Corner of Berkshire & Fairfax Message Board

General Category => General Discussion => Topic started by: ericd1 on March 31, 2009, 05:21:19 PM

Title: Closed-end bond funds
Post by: ericd1 on March 31, 2009, 05:21:19 PM
Looking at closed-end binds funds I find many/most of them have been beaten up along with everything else. Leveraged funds had difficulty renewing their notes (ARPS) and as portfolio values tanked, some funds had to reduce their leverage by selling portfolio positions and redeeming notes. The result appears to be enticing yields and opportunity for increases in bond values.

I've nibbled at a few (PTY, PHK, PFL), but before increasing my exposure I'd sure appreciate some input and comments from the collective wisdom of this esteemed group... Thanks in advance

Title: Re: Closed-end bond funds
Post by: cheapguy on April 01, 2009, 02:31:21 PM
How about some details of these funds.

Are they leveraged ?
What are the maturities and default rate assumptions in a "stress test" type of environment.

How about 25% default rate and higher inflation rate scenario ?
Title: Re: Closed-end bond funds
Post by: JackRiver on April 01, 2009, 03:25:24 PM
Ericd1

To be sure, people do need to pay special attention to the leverage in many of these funds, and the fact that the 1940s act sets hard guidelines on asset coverage ratios.  This has the very real potential in some of these funds to create a death spiral outcome for the equity holders.  That is, to meet the coverage ratio the funds are forced to sell assets, as they and others sell assets prices fall further triggering further forced selling to meet the coverage ratios. 

There may be some interesting plays in this area now, but for sure, investors who road these things down got screwed and will probably remain screwed.  The banks that extended the leverage are the big winners in these things, as are the portfolio managers who collect tens of millions of dollars in compensation for losing other peoples money.

And so it goes and so it goes.

Yours

Jack River
Title: Re: Closed-end bond funds
Post by: ericd1 on April 01, 2009, 07:12:44 PM
Here's some info on the Pimco closed-ends funds I mentioned

PTY - Corp Oppty    23.3% premium to NAV   yield 15.8% at market - Typically traded at a premium 15-20%
Diversified industry and credit quality  Avg BBB-  Avg Duration 5.7   Coupon 6.1%
Invest grade 52%  High Yield 17%  Mortgage 13%  Muni 9%

PHK - High Inc      58.7% premium   yield 26.3% - Traded at premium 10-60% since '06
Diversified industry and credit quality  Avg B  Duration 4.5  Coupon 6.7%
High Yield 59%  Invest Grade Corp 35%  Mortgage 12%

PFN - Floating Rate -8.1% discount yield 22.8%  - Traded at discount 10-15%
Diversified industry and credit quality (AAA to < B) Avg BB Duration 1.1  Coupon Avg  4.6%
High yield 42%, Invest Grade Corp 21%  Cash 20%

Late last year the funds were levered 50%, but because of eroding bond values and coverage ratio requirements they redeemed a portion of their auction rate preferreds, but mgt chose to hold selling and not paying the dividend for ~45 days to avoid total 'fire sale' prices. They sold in March and caught up the dividends after meeting the coverage ratio restriction. I estimate the funds are now 40%-45% leveraged.

Here's my back of the napkin analysis for the basket...

1) Yields are 2-3x normal, suggests portfolio values could increase 100%-200%.
2) Shrinking premium to NAV cuts gain by 50%, leaving gains of 50%-100%.
3) Defaults cuts gains by 15% leaving 40%-80% gains.
4) Average yield over return to normalcy (3 years) adds 10% annually to gains
5) Average returns three years ~ 22%-32%
6) Floating rate fund offers inflation protection

Appreciate your comments and thoughts...(I'm long these funds)
Title: Re: Closed-end bond funds
Post by: Junto on April 01, 2009, 08:08:49 PM
Hi ericd,

haven't researched these particular bond funds but I have been looking at the same sector just slower to move. hard to keep up on the required research between work and a new baby.

in general i think your logic is sound. The looming question is the default rate in the portfolio and the impact of liquidation on the portfolio. as a banker in this environment, the recoveries on a defaulted note are certainly not what they used to be and it is certainly taking longer to monetize recaptured assets.

in general though, i am extremely bullish in both leverage bond/preferred stock investing.
Title: Re: Closed-end bond funds
Post by: SharperDingaan on April 02, 2009, 05:01:04 AM

Eric: You might want to look at how much weighting you have to this, what its purpose is, & what your strategy is wrt this holding.

PTY & PHK will fall as rates rise (inflation) & are likely to fall significantly as current rates are artifically low. PFN should stay close to par. You are effectively betting than over the near term both the discount rate & the default rate are going to decline. Trading.

Beware of reaching for yield. There are a number of high quality prefs about that offer comparable yields without the same degree of risk. Risk/return.

Nothing wrong with the choices.
Just be sure they are in sync with your objectives   

SD



Title: Re: Closed-end bond funds
Post by: ericd1 on April 02, 2009, 05:26:07 AM
J & SD - Appreciate your comments...

I understand the inverse relationship between price and interest rates, but in this instance (once in a blue moon?) the fund yields are irrational. I believe prices for these closed-end funds will go up and yields come down as the credit markets thaw...the current yield offers some margin of safety. (I know...that's questionable)

Purpose - Approaching retirement and want to begin adding some fixed income to my portfolio. Very small allocation to these bonds so far, more in preferreds...BRK is my largest holding, holding FFH too!

