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Darren McCammon
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Darren owns ProActive Financial LLC. He manages private family and individual accounts as well as the yield focused, 50+ Portfolio. He has a Bachelors in Economics, an MBA and a Certificate in Financial Planning. Darren is most proud of having successfully managed income producing portfolio's... More
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  • You Must Be Crazy High Yield Portfolio - Risk Analysis 28 comments
    Jul 10, 2014 5:02 PM | about stocks: NLY, JNJ, EQR, SPY, MORL, CEFL, BDCL, DVHL, EFF

    In the blog post located here: http://seekingalpha.com/instablog/379412-darren-mccammon/2860573-a-high-yield-portfolio-using-ubs-2x-etns I introduced readers to a real money portfolio I created using UBS 2x ETN's called the You Must Be Crazy High Yield Portfolio (YMBC for short). The components of the YMBC High Yield Portfolio are: MORL, CEFL, BDCL, SDYL, DVHL and EFF. Later I followed up with a post reviewing YMBCs performance for the first half of the year: http://seekingalpha.com/instablog/379412-darren-mccammon/3031305-you-must-be-crazy-high-yield-portfolio-1st-half-2014. In this post I would like to further expand on risk and the risk characteristics of the YMBC High Yield Portfolio.

    Most people think of risk as the risk of losing money. Fair enough. However, many think of the risk of losing money in a particular stock instead of thinking of how that particular stock ownership would effect the risk of losing money for the entire portfolio. The two can be very different. I submit it is not the risk of losing money in a stock that the reader should care about, rather it is the risk of losing money over one's entire portfolio.

    Here is an example that might help get my point across:

    NLY: Dividend 10.3%, Volatility* 12.9
    AGNC: Dividend 11.0%, Volatility* 12.3
    CYS: Dividend 14.5%, Volatility* 17.3
    WMC: Dividend 17.9%, Volatility* 21.8
    •MORL: Dividend 24.5%, Volatility* 13.9

    * http://bit.ly/1pQW3MU

    **Disclosure - I am long MORL and a lot of the names to follow. This post is not meant to suggest you should invest in MORL vs. NLY, EQR, JNJ or whatever other large cap well known name you consider safe. It is meant to be educational and help the reader better understand risk and risk control.

    Many people, if they were going to invest in the mREIT space, would choose NLY, the largest and best known of the mREITs. They do so thinking NLY less risky, certainly less risky than MORL (a 2x leveraged ETN in the space). But look closer, even though MORL is composed entirely of mREITs, there does appear to be some diversification benefit from holding MORL. Furthermore, that diversification appears to be largely offsetting the increased volatility of holding a 2x leveraged ETN. Put another way, $10k invested in NLY would generate about $1k in annual yield. A better alternative may be putting $5k in MORL with the other $5k in a CD. This would produce both more income and less risk. Please spend a moment to think about this before moving on...

    The YMBC portfolio is primarily designed to produce a very high yield; however, overall portfolio risk was also a significant consideration. If possible, I wanted a portfolio which had risk comparable to the overall market. It appears that goal has been achieved, at least so far. The Sharpe, Treynor and Sortino values for the YMBC portfolio are all positive for 2014. For those who may not have a PhD in finance, here is a graphical representation which may explain better than quoting positive Sharpe, Treynor and Sortino values (provided with my thanks by macroaxis.com):

    (click to enlarge)

    As you can see the YMBC portfolio (marked Current Portfolio in the graphic above) is performing better than the S&P 50O (marked Market in the graphic above). It has both a better return (left axis) and a lower risk score (bottom axis). Yes, it is possible to beat the market; you can even do it with high yield. Next look at the smaller gray circles in the graph. Each represents a different component (e.g. MORL, BDCL, etc.) of the overall portfolio. Note that while almost all of them are more risky than the market (to the right on the graph) the combination of them (Current Portfolio) is actually less risky than the market. This is because these components have different traits, when some of them zig, others tend to zag. Or in finance terms, they have low correlation coefficients (more on this later).

    Now I like the YMBC portfolio as is; however, I realize many readers would be happier with high yield, market like returns and less risk. So in this next graphic I added cash until the return of YMBC portfolio equaled that of the market.

    (click to enlarge)

    Using the scale on the left, you can see the current portfolio now has the same return as the market. The return has declined because I have added 25% cash to the portfolio. The Current Portfolio in this second graphic represents 75% YMBC and 25% cash. This revised Current Portfolio now has return equal to the market, a double digit yield and a risk score almost half that of the market (.35 vs. the markets .63). For those of you with a more conservative nature, this may be a better option.

