Market displacement brings pain. It also brings cycles of asset revaluations that distinguish performances between those of us who manage our own money. Displacement selling is initially indiscriminate and the magnitude of single security initial displacement is often more dependent on trading volume than intrinsic value. While liquidity crises can bring layers of indiscriminate selling, a manager’s performance over time comes from their ability to manage risks with consideration of investor tastes, and to acutely identify “worth.”
Portfolio managers should always know what they own, and why they own it. They should have conviction as to what factors affect market price, just as they should have conviction as to what factors affect intrinsic worth. Your best effort requires consideration of both, and to be your own harshest critic. Assessments of each security and self-assessments should be ongoing. The practice brings sanity and in my humble opinion serves performance during and after displacements. Below I will share a sampling of my own recent assessments and associated actions.
An Emotionally Tough Sale
Perhaps its best I start by highlighting a position I made myself significantly reduce, prioritizing discipline over emotion. The feel good things I once liked about General American Investors (GAM), I still do. Its performance has been attractive over time, the shares trade at a historically significant discount, and the company makes NAV-accretive purchases. I sold on April 28th at $25.78.
What discipline lead to this emotionally difficult sale? I had on paper been rewarded by the discount narrowing, but the factors I believed with conviction to affect the market price were getting worse, not better. In my conversations with management, it became apparent the company was disinterested in voluntarily taking the proactive steps General American had the power to take to counterbalance environmental issues. Such is management’s choice as I’m no activist. Further, I objectively anticipated scarcer intermediate term demand for the shares. Goldman Sachs' headlines were particularly distasteful to the equity appetite of GAM’s unique investing audience. No matter how much I “like” GAM, a choice not to sell it would have lacked discipline. GAM’s discount has re-widened since my sale.
Selective Conviction among Income Securities
I do not presently like traditional bonds because of interest rate risk and the lack of risk-consciousness among the retail investors who are too concentrated in traditional bond funds. Securities I’ve recently purchased for a taxable income portfolio are believed by me to be biased toward dynamic distributions. I aspire to mitigate my exposure to traditional bonds with prices believed to have been driven by massive bond fund inflows.
High Conviction in a sparsely known Exchange Traded Bond
I first wrote about bonds with monthly coupons linked to inflation on January 20th. At the time a Prudential Issue (PFK) offered superior risk reward, but much has changed since. Both PFK and a Sallie Mae offering (OSM) mature at $25. The price of PFK rapidly moved to $25. At the time, Sallie Mae’s credit risk is evolving. In March, President Obama passed a student lending bill that repositioned the government as a balance sheet lender, and Sallie Mae as loan servicer. In my perception, Sallie Mae’s change in balance sheet exposure to student loans and the United States’ hands-on interference with its business model have significantly improved the safety and intrinsic value of OSM appreciably. OSM pays a monthly coupon, and matures at $25 on March 15, 2017. At current prices, the principal appreciation alone to 2017 maturity exceeds 50% and the monthly coupons make it particularly tasteful.
High Conviction in Preferreds with Dividend Upside
I’ve long liked “floating rate” Preferred Stocks because unlike traditional bonds, or “flat-rate” Preferred Stocks, the interest payments are poised to increase when short term rates normalize. I am content to give up a bit of the otherwise available current income to mitigate exposure to interest-rate risk. Bank Preferreds got crushed in Thursday’s selloff because everybody remembers the risk that owning them in March of 2009 entailed. What I believe Thursdays’ dumpers failed to consider is that intrinsically, the long-term risk profile for Bank Preferreds has changed very dramatically with the banks’ balance sheets.
To end (or stall) the financial liquidity crises, our society moved banks’ risky leverage to governments and diluted domestic banks’ common shareholders dramatically to shore up those bank balance sheets. Intrinsic risk matters to asset valuations. Accordingly, my income allocations reflect the belief that national bonds worldwide are overvalued as the recipients of a risk-transfer.
Among Floaters, I must with emotional shame admit my now objective favorite is evidenced by my long position in Bank of America Issue, Series G (BML.PG). It has been a bruise to my pride to take in Meredith Whitney's reappraisal and admit she is better at evaluating a bank’s balance sheet than I am. Frankly, pride is irrelevant to discipline. I suspect that it took great discipline for Ms. Whitney to herself reappraise Bank of America (BAC) for the current mark of solvency she sees it to represent today.
Even I must applaud Bank of America’s choice to Friday morning be transparent and be first to reveal a big bank's exposure to the “PIIGS” (Portugal, Italy, Ireland, Greece, and Spain). Obviously, the choice was an easy one given the relatively small affect on Bank of America’s now heavily diluted, less leveraged balance sheet.
There is another issuer of Floaters I still like, too. While the risk inherent in Goldman Sachs’ common equity (GS) is not something I want, I have also used the pricing affect of Goldman Sachs headlines to reacquire Goldman Floaters. GS.PD is more attractive than GS.PA at present. I’m being cautious not to own too much of the Goldman Preferred. Headlines can magnify undesirable market volatility regardless of intrinsic value.
Risk Profiles are not always as bad as they look, and often justified by expected rewards
I continue to expect Alpine Global Premier Property (AWP) to trade at a Premium in 2010. It currently trades at a double digit discount. Based on the depth of my research looking past Undistributed Net Investment Income “UNII” and into other less frequently revealed baskets, I believe the question is not “If” Alpine is going to dramatically hike AWP’s monthly dividend, but “When”. The name itself is scary and likely contributed to the knee jerk selling and discount to Net Asset Value “NAV” widening this past week. In reality, only 16.2% of the portfolio is in Europe and more than 50% is in North and South America. The reason for the discount has not been the choice of underlying investments, rather the choice to preclude the distribution from benefiting shareholders.
The catalyst for AWP grows like a beast, and such may be a manipulative reason for the Alpine management to further delaying the normalization of AWP’s distribution. In addition to unpaid accumulated income, the theme of Alpine’s recent Wells Notice has allowed me to contemplate another potential catalyst in the prevention of selective allocation of capture trades, a practice of theme that regulators appear unlikely to condone. Alpine’s Closed End Funds all have been marketed for using dividend capture strategies and there is portfolio overlap. Alpine’s backward looking history of alternate funds AOD and AGD (which trade at massive premiums) paying higher earned distributions with lower-yielding portfolio constituents appears unsustainable. I’m short AOD and long AWP, a position to which I added on Thursday.
Disclosure: Long a small position in GAM, with larger long positions in OSM, BML.PG, AWP, GS.PD and GS.PA. Short AOD