I see it as more of a blue moon opportunity than chasing yields. I also think bonds (and preferreds) will recover before equities.

Hope others will shoot holes in this - Thanks again.
Title: Re: Closed-end bond funds
Post by: StubbleJumper on April 02, 2009, 07:31:45 AM

I see it as more of a blue moon opportunity than chasing yields. I also think bonds (and preferreds) will recover before equities.

Hope others will shoot holes in this - Thanks again.

I am on the same page as you.  However, I think that SD makes a good point about buying only "quality" preferreds.  There is a good range of quality issues out there with "medium" dividend rates with only a modest probability of a catastrophic outcome.  If you want to "reach for yield" I would propose that using margin to buy the ORH preferreds or some other quality issue might be a better approach than buying some POS with a high yield. 

As others have pointed out in previous threads, margin interest rates are ridiculously low these days....

SJ
Title: Re: Closed-end bond funds
Post by: ericd1 on April 02, 2009, 08:06:00 AM
SJ - I totally agree with quality...my PFD basket has only a small amount of junk...

ORH has become one of the higher yielding quality opportunities at 11.9%...The WFC-J is 12.3%

Thanks
Title: Re: Closed-end bond funds
Post by: cheapguy on April 02, 2009, 10:08:30 AM
ericd1,
why wfc-j while wfc-l is yielding 15% ?

what is the probability wfc not paying the preferred dividends ?

there are some reports, which argue convincingly that wells has negative equity, and the loan losses could be more than what they are accounting for.
Title: Re: Closed-end bond funds
Post by: cheapguy on April 02, 2009, 10:16:16 AM
SD & SJ, ericd1,
Appreciate if you can list your picks of quality preferred's with little catastrophic risk of.
Thinking of margining up with borrowing costs of 6%.
Will keep some room, and hope not to get a margin call.

any advice on this strategy..

(have wfc-l, orh-a and some small portiion of risky preferreds like citi, hpt-pc..)
Title: Re: Closed-end bond funds
Post by: StubbleJumper on April 02, 2009, 11:39:44 AM
SD & SJ, ericd1,
Appreciate if you can list your picks of quality preferred's with little catastrophic risk of.
Thinking of margining up with borrowing costs of 6%.
Will keep some room, and hope not to get a margin call.

any advice on this strategy..

(have wfc-l, orh-a and some small portiion of risky preferreds like citi, hpt-pc..)

Well, to start with, peruse this list of preferreds:

http://online.wsj.com/mdc/public/page/2_3024-Preferreds.html

In there you will see a nice selection of cumulative trust preferreds for WFC, USB, or JPM...and then there are CORTs and TRUCs for GS...and then there are garden variety preferreds for RNR, ORH, Everest RE or MetLife.  So, that's a nice selection of potential candidates many of which are unlikely to blow up any time soon.  Yields on these tend to range from high single digits to low double digits.

If you already own ORH-A, I would say that you have one of the nicer combinations of risk and yield.  If your margin interest costs are 6% and you margin 2:1 then at today's prices for ORJ-A, an 18% return is conceivable.....as long as you are comfortable with ORH!

SJ
Title: Re: Closed-end bond funds
Post by: ericd1 on April 02, 2009, 12:47:06 PM
I haven't seen the negative equity reports on WFC. Like some of the other majors, they have significant challenges, but hopefully not like Lehamn, or Citi. Today's mark-to-mark changes sure won't hurt, nor will the toxic asset plan if it works.

There aren't any guarantees on the dividend. My belief is that WF won't fail and like Citi's PFDs there's some assurances a swap for common won't wipe you out. As others have mentioned, spread the risk and own several.

In my watch list ORH is probably the highest quality and highest yield. There are some other insurers that have been mentioned (look back in the thread). The quality corporates pfds seem to be yielding 6-8% and quality banks 8%-10% (JPM, USB).

The Financial PFD ETF is now yielding ~13.6% and appears to still have some upside. I've held it along with my basket, approx same movement, not sure I'd margin it, but it's an option. The PFD bargains are rapidly vanishing...I'm going to look at the WSJ PFD list tonight...


Title: Re: Closed-end bond funds
Post by: cheapguy on April 02, 2009, 01:02:37 PM
ericd1 & others,

Anyone looked into PSA 's preferred.

they have equity about $10Billion and the have preferred for about 550million.
so the debt/equity is 5-6% only.

their preferreds are earning in high 9's (close to 10) and very unlikely of not paying dividends or default.

also as they are not in finance, it could be a good diversification.

please poke holes in this corporate, preferreds
Title: Re: Closed-end bond funds
Post by: sswan11 on April 02, 2009, 06:46:52 PM
What will happen to the prices of preferreds if we get (massive) inflation?
Title: Re: Closed-end bond funds
Post by: StubbleJumper on April 03, 2009, 06:39:26 AM
Define the term "massive inflation."  In a recent context, 5 or 6 percent annually might be massive.  If we get 5-6 percent for 4 or 5 years, that's no biggie as the nominal yield from ORH-A is about 12%.  If inflation increases and corporate spreads decrease (as I think they will), the impact might not be enormous.

On the other hand, if you think that massive inflation means 10-15 percent for 4 or 5 years, you'll get killed in preferreds....but you'll also get killed in many other asset classes.   In fact, if you believe that this magnitude of inflation will prevail, the best approach might be to buy real-estate with a very long term fixed mortgage.....

My money is on a mildly inflationary future....but who the heck knows?!?!

SJ