Michael Fabian

Registered investment advisor, etf investing, closed-end funds, dividend investing
Michael Fabian
Registered investment advisor, ETF investing, closed-end funds, dividend investing
Contributor since: 2013
Company: FMD Capital Management
I don't submit my articles to SA very often anymore, but you can subscribe to our blog at FMDcapital.com. I write CEF articles about once a week and they get syndicated to a few other places, but our blog has the most up to date content.
PDI still carries a large notional amount of long maturity pay fixed swaps to hedge interest rate risk. Yet the portfolio's spread/credit characteristics have changed since I wrote this article. I'll do an update either this week or next. For what its worth, the fund is still one of the largest holdings in our managed CEF portfolio. You just cant beat the underlying portfolio income generation/UNII figures, plus they recently raised the dividend... Stay tuned.
I think you might be placing too much faith in riding the coat-tails of SEC form 4s from a timing perspective. While I will preface that by saying I have not sold a penny of PCI or PDI, yet... it's because I don't believe there is an immediate need to. I like to write about my thoughts in real time, and then begin to ponder how I might change our portfolio in the future.
However, I think its important that you understand that institutional money managers can't get as strategic when it comes to timing their portfolio changes in the same way you or I could. They are beholden to quarterly in-house compliance reviews of every position they own, and alerting compliance personnel of any unplanned sales or purchases. More specifically, in the case of CEFs, control personel are often restricted to windows to purchase shares due to fund reporting and announcement schedules. Furthermore, depending on a firm's internal policies with regard to owning sponsor funds with insider knowledge, they may actually never be able to sell that holding while still occupying a control position within the firm. Meaning any investment they make carries no ability to time the underlying holdings or premium/discount in the first place.
So as I'm sure Bill has a lot of faith in Ivascyn's funds (which should come as no surprise since he was just promoted to deputy CIO) he isn't looking at the next 6 months of potential ownership while comparing the opportunity costs of owning other funds in the CEF universe. I will also note that his investments in the funds probably represent less than 1% of his net worth. Think about the last time you invested less than 1% of your net worth and then concerned yourself with executing perfect timing?
Other structural influences likely exist within a firm culture like PIMCO's, such as timing new investments in the wake of a quarterly, semi-annual, or annual bonus schedule. Keep in mind Ivascyn probably easily tops $100MM per year in compensation, while Gross could reach over $200MM per year.
While I think trolling Form 4's provides good anecdotal insight on portfolio managers that eat their own cooking; I don't think they should be put at the fulcrum for any investment decision with your own hard earned assets.
While I'm confident that if interest rates rise swiftly or slowly over time alongside a strong credit environment that both underlying portfolios will likely exhibit strong relative performance amongst their peers. But as I'm sure you are probably aware, the market price can and probably will react completely different to such changes.
It might be more of a behavioral finance observation, but when 100% of any group of people unilaterally believe and then agree on only one outcome when there are so many different variables in play. It makes me gravitate toward the opposite side of their hypothesis. But thats what makes a market I guess.
Although I do believe in the ultimate destination, that rates will rise, I just don't think the journey is going to be as linear as these economists are suggesting in their comments to investors.
While I'm not familiar with Samuel Lee over at Morningstar and wasn't aware that Morningstar had CEF portfolio recommendations made by an analyst. If we do have similar portfolios, we are probably like minded in our approach to weighting certain CEF characteristics highly in our own individual research processes.
As Fibonacci S. points out, perform your due diligence carefully, and don't rely on 3rd party data so readily without double checking the facts.
PCI does have positive UNII during the last reporting period.
I agree with exactly the point Fibonacci S is making, in the case of PCI for example, most data feeds (including the one cefconnect utilizes) do not include swap income. Which is a significant contribution to the total annual earnings for the fund. So much so that PCI does in fact have a positive UNII over the last reporting period. If you look at the annual report, you can see from the foot notes that swap income is separate.
In another example, DSL is just beginning to report full year operating history with a fully invested portfolio. Starting with 100% cash can throw off earnings data until new fixed income purchases are fully settled, and cash flows/accruals begin contributing to investment income. In addition, I was on a recent conference call where Jeffrey Gundlach was bold enough to make the assertion that DSL likely would cover its distribution or beat it by a small margin in 2014.
I agree, Gundlach is using a small quality/credit balance within the MBS sleeve allocating to both non-agency and agency, but that's about it. However, like you pointed out EM credit is essentially a directional bet, he doesn't use IR, CDS, or currency hedges, so it will be interesting to see how the portfolio evolves over time. Or if he takes swift action to counteract volatility (my guess here is probably not since there is no liquidation requirement). I also couldn't agree more that DSL's underlying portfolio needs to be monitored closely. Not so much a "set and forget it" fund like some of his OE variants.
DBL appears to me to be a DBLTX portfolio on steroids: long duration, and a good amount of inverse floaters, I/Os, and other agency derivatives.
Thank you for the compliment on our website, we very much appreciate it!
