When I was an investment grade corporate bond manager (2001-2003), my analysts would come to me and explain the credit metrics of the company whose bond we might buy. Now, that was a period of great stress in the credit markets. Often my analysts would stress that the low enterprise value to EBITDA ratio would help protect us, and it did.
Fast forward to 2006-2007. Companies with low enterprise value to EBITDA ratios are being taken private, and the corporate bonds with no change-of-control covenants are being downgraded to junk, because of the additional senior bank debt subordinating the old corporate bonds.
This is another situation where the manager wants Goldilocks. Not too hot, lest it be taken private. Not too cold, lest it default. It’s a tough situation to be in, and if I were managing a bond portfolio, I would move to higher quality with corporate bonds (not much yield give-up), while buying junk-rated corporate loans, so long as they have protective covenants.
It’s a tough situation. Clients want yield and safety, and the trade-off is tough. The best a corporate bond manager can do is to play it safe with spreads so tight, and wait for a better day to take credit risk.
Sorry for my relative silence over the last few days, but I had to get my taxes together. My employer gave me K-1s in early April, so I had to push to meet the April 17th deadline. Maybe if I weren’t negatively disposed to the way the US government uses the money, I would be more chipper. Instead, I think we should hold elections near April 20th, or move the normal tax filing date to October 31st, which would highlight the ghouls that are sucking our blood for little good reason.
Of course the politicians would never do this. A sleepy electorate is the best electorate. The cozy duopoly of the Democrats and Republicans helps insure that no change will happen to the dysfunctional political process that we now have.
Well, my RealMoney column from April 9th got republished on the free site, and got syndicated out to Yahoo! as well. When I write a piece where I mention a company, like Assurant, it’s fun to see the piece appear on the Yahoo! news. But when I don’t mention a ticker, I know that if they put it on the free site, I know they also syndicate it out to Yahoo!, and a number of other places as well. I get amazed at times where my stuff ends up. Well, I hope it makes money for them, and most of all, I hope it benefits those who read it.
That’s particularly true for this piece, because it focuses on risk control in a very direct way. Too many market players don’t realize that risk control is a way to make more money on average over the long term. How does that work?
- It keeps you in the game. Absent war on your home soil and aggressive socialism, being an owner in society is a winning strategy over the long haul.
- Rebalancing allows you to pick up an incremental 2-3% annually on average. It forces you to buy low and sell high.
- There will be drawdowns. You will get drawn down less, and if you stay with strong companies in industries that have previously underperformed, when the bottom arrives, you will outperform the market.
I view risk differently than most market players, and than almost all academics. Risk means trying to avoid loss on every name in my portfolio, not avoiding loss on the portfolio as a whole, and certainly not standard deviation of returns, or even worse, beta.
“Don’t keep all your eggs in one basket.” True enough. “Keep all your eggs in one basket, and watch that basket carefully.” Also true. “Watch every egg.” That’s what I try to do. I’m a singles hitter, not a home-run hitter with attendant strikeouts. I try to make money on every company, by following my eight rules. That doesn’t guarantee success, but my losers over the last 6.5 years have been less than 10% of the names that I invested in. And, in each case where I lost, the error of judgment came from neglecting one of the eight rules.
All that said, I encourage you to focus on risk control. It’s a lot easier to make money if you don’t lose it.
Full disclosure: long AIZ
I had a pretty good day in relative terms today. Leading the charge were Premium Standard, Patterson-UTI, YRC Worldwide and Jones Apparel. Trailing the pack were Cemex, Lithia Automotive, Group 1 Automotive and Komag.
My main intent in this post is to encourage everyone to vote their proxies. We have a responsibility as capitalists to watch over the firms that we own to the greatest extent possible, and to encourage them to foster greater shareholder friendliness. I don’t want shareholder votes to be like ballot initiatives in California, where one becomes an amateur legislator, but I do want the ability to vote down directors, and for 5% of the shareholders to be able to propose binding rules to the company, for the shareholders as a whole to vote on.
In my own voting, I vote against management when they have not provided an adequate relative return, and vote with them when they have, aside from the principles listed above. If all mutual funds voted this way, corporate America would clean up its act, and rapidly.
Full Disclosure: long PORK, PTEN, YRCW, JNY, CX, LAD, GPI, KOMG
With Buffett’s purchase of Burlington Northern, I have to toss out this idea: what if Burlington Northern took its extensive land holdings and spun them off into a REIT, where the railroad would pay the REIT a fee for renting the rails?
This could be a very tax-effective means of running the business(es). I would imagine that the operating company would pay a small dividend at best, while the REIT would pay a significant dividend.
