Bob Carlson

September 23, 2016

MLPs vs. Infrastructure

Filed under: Income Investing — Bob @ 8:20 am

Here’s an interesting post comparing investing in master limited partnerships to investing in infrastructure companies, including MLPs. It makes a number of good points and focuses on comparing two ETFs that initially appear to be similar but have very different holdings and performance over the last few years. It concludes that MLPs largely have morphed into something different than they used to be and what many investors thought they were buying.

One of the lessons of the past year or so is that the MLP sector, which started life as a largely utility-like asset class, didn’t escape the hype of the shale boom. The MLP financing structure was transferred from boring old interstate pipelines to riskier things like refineries and gathering systems, and a ton of debt was taken on, as the investment pitch changed from reliable payouts to fast-growing payouts.

Many investors, dazzled by the combination of yield, growth and apparently “toll-road” like assets, didn’t necessarily read the fine print.

August 31, 2016

Bond Market Bubble

Filed under: Income Investing — Bob @ 5:20 pm

Most members of the Chartered Financial Analyst (CFA) Institute say that bonds are in bubble territory. But they’re also likely to stay there for a while, because central bank policies pushed bonds into this territory. The central bank policies are continuing.

For instance, PIMCO is buying negative yielding Japanese bonds and using swaps to lock in exchange rates, effectively quadrupling the yield on long-only US bonds of similar duration. So, they are buying negative yielding bonds, but using savvy finance skills to transform it into positive yield.

And that’s really the game, isn’t it? Low and negative rates are forcing legions of investors to seek higher yield, and in doing so, they are taking on more and more risk. Maybe it’s because they know that the central banks will maintain these policies despite potentially adverse consequences in the long term.

August 18, 2016

The Quiet Monetary Tightening

Filed under: Economy,Income Investing — Bob @ 5:38 pm

Central banks aren’t tightening policy, but regulations and other factors are, says David Kotok. He points to market action as evidence that the other factors are raising market rates and tightening liquidity even when the central banks are trying to keep policy loose. Because of that, his firm has become much more conservative with its bond investments.

What we do know is that the rates in LIBOR and related metrics are rising faster than the central bank’s policy rate. Example: the Fed has raised its policy rate one time and by 25 basis points during the last year. Meanwhile, 3-month LIBOR was about 30 a year ago and is now over 80 and rising. LOIS was 20 basis points two months ago; it is now over 40. “Japanese banks face dollar funding pressure,” Joe Abate of Barclays observed on August 11. That pressure is about $100 billion in size. Australian, Canadian, Swiss, and US banks fund themselves with CP in the hundreds of billions.

So all these rates are rising, which means that the cost of funding to lending institutions is rising, as is the pass-through of that cost to the borrowers.

How Regulation Changed the Bond Market

Filed under: Income Investing,Investing — Bob @ 12:23 pm

Here’s an interesting piece from discussing sectors of the market that are vital to its operations but little-known to most investors. The bottom line is that for all investments that aren’t among the most widely-traded, it can be tough for a seller to find a buyer. Trading desks from banks, brokers, and other firms are for the most part regulated out of the business. That’s created openings for investments firms that want to step in, but it also makes life harder for sellers.

The bond dealers and investment banks that make up the sell side were once the lords of fixed-income markets. They would have snapped up that Rent-A-Center paper before McClain had spotted it. Prior to 2008 they maintained large warehouses of bonds and were the first port of call for investors looking to add or offload securities. They also took debt onto their own balance sheets, made bets with their own money, and spearheaded developments in trading and technology.

Today, post-crisis regulations intended to make banks safer and discourage risk-taking are eroding their profits and forcing dealers to rethink their business model. Banks are pulling back from market-making and shedding assets, business units, and employees. The dealer has essentially been demoted from maitre?d’—deciding where everyone sits and recommending dishes—to a waiter taking orders. These changes have created a vacuum in the bond market and made trading much trickier.

August 10, 2016

Analyzing Lending Club

Filed under: Economy,Income Investing — Bob @ 5:32 pm

The peer-to-peer lending business has several innovations. Of course, it uses technology to disrupt an established business model. It also has investors lending directly to borrowers using an intermediary’s technology. Lending Club is the leader in this business and generated headlines a few months ago that forced its head to resign. The Financial Times takes a deep look at Lending Club’s latest financial report to see if conclusions can be drawn about the state of the business and the economy. I haven’t recommended Lending Club or its competitors to investors, because I want to see how their computer models for setting loan terms handle a full economic cycle.

He’s basically saying that subprime borrowers have been coming to Lending Club for easy credit, rather than debt consolidation. It’s still an open question as to whether or not the deterioration in online-originated credit is a sector issue or a canary in the coal mine about the wider economy — for now the former seems more likely, but Sanborn’s statements are ammunition for either theory.