You could be right, and you make very valid points. There are many underwater owners since these were two of the largest CEF IPOs in history. However, I still believe that through superior expertise in management, and large leverage ratios, they make great plays for a tightening credit environment. Meaning strong NAV performance could ultimately drag the market price higher, all the while collecting roughly an 8.5% yield on market price.
They are both diversified amongst F/C HY corporates, F/R loans, and non-agency MBS. In addition to special situations: PCI has a distressed debt sleeve, while DSL has a larger EM debt sleeve. They are also not hedged to the extent PDI is, so it could make for an interesting 4th quarter.
Thanks again for the comments.
We were about 50% cash going into the CEF selloff, making sales in DBL, PKO, reductions in GOF, etc right about the time I wrote this article:
I obviously underestimated how much rates would ultimately rise, however, like the article says, I focus on NAV performance vs. market price performance. As market prices slipped in relation to their TTM average Prem/Disc. NAVs held up relatively well, so I continued to add to positions during the correction. As of right now the portfolio is roughly 95% invested.
Its nice to see some relief off the lows, and on a total return basis we have some healthy gains on most positions. I was actually expecting the treasury default would stir up more volatility, but it never came to pass (we did not sell any positions as a result of the treasury default fears). The two positions we continued to add to during the last week was DSL and PCI with proceeds from HNW. I tweet about certain additions like that, so join our twitter feed for additional play by play.
I agree JustGiveMeDividends, I should have mentioned the recent bump in dividend for PDI from 0.177 to 0.191 cents per month (roughly 8% increase).
The large special distribution will likely have to be made for the fund to avoid paying taxes on the additional income it has been receiving most of the year.
Thank you for your comment.
AWF isn't a fund that I cover to the extent I have read through their most recent filings and reports, so I would definitely point you in that direction to glean some more specifics on its portfolio.
However, at first glance they have a consistent payout history, good UNII, and its currently trading at a healthy discount to its 12 month trailing average premium. All good characteristics.
Just be sure that the manager's style aligns well with your personal income/total return goals. Thanks for the comment.
NII stands for "Net Investment Income", which is basically a measure of what a portfolio is earning in income, in excess of it's expenses, but before taxes.
UNII stands for "Undistributed Net Investment Income", which is what a portfolio earns in income in excess of its distributions to shareholders. A CEF that over-distributes could simply be returning capital to shareholders (ROC). It can get even more complicated when you start looking at distribution from capital gains, or income from derivatives etc.
I try to avoid those funds that regularly return large amounts of capital to investors whenever possible, but there are always a few exceptions.
Looking at their most recent filings, EHI is 95.4% U.S. Dollar denominated, and I believe HYI is 96% U.S. Dollar denominated.
Looking at a chart of the U.S Dollar, its mostly unchanged on a 1 year basis, it certainly fell, then rallied, but no discernible trend.
For CEF's you usually need to get into the semi/annual reports to ascertain the aggregate reset of the entire portfolio.
With ETFs and Mutual funds, the figure is typically posted quarterly. Furthermore, If you own a passively managed fund, you know it will remain static between rebalancing periods.
Most every (highly diversified) portfolio I have analyzed is in that 45-60 day window. Thanks.
Not necessarily, That purely depends on the manager's risk management and/or hedging practices.
Which is exactly my point, there is no "forced" transition. A manager can simply ride out the volatility without doing a thing. Volatility always comes and goes, the most damaging thing to portfolio performance is poor security selection, and buying or selling at an inopportune time.
In addition, CEFs are typically allocated differently than OEFs. Using the above example, GOF's NAV outperformed GIOAX's NAV by a margin of over 4% YTD. Which can't only be attributable to leverage. When putting the two portfolios side-by-side, there are some real differences.
I agree, for those that arent interested in CEF's. However, there are some subtle differences in portfolio construction, and it only makes sense to purchase this fund on a load-waived basis.
I was considering writing an article on Preferred CEFs. You can see some of my others on fixed income CEFs. Stay tuned, I'll write one next week. Thanks for your comment.
all the best,
I would categorize the NAV pricing as very accurate. Going from memory, I recall PDI holding approximately 10% in Level 3 assets stated in their latest annual report issued in March. Naturally holding illiquid MBS isn't an issue for a CEF, since they will not be "forced" to sell at an inopportune time.
I believe PIMCO likely marks these assets as close to on the money as is institutionally possible. Undercutting their market value could be considered tax evasion, and over pricing them would have the board of directors of the fund all over them. I believe they take their reputation and fiduciary responsibility very seriously in this regard.
The real magic within this fund is Dan Ivascyn and his team's hedging strategies using pay-fixed swaps. He has done an amazing job balancing the credit, currency, and interest rate risk.
Looks like some bottom feeders are already jumping on PDI's opening swoon.
It appears to me ILB only has roughly 23% in EM debt exposure, so I wouldn't classify it as an emerging market bond ETF. It also wasn't my intention to directly compare ILB and TIP side by side, but merely just to point out a different option for Inflation Linked Bonds.
