2012) compared to SPY's 15.06% and 15.99%.  The EWS total return in 2013 was +.96% and +2.91% in 2014, based on net asset value, so that market and the U.S. are not in tandem to the upside. The ten year annualized total return is a decent 9.86% through 1/16/15, particularly given the dismal 2008 number of -47.01%. This security does provide some diversification to a U.S. weighted stock portfolio.

Sourced From: EWS Total Returns

Distributions: Dividends are paid semi-annually in June and December. For 2014, the fund paid $.4381 per share. The rate will be variable. Assuming $.44 per share on an annual basis, and a total cost per share of $12.8, the dividend yield would be about 3.44%.    

Rational and Risk: With this ETF, I achieve some diversification into a developed market that will participate long term in Asia's growth. The dividend yield provides some support.

EWS will have a much higher standard deviation than SPY. Morningstar calculates the 3 year standard deviation for EWS at 15.61  and 22.96 over ten years-through 12/31/14.

Standard Deviation Defined

One risk is highlighted by the total return in 2008. Any foreign country fund will a number of important risks, including currency risks and what is generally labelled "country risk". Singapore is going to have less country risk than other Asian markets or any Latin America stock market. Singapore is not viewed as emerging market and consequently would not be included in an emerging market stock fund.

The Singapore Dollar has been declining against the USD which is another negative, assuming it continues since the currency decline will flow through into the USD priced EWS. USD/SGD Interactive Chart

On 7/23/14, 1 USD would buy about 1.23SGD and over 1.33 now, or about a 8.13% decline in the SGD which would flow into the EWS price. 

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