The second thing to note from the slide above is the interest rate hikes. Since the Fed raised rates by 25 basis points in December last year, Lending Club has raised its rates by 135 basis points on a weighted-average basis. We’ve talked before about the pro-cyclicality of the marketplace model of lending, so we won’t go into it again at length now, but if businesses like Lending Club become an economically significant source of consumer credit we will have new issues to grapple with in terms of the transmission of monetary policy.

July 25, 2016

The Utility Stock Dilemma

Filed under: Income Investing — Bob @ 5:30 pm

Utility stocks have been one of the leading market sectors in 2016, returning over 20% so far. That brought the dividend yield for new buyers below 3%. Utility stocks usually are purchased for either safety or income, or both. How should investors assess utility stocks today? This article gives several ideas. At Retirement Watch, we sold them because they’re too expensive.

A recent research report from Citi analyst Praful Mehta illustrated the challenge investors face with utilities today. Mehta has a neutral or sell rating on most of the stocks he covers, but still shies away from predicting any kind of imminent correction.

Why? “Because there is meaningful market uncertainty right now and we don’t want to suggest a correction too early as it would mean lost dividend yield for investors in a market where yield is scarce.”

July 20, 2016

The Case for Continuing Low Interest Rates

Filed under: Asset Allocation,Income Investing — Bob @ 12:20 pm

Managers from two of the top-performing bond funds explain why long duration bonds have been big winners in 2016, and why that is likely to continue.

Hunt and other bond bulls point to dimming prospects for a pickup in inflation, the bane of fixed-income investors. A Fed measure of inflation expectations starting in five years and going through the following five years is close to historic lows.

Holding long-duration Treasuries “is a strategy that, I must say, has worked very well, though it’s not always been popular,” said Hunt, 73, who’s based in Austin, Texas.

“While any one of many factors can cause the bond yields to rise over the short-run, we do not believe they can go up and stay up,” he said. “We do not believe that the secular low is at hand. We believe it’s in front of us.”

June 8, 2016

The Long View of Investment Returns

Filed under: Income Investing,Investing — Bob @ 5:20 pm

Bill Gross, now of the Janus Funds, wrote in his latest monthly essay about long-term investment returns. First, he pointed out how strong and consistent returns have been during his 40-year career. Despite all the bad events during this period, a long-term chart of most basic investment indexes reflect steadily-rising returns to investors. Even a conservative bond index returned more than 7% per year over the period. But Gross’s real point is that the factors that set up this period of high returns aren’t in place any longer. He thinks investors aren’t likely to earn anything like the long-term returns in coming years.

Here’s my thesis in more compact form: For over 40 years, asset returns and alpha generation from penthouse investment managers have been materially aided by declines in interest rates, trade globalization, and an enormous expansion of credit – that is debt. Those trends are coming to an end if only because in some cases they can go no further. Those historic returns have been a function of leverage and the capture of “carry”, producing attractive income and capital gains. A repeat performance is not only unlikely, it is impossible unless you are a friend of Elon Musk and you’ve got the gumption to blast off for Mars. Planet Earth does not offer such opportunities.

May 31, 2016

A Case for Treasury Bonds

Filed under: Asset Allocation,Income Investing — Bob @ 5:20 pm

This post from Vanguard argues against the notion that bonds are too expensive and have little value in a portfolio today. The argument is based primarily on the lack of correlation between stocks and bonds. The bonds will provide diversification when stocks decline.

My colleague Fran Kinniry has called high-quality bonds1 the Rodney Dangerfield of investments. Like the late comedian, they get no respect. And as yields have crept lower, their status has declined. But that drop in status is undeserved. Successful portfolio construction is not just about return. It’s also about diversification. And at the moment, the data indicate that no asset boasts more potent diversification power—and more potential to protect a portfolio in a stock market downturn—than U.S. Treasury bonds.

May 23, 2016

The Endless Errors of Bond Bears

Filed under: Economy,Income Investing — Bob @ 12:22 pm

Many on Wall Street and elsewhere have been predicting higher interest rates and lower bond prices for years. They’ve consistently been wrong. This article from The Financial Times summarizes their worst calls and argues that perhaps all the missed calls have made bond investors too complacent. Perhaps bond yields finally might rise more than expected.

Wall Street’s forecasting toolkit for Treasuries has proved consistently too pessimistic, eroding the confidence of all but the grizzliest bears.

“The market has been looking for higher yields for a long time and getting beaten up on it,” says Harvinder Sian, head of G10 rates strategy at Citigroup. At the start of the year, the consensus forecast put the year-end yield at 2.8 per cent. Instead the drop in yields has generated a total return of 5 per cent for the Barclays 10-year Treasury index so far this year.

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