Like I mentioned in the article, I agree the lack of consistent dividends isn't something I'm attracted to, but I suppose it all works into total return in the end. Thanks for your comment!
You can take a look at the indicated yield I based my figures on at ishares.com, the ETF provider. The 12 month trailing yield can be somewhat misleading because dividends from foreign companies can be lumpy, hence the reason I always use SEC yields since it makes for a more equal comparison.
10% was exactly the number I was thinking as a typical allocation, especially if it works to fill in part of your high yield bond bucket. I think you could go as high as 20% to replace core fixed income funds in either a rapidly expanding economic or interest rate environment.
Loans can be a relatively safe asset class, even more so in light of the Fed's QE program. However, They do have a tendency to sell off extremely fast in an unfavorable market, usually when credit spreads really start to blow out and/or liquidity dries up. Since the asset class has seen a lot more issuance and is more broadly owned amongst institutional and retail investors than in 2008, they are much better off, but its still something to be cognizant of. If an event like what I'm describing were to occur it usually makes for a fantastic buying opportunity!
I agree, thank you for the contribution. Two of my favorite Floating rate CEF's are (JRO) and (VVR). (PFN) is a great one as well, but it isn't exclusively floating rate. However those that arent apt to monitor premium/discount spreads, leverage, etc. should stick to an OEF.
Although the loan market has changed a lot since 2008, they can still go through periods of volatility due to liquidity squeezes during times of stress in the markets.
Interesting perspective, timely opinion too:
I agree whole heartedly with Mr. Gundlach, I just wrote an article on this very subject yesterday. Please visit:
To my point, they have a much more open investment mandate which is why I prefer these three funds. In the interest of transparency, there are a few other additional holdings you actually left out that AGG or BND cannot own, they include interest rate swaps, convertible bonds, senior loans (floating rate notes), TIPS, STRIPS, Warrants, Tax exempt Munis, and preferred stocks.
I still think there is no better way to compare a fund than to its benchmark. All three of these funds use the Barclays Agg Index as their benchmark. I can see why you might disagree, but when I evaluate investments, that is where I start.
all the best,
You can take a take a look at the symbols in comparison on Yahoo finance or any other publicly available data provider. Or you can view the fund company's website at:
The two primary points I make in the article are:
A)The Barclays Aggregate index has gotten way overweight two areas of the market, and in turn these two ETFs have done the same. Let me put it in a different context, I am actually a big proponent of index investing for equities. If the S&P 500 were to become so bloated that Technology and Energy made up over 50% of the index and muscled out other value stocks in the Healthcare, Consumer Staples, and Utillities sectors, I would be saying the same thing about the S&P! I know I've probably upset the Bogglers, that blindly agree with index methodology no matter what the construction, but in the bond market its simply not that easy. My point is that the index is broken, not that style of investing.
Probably half the people that own AGG and BND despise the governments irresponsible issuance of debt, and are telling their friends at cocktail parties how much they hate the current situation, however much to their chagrin, by indexing they are buying more and more treasuries each quarter.
B) Active management has done far better for far longer in the case of the three funds I've mentioned. If your an investor, you want good investment outcomes that will yield you the best return possible considering your goals and risk tolerance. Otherwise whats the point, or at least in the case of my clients that hold us accountable for the returns on their accounts. There should be sound reasoning behind every investment selection made, and my point was that I just dont see any in the case of (AGG) and (BND).
I had been planning to write an article on floating rate notes within the next couple of weeks, I'll go ahead and speed it up and work on it over the weekend. I'll hopefully have it posed early next week. I definitely have some favorites in that space. Stay tuned. Thanks again.
Thanks for the kind remarks 70f9,
I will also add PIMIX to that pile, another fund that has really benefited from active management.
Im fairly familiar with TCW's strategy since its very similar in nature to DoubleLine's, however there have been some changes over there since Jeffrey Gundlach left in 2009. There is a much higher percentage of ABS and Treasury Securities within their portfolio when compared to DBLTX. I still prefer Doubleline as a firm as I believe their "house Views" are more aligned with my own and that of my clients.
I believe your investment in TGMNX will continue to perform well in the current climate, however be aware of the changes they make to counter the effects of interest rate volatility.
The actively managed trio are "forced" to own investment grade bonds as well, they have prospectus limits that they cannot surpass in junk securities. During certain times, these securities have hurt more than they have helped, 2008 is a prime example.
The amusing thing is that the Barclays Agg. index used to hold Non-Agency MBS securities within their portfolio just like DoubleLine and PIMCO, however they were removed from the index at the depths of the credit crisis, in other words, the worst possible time. It wasn't all the index's fault since the rating agencies got it all wrong as well. At the time Jeffrey Gundlach had very little if any Non-Agency MBS exposure in the TCW Total return Fund, and began to add when dislocations began to present themselves.
I believe the active management from each firm has benefited investors significantly. When you are retail investor shopping for a bond fund, in my opinion this is as apples-to-apples as it gets.
Left banker,
I tend to agree, if only they would create an ETF that's user customizable!