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Tag Archives: Portfolio management
closed-end funds
Investment companies in the US are a specialized form of corporation that is exempt from corporate income tax, a privilege they get in return for agreeing to restrict activities to investing in securities and to distribute to shareholders virtually all their realized profits (which become taxable income to recipients).
The predominant form of investment company is the mutual fund/exchange-traded fund, also called an open-ended fund. What makes the fund “open-ended” is that the investment company itself regularly issues new shares to buyers and redeems them from holders who wish to sell. Put another way, the number of shares of the company–and therefore the amount of money under management–is variable. It typically ebbs and flows with market sentiment or with the track record of the professionals the company hires to manage the money.
A less common form of investment company is the closed-end fund. In this format, the investment company raises initial capital in an IPO and trades its shares on an exchange. It does not allow shareholders to purchase and redeem directly from the company (the reality is slightly more complicated, but nothing to worry about). Instead, buyers and sellers find a counterparty on the exchange, just as if they were selling a regular stock or bond.
What makes closed-end funds interesting to you and me is that they almost always trade at discounts to net asset value. There are some exceptions, like if they specialize in some exotic foreign market that’s hard to invest in directly and which happens to be flavor of the month, or if the managers have been shoot-out-the-lights successful in their investing (I can’t think of one in this second category).
This is particularly true in times of stress.
If the discount to NAV becomes too great, or persists for too long a time, predators may try to take control of the fund and liquidate it–which, of course, makes the discount disappear as well as the fund.
Why am I writing this today? …because I’ve been reading that closed-end bond funds are trading at unusually high discounts to NAV at present. I presume that this is in anticipation of higher interest rates.
I’m by no means an expert on these funds. And I can’t imagine rushing out to buy bonds today. But these may be a class of securities to begin to learn about and keep an eye on.
Janet Yellen, this week and last
Fridays are strange days on Wall Street. That’s because, unless they’re super-confident, short-term traders don’t like to hold a large inventory of securities over a weekend. Too much time for bad stuff to happen. So they sell enthusiastically on Friday afternoons.
There’s certain sense to this behavior. For them two days+ may be a long holding period. Also, companies and people, particularly sneaky ones, like to save bad news up for late Friday afternoon or the weekend, when they think no one is paying attention. This lessens the pain, they think. Often, it has the opposite effect, however, since anyone who’s been around for a while knows what a late-Friday press release invariably contains.
So in one sense it’s not a great surprise that the huge effort–enough to send her staggering off the stage–Janet Yellen put out yesterday to explain that, yes, the US economy is in great shape and, yes, the Fed is going to take the first baby steps to get the country out of interest rate intensive care (IRIC (?)–although it may be too late for this acronym) before New Year’s eve had no lasting positive effect on stock prices today.
The reason is that, aside from robots designed to react to newsfeeds, everyone knew that already. In fact, her announcement on Thursday the 15th that the Fed Funds rate would stay at zero for now wasn’t a shock, either. Futures markets had been putting the odds of a rate hike in September at less than one in three.
Yet the stock market took something Ms. Yellen said last week the wrong way. If it wasn’t the interest rate announcement, what was it?
Actually, I think there are two things, one said and one not.
The first, and more important, in my view, is the unspoken but strongly held belief by the nation’s finest economists that if we have to depend on the White House and Congress for economic support, we’re doomed. That’s because monetary possibilities to plug up a hole in the bottom of the boat are all used up. The federal arsenal now contains only fiscal policy—changes in government regulation of business, or in spending priorities or in taxes. The Fed knows it isn’t going to get bailed out by Washington if it raises rates too soon–something that has gotten many nations into trouble in the past. Therefore, it has to err on the side of caution, even if that’s unhealthy to do.
We all sot of know this, but it’s not a plus to be reminded that as a nation we’re stuck in at best second gear as long as Washington dysfunctions its way through life.
The second, the one said, is that developments in China have the potential to hurt US growth enough to tip us over the edge. I don’t think the effect on the stock market is so much about the details. It’s the headline that matters–that the US is no longer so large that we’re impervious to what may happen in any other single country. It conjures up thoughts of the post-WWI, when the UK passed the mantle of world economic leadership to the US, except that we’re now in the role of the UK.
Again, everyone sort of knew this was happening. But having it confirmed by our foremost economists is another thing.
To put this in stock market terms, I don’t think Ms. Yellen is calling into question the market’s ideas about current earnings as about the multiple those earnings are worth.
actively managed bond funds in a rising interest rate environment
During my working career as an equity portfolio manager, I experienced the US bear markets of 1980-82, 1987, 1990-91 and 2000-2002. Because I spent the majority of my career as a global manager, I also lived through the collapse of the Japanese stock market (then by far the largest in the world) in 1989 and the currency-triggered bear market in many smaller Asian countries in the late 1990s. I started writing this blog as a way of helping myself think about the bear market of 2007-09 and what would follow.
