Erik Gholtoghian's  Instablog

The economy is in an uncertain state, but one which appears to have some footing of some sort.  Europe, although unsteady, seems to have most of the fear factor eroding.
US junk bond fund payments/dividends fell apart for years, but of late they have been holding up more steadily. 

The SPDR Barclays Capital High Yield Bond ETF (JNK) for example has been holding steady with an average monthly dividend of roughly 24 cents for the prior six months, which translates to 7.92% per year at current prices.  The AGIC Convertible & Income Fund (NCV) on the other hand is a closed-end fund which is offering 12.19% and a steady payment history of roughly nine cents per month.  The PIMCO High Income Fund (PHK) is offering a monthly payment of 12 cents, which equals approximately 11.90% per year at these prices.

The funds have their own unique advantages.  (JNK) offers options and the most liquidity.  It also offers quick transparency with the actual bond markets.  Meaning, when junk bonds fall in value, (JNK) falls in value nearly in lock-step.

(NCV) offers a managed fund of mostly convertible bonds, with the goal of trying to earn even more income than junk bond funds by adding in leverage and some other management techniques.  The risk is that the monthly payments are set for long periods of time and are then rapidly hiked or in this environment cut.  The downside is this can trap investors who do not want to take principal risk.  The fund also nearly always trades at a premium to NAV (net asset value).  The current premium is 10.80%, which means the fund could someday fall to net asset value very easily, trapping investors further.

(PHK) offers the same managed fund style as (NCV), but the big difference here is you are paying a much larger premium to net asset value.  The current premium to net asset value is a whopping 70%!  This can be looked at two ways.  Either the fund is in fact the best managed in the world, and the premium is justified by the superior management techniques, or you can look at this premium as a rip-off of 70%.  It does not happen often, but I have seen hedge funds try and knock down this fund's premium by shorting the shares, and at times they are effective.  But the Bill Gross managed fund continues to regain its composure every time it is knocked down.  The main reason the premium lives on is that the large monthly dividend of this fund is one of the only in existence with such standing power that it has not dropped its gigantic dividend payments even one time.  The fund has been known to employ unconventional fund techniques, such as being net short US treasury bonds.

Conclusion:

If you are looking for a liquid instrument for which you can accurately trade the high yield bond market, (JNK) is your choice.  Options give your positions tremendous flexibility as well.  If you are looking for a fund with a huge monthly dividend but only a small premium to (NAV), (NCV) is your choice.  But beware that the huge dividend is more likely to be cut than many other funds if the market contracts too far.  (PHK) is the choice for those who want their money managed by the largest name brand in the business.  70% is truly an astonishingly high premium to pay, but something about having Bill Gross manage your bond portfolio in turbulent times does feel good. 

An excellent idea is to diversify across all three funds to have the best of all of the fixed income world.  (JNK) puts can also serve as excellent insurance for all three funds losing principal.  (JNK) is shown below versus both (PHK) and (NCV).

Disclosure: I am long JNK.

Additional disclosure: My position is a synthetic option position.

Introduction:

There are some stocks which have solid financial statements, a solid, growing business, and a solid market niche.  Then there are companies which are doing nothing but taking up space.  How analysts or authors can recommend others to buy a stock which is nothing but a speculative play still alludes me.  Maybe these so called analysts are getting kickbacks for their so called analysis.  Whatever the case may be, what if a real quantitative analyst with no bias tried to value Arena Pharmaceuticals?  What would he or she recommend?

(ARNA) is a speculative pharmaceutical company which is expected to lose money for the foreseeable future.  The stock rises and falls in a very jerky manner, mainly as a result of FDA related news about its drugs.  The purpose of investing in such a company would be to provide growth to a portfolio.  There is no dividend, no profits, and no reason to want to own this stock at this time other than as speculation.

Valuation:

Because most stock moves are unpredictable, CAPM analysis can help determine whether a company is overvalued or undervalued using statistical measurements rather than useless technical analysis.  The beta of the company is .70.  Over the past year the stock is up 40% while the S&P is up 0%.  This means that from a basic statistical level, ARNA is 40% overvalued, unless the S&P rockets upwards soon.  In other words, what's better about (ARNA) than the S&P 500?  I see nothing.  In fact I see many more problems than the the average company has.

We are in an economic environment in which the proportion of Americans who are insured with health insurance is falling the most it ever has in history, so the number of potential customers this company will have faces horrible headwinds, even if its products in development prove useful.  Although, there is some safety in the sector overall due to the fact that the government subsidizes health care companies of all sorts to such a great extent. 

The company's prospects seem to be betting on the success of a weight loss drug.  In short, I don't think weight loss drugs are worthy of my investment money.  In fact, when I get weight loss drug advertisements, I tear them up and throw them in the trash.  I think any management team spending time and money on research for such a product is wasting resources, especially when they have no profits to show for their efforts.

Fundamentally, the stock is a wreck.  The company is fairly overleveraged with a debt to equity ratio of nearly 3X, a price/book ratio of over 9, ROE of -165%, price/sales of over 22, and a dwindling level of assets and equity while debt has risen dramatically.  These are all very negative signs, and other than as a pure gamble on a miracle drug being developed which makes the stockowners rich, I call this stock worthless.  If the European crisis continues to accelerate and the lending market begins to worsen, (ARNA) is one of the companies I would most expect to have trouble continuing operations due to a lack of financing.  Anyone holding shares with gains would not be ignorant to sell and cash in those gains, unless you believe that weight loss drugs are good investments.  If that is the case, I have a bridge in Brooklyn I'd like to sell you...

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

If I was the legal judge in place at the SEC, and I set all of the rules and punishments that individuals would get in this country when tampering with the securities laws, the exact punishment I would enact over George Economou would be that his entire position in Dryships be forfeited.

His flagrant abuses of the securities laws, his absolute total disregard for the safety and securitiy of the United States based investors which placed faith in him, if I were a judge, I would take pleasure in announcing to the court, "Ladies and Gentleman... Mr. Economou, your sentence is complete loss of investment, with the proceeds to be distributed to the shareholders of date.  You are no longer in control of this company anymore; you are a shameful man, a con artist, a thief, and should live in shame for eternity.  No further punishement.  Get the hell out of my courtroom, and take your goons with you...

This would transfer control of the ownership interests in the company from another country into the United States.  If the international jurisdiction had a problem with my decision, I would immediately enact emergency powers and halt trading in the stock and investigate options for a complete ban on ADRs, American Depository Receipts.  The very chance that international criminals are able to plunder the United States through continual share dilutions and fraud reaches well beyond the law.  The issue reaches all the way into the currency markets.  The United States should be tough enough that the securities markets should always be regulated closely enough such that at all times investors should be able to rely on their own currencies never being used against them at the international level.  Meaning, no investor in the US should have to worry about international robber barons holding the keys to their retirement plans. 

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.