Posts Tagged ‘high’

A little more than 3 months ago, the Mutual Fund Site provided a couple of firm recommendations on where mutual funds investors should invest their money. As far as we were concerned, these were exactly where to invest, even though our gut told us at the time that then-current market conditions made such a task rather difficult.

Those two funds were the Janus High Yield Fund as part of our Income Class recommendation and the Ivy Small Cap Value Fund as part of our Growth Asset Class.

To date, the Janus High Yield Fund has returned 4.37% YTD, a reasonably good return given all of the speculation and doubt surrounding the Income asset class these days. Are we satisfied with this return? With the performance?

Yes, indeed we are. The fund remains under the management of Gibson Smith and has stuck to its mandate. It remains invested primarily in mid-term, below investment-grade bonds (the average yield is a touch over 10%) and, well, provides investors with a positive rate of return. This is no easy task since, as we all expected, interest rates are on the move.

Our other fund, the Ivy Small Cap Value Fund, has returned 13.39% YTD. Some of the reasons this fund has performed so well could have something to do with Ivy’s overweightedness in financial services. However, we are not overly concerned that this fund is at risk the way most individual investors and some other funds are. The reason is simple: Ivy has invested in medium and small cap financial services firms. Dividend yield are strong (they would make GE and other financial firms look cheaper and greedier than they are) and many of the underlying assets have yet to enjoy the gains that the rest of the sector has thoroughly enjoyed recently.

Would we change anything?

No, not at this point. Both funds remain healthily below average in terms of the risk profiles versus their peers. And both have returned more to investor than anyone else would have expected at the start of the year (we even found some interesting trash talk on another, nameless website). Which bring us to the rest of the year…

We expect the Janus fund to handle the obstacles ahead with relative ease. They have performed well to date, but the challenges will keep Gibson busy.

We also believe that the Ivy Small Cap Value fund will face challenges, particularly when so many individual investors who have poured their money into these big bank stocks realize that the fundamentals are not there to support those price run-ups. However, the fact remains that the companies in which the Ivy fund has invested remain profitable and well capitalized with continued improvements to their equity positions through retained earnings. Overall, both funds are not only where to invest your money, but will continue to see some strong returns throughout the year.

In an article published at Bloomberg.com on March 18, 2010, it was noted that bonds issued by financial services firms like JP Morgan and Credit Suisse in particular came with rates that were substantially higher than rates in the general market. What this means for mutual funds and growth funds in particular is that there is plenty of opportunity in the financial services sector. Let’s take a closer look.

The Bloomberg article in questions makes it quite clear that the debt sold by banks, brokers and insurers returned 0.81% compared to the broader market’s return of 0.48%. This is a premium of more than 80% over what the broader market dictates. Consider this for a minute as we explore another interesting comment that was made in the article in question.

Brian Machan, a money manager at Aviva was quoted as saying that very few people are “underweight” in financials. This means that mutual funds are heavily buying up this debt. They are doing it because it looks attractive. The reason it might look attractive is that the yield is expected to drop, thereby increasing the value of those bonds on the open market.

The flip-side is that the financial services firms issuing this debt find rates attractive. This means they expect rates to increase in the future, allowing them to finance debt at today’s currently low rates. All indications support a rising interest rate environment; if ever there was a time to issue corporate debt now be that time (to the benefit of the borrower, that is).

Now, getting back to the premium paid by these financial services firms. Consider why they might need to raise this type of capital. It is cheap. Plus it helps finance a whole lot of plans. These banks have something up their sleeve and it is just around the corner by the look of things.

As far as growth funds are concerned, the mutual funds that are bullish on financial services such as the Ivy Small Cap fund we wrote about already or the Dryden fund we bragged about earlier, send a strong message to the investment community: financial services stocks are expected to outperform. This sure seems to be supported by the level of debt they are confidently raising right about now.

Other growth funds that invest heavily in financial services stocks include the FBR Small Cap Financial fund which has a history of LOW risk and above average returns. Morningstar rates it as a 5-star fund! Like the Ivy Small Cap fund that we touted as our Top Small Cap Pick for 2010, the FBR fund has a large interest in Iberiabank and East West Bancorp, regional banks that stand to substantially benefit from a positive shift in the economy.

