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  • Is Fixed Income The Next Bubble?
    In the spirit of dialog with SA readers, are there any opinions out there about the general valuation of risk assets in the fixed income market?

    With Ben Bernanke Hoovering up agency MBS to the tune of $6 billion each week, it is enough to match nearly every new loan produced. QE1 seemed to have solved the fundamental asset valuation problem and provided a floor for the market, but has this gone too far? Operation Twist's appetite crowds out domestic and foreign central banks who need to deploy economic capital.

    Fixed income ETFs have been flush with new money this year. While an ETF is a solid investment tool, has the demand for index securities gotten over its ski's? The demand for index eligible bonds which are in the sights for bond ETF's have exhibited immense demand and increase in price, but when is enough enough?

    Municipal bonds were licking their wounds 12 to 18 months ago but seem to be out of the gun sights of the press. Fundamental valuation of many state and local balance sheets are not significantly better enough to justify this rise in valuation.

    Tags: Macro View
    Mar 30 2:45 PM | Link | Comment!
  • Closed End Fund Arbitrage
    The March edition of Bloomberg Markets magazine contained an article about Northbrook, Illinois based Relative Value Partners LLC.  The article describes the investment tools used by Relative Value Partners which include ETF’s and closed end funds, as well as some tactical investment approaches used by their absolute return strategy.  In detail, “As of the end of January, for instance, the correlation, or beta, of the NFJ Dividend, Interest and Premium Strategy Fund managed by Allianz Global Investors to the SPDR Trust Series 1 exchange-traded fund -- a proxy for the S&P 500 -- was 0.905.  “That would tell you how many SPDRs to sell to hedge this security,” Fertig says. “If we bought $100,000 of this, we’d short about $90,000 of SPDRs.” 

    Read the full article

    The article is vindication to our strategy piece from July 8, 2009.  In July, hETFund described a similar approach, and now we add a new tactic of protective puts in order to enhance yield.  First, we review the mechanics used in Fertig’s idea.  NFJ recently traded at a 16% discount to its net asset value with an annual yield of 4.2%.  About three quarters of the fund are equities with the remaining assets in corporate bonds and preferred shares.  In the periods ending over the past 6 months, 1 year, and 2 years, NFJ maintained a correlation with SPY of 88%, 82% and 80%, respectively.  However, the net asset value of NFJ held a tighter correlation with SPY of 95% in all of those periods.


    State Street Global Advisors SPDR ETF (NYSEARCA:SPY)

    • SPY recently traded at $105.89, and has a current payout ratio of 2.23%.
    • SPY tracks the price and yield performance of the S&P 500 Index.  This ETF has net assets of $79.6 billion.
    • Strategy: if you own a closed end fund like the one described above worth $100,000, then you could sell short 850 shares of SPY to create a market value neutral position and sell 8 put options struck 10% out of the money.  The short sale of 850 shares is about $90,000 market value. 
    • The net yield of the position is 1.97% after paying a 2.33% dividend on SPY.  The April 17, 2010 expiry with a $96 strike is 10% out of the money, and this recently traded at a $1.58 premium.  On an annual basis, the 10% out of the money position yields 8.4%, thus the net yield of the position is 10.4%, before management fees of the funds.
    • Risks: 1) correlation with a closed end fund can change over time, 2) reduced volatility will cause a decline in future call option premiums and lower annualized yield of the strategy, 3) bi-monthly maintenance of the option position, or 4) if the put options were exercised in a bear market then the short position will no longer hedge the closed end fund.

    Disclosure: Long & short SPY
    Mar 29 9:33 PM | Link | Comment!
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