Strategies For Uncertain Times: Municipal bond update

The two major muni bond closed end fund (CEF) companies are Blackrock and Nuveen. I’ve written previously about my preference for insured-only investments because it reduces default risk and raises the certainty of your returns. My previous post about munis is here: https://knowledgecapitalist.wordpress.com/2009/12/15/strategies-for-uncertain-times-municipal-bonds-munis/

Here’s the link to the Blackrock funds list (munis listed and sortable by state so you can find the one that applies to your location).

http://www1.blackrock.com/Default.aspx?cmty=ind&m=ind_2&m1=ind_2_1&lo=9&appname=wsod_perf&appurl=http://www.blackrock.wallst.com/public/performanceCenter.asp?fundSwitch=CE

Here’s the link to the Nuveen funds list (munis listed and sortable by state so you can find the one that applies to your location).

http://www.nuveen.com/CEF/DailyPricing.aspx

Strategies For Uncertain Times: Municipal Bonds (Munis)

Overview: I list this separately from “debt” because I view munis as a tax-avoidance strategy, and also because unique characteristics about the munis I look at like pre-refunded status and insurance mean they have different risks than other types of fixed income. Additionally, because I only look at New York muni bond closed end funds (CEFs) trading at a discount that are both insured and New York City tax-exempt, the long-CEF strategy is effectively a strategy by itself. The best way to pick muni CEFs based on  your location is to find them on CEFConnect and then go to the actual fund manager websites for additional detail and the most recent data.

Municipal Bonds

Overview: Generate tax free current income (federal and state if you buy a fund for your state, and potentially no city taxes either). Risk from material state-level fiscal problems across the nation. Some muni funds invest in insured securities, some don’t. Hold in a taxable account b/c income is already tax-free. Almost always makes sense to buy muni bond CEFs at a discount.

• Open-end mutual funds: THERE ARE LOTS OF THEM, BUY CEFs INSTEAD
• CEFs: THERE ARE LOTS OF THEM, ONLY BUY AT DISCOUNT
  • MYN: BlackRock Muni NY Insured
  • NNF: Nuveen NYC Insured
  • MHN: BlackRock Muni NYC Insured
• ETFs:
  • PZT: PowerShares Insured New York Municipal Bond
  • INY: SPDR Barclays Capital New York Municipal Bond

Strategies For Uncertain Times: THE OVERVIEW

I believe that tremendous uncertainty supports the adoption of hedge fund replication strategies.

At the end of 2008 I felt very certain that, given the oversold levels of various equity markets around the world, a basket of China, India, and LatAm (Brazil) were extremely likely to experience very solid price appreciation. Multiples for their respective indexes were lower than they were in the US (which is rare) and I knew that emerging market economies will precede the US coming out of the trough of the macro cycle. Additionally, their macroeconomic situations were comparatively healthy versus the US. In retrospect, it was a no-brainer and a huge winner. I nearly bottom-ticked those equity markets and ended up doing extremely well on a percentage/relative basis as their TTM performance has been stellar.

This year I have the entirely opposite mindset: I have ZERO idea what will happen to equities over the next two years and I think anyone who says they do is selling a theory that they can’t realistically support as actually PROBABLE. Hence, I’ve put together a list of strategies/asset classes that, in aggregate, satisfy my desire to make money over the next year or two. Some ideas are targeted at generating current income, some ideas are targeted at capturing potential equity market appreciation, and some ideas are just uncorrelated strategies or asset classes that offer non-equity means of potentially increasing in value (income plus price appreciation).

Some people refer to compiling these strategies and/or adding non-equity  asset classes  as “hedge fund replication” whereas I just call it considering your alternatives (zing). I believe that, while unlikely to repeat the huge outperformance of my portfolio this over past 12 months, this strategy should produce sold tax-managed returns with favorable volatility over the next one to two years. This is really just a study I prepared for myself (AKA The Dan-Don’t-Be-Broke-Portfolio), but you might find some interesting info for yourself.

There is a considerable amount of disagreement about the definition of the term “hedge fund replication” but, to me at least, it means any combination of three things: 1) not being exclusively long equities (long only), 2) maintaining short exposure as a hedge against bearish moves in equities or the economy overall, and 3) looking at various asset classes and strategies that seek to generate uncorrelated or low-correlation returns with equities.

Clearly 2008 demonstrated that many “hedge funds” were not appropriately hedged, if at all. If the S&P was down 30%+ in 2008 and hedge fund XYZ was down roughly the same amount, then they did not come close to producing returns for their investors that were either 1) positive on an absolute basis (greater value at end-of-period than at beginning-of-period), or 2) positive on a relative basis (lost less value on a percentage basis than the S&P, which is admirable but still fails to increase investor wealth), and 3) most likely generated a return that was highly correlated with the performance of the S&P, which is not acceptable given that investors pay high fees to hedge funds in the expectation that they do NOT produce results similar to what the overall equity market does.

This list is not inherently “fully hedged” or “market neutral” but the list (when aggregated as a portfolio) has a correlation with the S&P of less than 1.0 and potentially has the ability to increase in value even if the S&P falls.  Obviously, my allocation to each of these strategies will vary greatly depending on changes in value, and I might not even currently employ any one of them at all.

Non equity asset classes:

-Commodities

-Debt (emerging market)

-Debt (floating or variable corporate)

-Muni bonds

-Closed end fund (CEFs) arbitrage

-Private equity and/or venture capital (PE and VC)

-Currencies

-Convertible bond arbitrage

Equity-based strategies:

-Merger arbitrage and special situations

-Closed end fund Fund-of-Funds (CEF FoF)

-Biotechnology

-Stock buyback funds

Covered call funds (buy-write strategy)

Real estate (US and/or international)

Long/short equity (partially hedged or market neutral equity)

Managed futures (this can mean several things)

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I have prepared my own investment guide that spans all of these strategies. You can download it by clicking here.

Strategies For Uncertain Times

I prepared it awhile back, so it may not reflect current market conditions, valuations, or discounts. It is based on my own financial situation, goals and objectives, risk profile, and tax considerations. My picks/selections are bolded, there may be two per strategy/asset class. In many cases I prefer closed-end mutual funds (CEFs) b/c they trade on an exchange like stocks, and frequently trade at discounts to their “net assets” per-share, which occasionally creates a built-in margin of safety. I will continue to hold a good portion of emerging market equities, which I trade in and out of depending on valuation on price changes. I hold HAO for China, GML for Latin America, RSX for Russia, and EPI for India. I just typed up my handwritten notes, so there are plenty of abbreviations, typos, and short-hand notes. The format isn’t meant to be anything more than acceptable, so just call me if you have a question about what something means or what I’m thinking.