In other words, for equity managers there have been lots of bad times to help us along with the painful process of being able to, as they say, make the critical distinction between brains and a bull market.
Also, the bad periods themselves have been long enough to force us to recognize that different investment styles (growth or value) work best in different economic circumstances. We certainly won’t change our overall philosophies. However, successful equity managers all realize that for them there are some times to be in fifth gear with the gas pedal to the floor and others to be in second gear and tapping on the brakes.
Looking at the bond world from the outside, it seems to me that little of this has been the case for bonds and bond managers since the early 1980s. Yes, junk bonds or emerging markets debt may have gotten ugly now and again. Nevertheless, the continual decline in interest rates from the early Volcker years to the present has made for a remarkably smooth, and consistently bullish, ride for bond investors and managers.
The amazing part is not a long bullish period–after all, equities in the US had that for most of the 1990s–but the fact that the benign environment lasted over thirty years. To have experienced an ugly time for bonds comparable to what happens to stocks every business cycle, you would have to have been a bond manager in the 1970s!
This is my main concern for actively managed bond funds.
We’re (already) in a period in which interest rates are not going to decline. They may fluctuate for a while, even a long while, but the new main trend is going to be for rates to rise. And we haven’t had circumstances that have forced bond managers to cope with a situation like this for decades.
Instead, the recipe for success over the past thirty-five years has been to throw caution to the winds and bet as heavily as possible on continuously declining rates. The most successful managers would have been the most aggressive, the ones willing to double down on any bet gone wrong and to stack their portfolios full of risk. Brash, bold, stubborn, no sense of nuance, not the brightest crayon but tenacious. Think Jon Corzine and what happened to him.
Will bond fund managers be able to adjust to the changing trend? I don’t know.
Bill Gross is another interesting case in point. He became the “bond king” by betting aggressively on lower interest rates. My reading of his results for his last several years at Pimco is that he tried to keep his performance numbers up by layering on extra amounts of risk to the main bet that had stopped providing results. That didn’t work so well, in my view. Since leaving for Janus, where he could express his ideas in his portfolio without an outside sanity check (outside interference?), he’s done poorly.
This is not about old dogs and new tricks in the sense of age but only in having the temperament and mental flexibility to adjust to changing circumstances.
bond funds when interest rates are rising (ii)
Yesterday I referenced an article in the Wall Street Journal that talked about possible liquidity problems with junk bond funds as rates begin to rise. Based on information provided by Barclays, a huge provider of ETFs, the reporter, Jason Zweig, concluded that junk bond ETFs are a safer alternative to traditional mutual funds.
My comment from yesterday, boiled down perhaps to the length it should have been, was that since the first junk bond crisis in the late 1980s, junk bond funds have adopted very rigorous pricing mechanisms, so the chances a junk bond fund is badly mispriced are very small. On top of that, mutual fund companies have lots of tools available to deal with high levels of redemptions.
As to ETFs, while as a practical matter it may be that these vehicles themselves may not be subject to the same selling pressures as traditional mutual funds, the way that ETFs insulate themselves can be an issue for you and me.
In the case of traditional mutual funds, we buy and sell directly with the fund, once daily, after the close, at NAV.
ETFs are considerably more complicated. We deal with broker intermediaries who make a continuous market throughout normal trading hours, though with no guarantee about how closely the bid-asked spread they set will match up to net asset value. (Authorized participants, who typically deal in minimum blocks of 50,000 shares are the only ones who transact directly with ETFs.)
The tendency of ETF market makers in times of market stress is to widen the bid-asked spread. This does two good things for the broker. He gets a higher return for transacting at a risky time. And the wider spread discourages people from trading. Translation: liquidity for you and me dries up.
How bad can it get? I don’t know. Several years ago I tried to collect data on the performance of stock ETFs at the market bottom in early 2009. The only information available then was a comparison of the last trade on given day with the NAV calculated after the NY close. In one case, for a foreign stock ETF, the last trade was at a 12% discount to NAV. The discount may have been considerably wider during the day. At that time, ETF companies told me they just didn’t know.
I haven’t checked since. I haven’t done this for bond funds. And one might argue that the 12% discount is an outlier. But the horrible problems ETFs had during the last week of August suggest to me that the situation hasn’t changed for the better.
My experience is that trying to trade during highly emotionally charged times is usually not a good idea. But it also seems to me that the potential risks inherent in trading in mutual funds at times like this to you and me, not to the fund company, pale in comparison to those involved with ETFs.
This has gotten much longer than I intended. More tomorrow.