Regardless of what type of mutual fund you choose, ensure that your growth funds have at least some exposure to the financial services sector. Whether they are smaller, regional financial companies like those held in the IVY or FBR mutual funds or larger banks like JP Morgan and Credit Suisse, the indications are quite clear that these firms expect to reap the profits and rewards of an economic turnaround that is just waiting to happen.

The arena of high yield investments is technically very difficult for many to understand. The reason for this is the “term high yield investments” typically refers to a particular class of bond investment and as a whole, bonds are difficult to fully understand. And this does not relate solely to the inverse relationship between rates and price; it refers to the broader spectrum of bond analysis.

Luckily, there are bond funds available on the market that are not only highly ranked within the industry, but come with an intelligent analysis department that takes all of the hard number crunching and the complex chore of making heads and tails out the myriad of connected economic statistics off of your hands and drops those problems on someone else’s lap (someone who is paid a decent salary until you factor in the overtime).

Now, just because the term bonds is often linked to that attractive arena known as high yield investments does not mean that the risk is limited. Of course, in the most sense risk is minimal as bonds will be rated by independent rating agencies like Standard and Poors and Moody’s. And yes, bonds will have a security value attached to them (compared to common stock which lays no claim on any assets) . And yes, bonds are secured creditors which means they are to be paid ahead of any unsecured claims in the event of liquidation.

But bonds fluctuate. And even the best high yield investments, including the top-ranked bond funds will outperform the overall markets in times of both bull and bear periods. Even these top-ranked bond funds will have beta that exceed the market-standard of 1 (Beta is a measurement of how much a security or investment will fluctuate given changes in the stock market. For example, an investment with a beta of 1 will match the market movement, whereas an investment of 1.2 will  move 1.2 times the movement in the market… so, all things being equal, a market move of 4% will mean a move of 4.8% for the investment with a 1.2 Beta).

Knowing this, many investors still see high yield investments as a fairly risky proposal and opt instead for locked-in, inflexible term deposits at rates that rarely, if ever, exceed the consumer price index, or inflation rate.

The argument here is actually FOR high yield investments, particularly as an alternative to higher risk equity funds and lower risk (are they?) and lower-rate term deposits. The reasons are plenty, but we will touch on a few right here:

>> High Yield Investments are liquid. Just like your equity funds, a high yield bond fund will allow you to liquidate at any time and at no cost (note: this does not include any loads that may or may not be charged by the fund company).

>> High Yield Investments are secured by assets in most cases. Unless you are looking at a junk-bond class of investment, most bonds in this category are acceptable risk, meaning their assets are in place and, usually, contributing to revenues.

>> High Yield Investments are closely monitored by fund companies. Of course, this is speculation, but many top-ranked high yield bond funds will have turnover rates greater than 100%, meaning they turn over their entire portfolio, on average, at least once per year. As well since high yield investments are actually below investment grade, meaning BB or lower, the fund company will review their holdings regularly to ensure the risk of default is minimized. (Remember, this higher risk as deemed by the rating companies is what justifies the high rates paid on these bonds). One particular high yield bond fund hold companies like Ford, Teck Resources and Dole Foods among its Top 10 holdings and none of these bonds pays less than 7.45%

These three arguments are rather convincing for most investors. Companies like Ford, for example, may default on a bond payment but the consequences could mean losing a piece of equipment. With investors fighting for automotive assets (think of Magna, the Russians, etc. to start) it seems unlikely that even a highly specialized piece of equipment could lose enough value that bond holders are stuck with scrap as security.

Regardless, high yield investments provide some indisputable advantages over common equity funds. While there is no ownership claim for bond holders, there is a tangible asset that protects bond holders against complete loss. Additionally, bond holders are normally paid a guaranteed rate of income. In practical terms, high yield investments are often just as liquid as shares or equity funds, meaning that they can be cashed in when the funds are needed, unlike term deposits which most often cannot (not without fees and penalties). Most importantly, high yield investments provide greater income opportunities for investors.