Now, the fun question is which entity would be more valuable. I would guess that the REITs would be more valuable, given the scarcity of tracks. That said, logistics are probably worth more… the ability to use the track intelligently is worth more than the tracks, until things become more congested on the rails.
Cemex finally achieves it great ambition of becoming the world’s largest cement company by market capitalization with its acquisition of Rinker. Holcim and Lafarge slip behind Cemex.
Cemex is still cheap in my opinion, and will wrench cost savings out of Rinker. The US authorities have already passed on the deal, telling Cemex what they must divest. The market rendered its own verdict, sending both Rinker and Cemex up in price. That’s a good sign for the future.
Today was another good day for me, with Cemex leading the pace, followed by Bronco Driling and Anadarko. Trailing the pack were Dow Chemical, Tsakos Energy Navigation, and Komag.
Full disclosure: CX LR BRNC APC DOW TNP KOMG
The broad market portfolio did well yesterday. A leading reason for that was the rumors regarding Dow Chemical being acquired by private equity. I don’t care about private equity, Dow Chemical is cheap; I’ll own it anyway. Also adding to the party was YRC Worldwide. In an economy as strong as this one, trucking should be strong.
Away from that, for those with subscriptions to RealMoney.com, I had an article published there that explained how to size portfolio positions. This article was inspired by Rob Pollock, the CEO of Assurant, who encouraged me to read “Fortune’s Formula,” which is a popularization of the Kelly Criterion.
Full Disclosure: long DOW YRCW AIZ
I would like to draw your attention to this free Wall Street Journal article on Dan Fuss of Loomis Sayles. Dan Fuss is a fundamental genius in bond investing, and anything you hear about him is worth reading. Largely because of his reasoning, I own a decent slug of Canadian bonds for my balanced mandates.
I will contrast him with the better known Bill Gross of PIMCO. PIMCO is largely a quantitative shop, implicitly writing out-of-the-money calls against their fixed income positions to generate incremental income. Dan Fuss makes big investments on what he believes the world will be like 3-5 years out. His view of the world has been uncanny for several decades. No surprise that he has been the best in bond management over the long haul.
An article in Friday’s Wall Street Journal described the creation of new closed-end funds dedicated to the production of yield. I am simultaneously horrified at the concept, and yet wondering whether I couldn’t create one with multiple strategies to smooth out the difficulties of single strategy yield creation. I could buy:
- unusual bonds with high yields.
- certain fixed income closed end funds at a discount.
- dividend paying stocks, and occasionally (ugh) preferred stocks.
- non- or low dividend paying stocks that fit my eight rules, and sell out-of-the-money calls against them.
- lever the fund by borrowing at LIBOR.
- Use my mean reverting REIT, utility, LP strategy. Backtests have it generating a 20% return annually, and I haven’t tweaked it.
The thing is, though, yield is a conceit. People like to think that they are merely scraping the income off of the portfolio, when in many cases, they are truly consuming capital, but the accounting doesn’t make it look that way. Think of a high yield fund with a single-B average credit quality. During good times, the full yield, and maybe a tiny amount of capital gains comes into income. During bad times, the yield shrinks, and capital losses get passed through. Over a full cycle, the NAV of a high yield fund shrinks.
Logical people would not invest in income vehicles like that, but invest they do. Two parting bits of advice. One, there is no reason to ever invest in a closed-end fund IPO. Closed-end funds should trade at a discount equal to the annual fee times five (or so). Two, be conservative in yield investing. It is little known that lower yielding REITs tend to outperform higher yielding REITs. The only time to stretch for yield is when everyone is scared. Even then be careful; make sure the yield that you are getting is secure.
Recently I have had rebalancing trades, selling a little Dorel Indsutries and Sappi. Also, I swapped Sonic Automotive for Group 1 Automotive early on Tuesday. I was able to enjoy two unexpected sell-side upgrades. It’s not supposed to work this well, but it is nice when it does.
On another note, from a piece by Lloyd Byrne of Morgan Stanley, in 2006 only 73% of oil production was replaced by new reserves for companies that they follow. This is just another reason why I am overweight energy. The replacement ratio has fallen for the last four years.
Finally, if you subscribe to RealMoney, be sure to read Jim Griffin’s post, Fed-Watchers Have Blinders On. I have been contending that the housing lending crisis is serious but will not derail the economy on is own. With the decline in the dollar, it is no surprise that our exporters are seeing some growth. Funny that few notice that. I guess we are used to being importers only….
Full disclosure: long GPI DIIB SPP