    Now, back to the correlation coefficients:

    (click to enlarge)

    They are the magic that makes better portfolio return with less risk possible. A number of 1 means the two assets tend to move in lockstep with each other. One would expect SPY, the S&P 500 ETF, and the S&P 500 Index to have a correlation coefficient very close to 1. The highest correlation between the portfolio components, at .55, is between SDYL and BDCL. About half the movement in one can be associated with the movement of the other. Most of the other correlations however, the orange one's, are very close to 0. This means those assets have very little in common. When one goes up 20%, it tells you almost nothing about what the other one is going to do. In other words, when one zigs, the other may zag. While each individual component in the portfolio may have risk greater than the market, this is what causes the overall portfolio to maintain a risk less than the market.

    In the end, isn't risk more about not losing money than not having an a particular asset which lost money?

    Disclosure: The author is long MORL, CEFL, BDCL, SDYL, DVHL, EFF.

    Additional disclosure: I say right there in the name, if you follow this portfolio YOU MUST BE CRAZY! I don't know who you are much less your particular situation; so how can a recommend this portfolio or for that matter any investment to you? Don't follow a crazy person, do your own due diligence.

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Comments (28)
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  • mts
    , contributor
    Comments (101) | Send Message
     
    Very nice!

     

    Those correlation coefficients are amazing. Did you set out to get those when you built the YMBC portfolio?

     

    The cash addition shows quite nicely how you can calm down a portfolio and still participate in the market. Dry powder demonstrated.

     

    Which portfolio analyzer did you use? Where would the green optimal portfolio circle be and why isn't it shown?

     

    Thanks!
    10 Jul, 06:00 PM Reply Like
  • Darren McCammon
    , contributor
    Comments (848) | Send Message
     
    Author’s reply » The portfolio optimizer used was macroaxis.com (see the link above). Some of these components didn't exist last year so it was done with only an 8 month look back. This is admittedly much shorter than I would have liked but there was nothing I could do about that.

     

    The optimal portfolio would not have included any BDCL because of it's poor return YTD. I didn't agree with that and more importantly felt it misleading to the reader, so I didn't include it.
    11 Jul, 01:32 PM Reply Like
  • mts
    , contributor
    Comments (101) | Send Message
     
    Thanks for the response. Seems like you're having fun with this :)
    11 Jul, 04:28 PM Reply Like
  • Urbannek
    , contributor
    Comments (560) | Send Message
     
    Great article. I am really interested in these types of investments. Long CEFL and MORL
    11 Jul, 01:43 AM Reply Like
  • Darren McCammon
    , contributor
    Comments (848) | Send Message
     
    Author’s reply » Thanks for the comment.
    11 Jul, 01:38 PM Reply Like
  • liusing
    , contributor
    Comments (394) | Send Message
     
    I evenly long MORL, CEFL, BDCL, & DVHL. From yesterday's volatile market, BDCL followed closely, the others seems unaffected with MORL slightly up. (so happened, all of them Ex distribution yesterday).

     

    I am thinking, if one have strong view about the market, like if it is going to the upside, should increase weight in BDCL. Cut the weight if thinking of a down market.

     

    Anyhow, my original plan for this portfolio is for dividends, so I better keep it stable and side bet with BDCL ??
    11 Jul, 09:14 AM Reply Like
  • Darren McCammon
    , contributor
    Comments (848) | Send Message
     
    Author’s reply » A strong portfolio would be one which stays stable or ideally makes money in both up and down markets. Thus you need some investments which are likely to outperform when the market drops significantly (MORL, EFF, DVHL) and others which are likely to do well when the market rises significantly (BDCL, SDYL). Eliminating a part, e.g. BDCL, in my opinion is a mistake. It is both market timing and almost exactly the opposite the market timing I suggest. My suggestion is you use all the dividends to buy whatever has done the worst lately (buy low). That means I would be using dividends to buy BDCL right now, not sell it.
    11 Jul, 01:37 PM Reply Like
  • mrmedusa
    , contributor
    Comments (236) | Send Message
     
    I remember using a piece to show why a systematic investment worked better than lump sum- The old fund a vs fund b. Both start at $10 a share, and in a year A rises to $14.00 a share in a steady climb. Fund B fumbles and stumbles, drops to a dollar a share in July, and somehow ends up back at $10 a year's end, but never makes it over $10 the entire year (sounds like some of my stuff). You put $100 a month into each fund, and you get no dividends.
    A B
    Jan 10.00 10.00
    Feb 10.47 9.29
    Mar 11.20 8.02
    Apr 11.70 6.88
    May 11.92 4.23
    Jun 12.14 2.80
    Jul 12.45 1.00
    Aug 12.88 2.49
    Sept 13.02 3.59
    Oct 13.30 5.80
    Nov 13.64 7.99
    Dec 14.00 10.00

     

    When you figure out how many shares you buy each month, you find you are left with one fund with a value of almost $1400, and the other fund with a value of almost $3150.
    I will be buying BDCL and LMLP as dividends from the others come in.
    12 Jul, 07:25 PM Reply Like
  • mrmedusa
    , contributor
    Comments (236) | Send Message
     
    Pretty lousy columns there. It's a month by month price of each stock
    12 Jul, 07:28 PM Reply Like
  • liusing
    , contributor
    Comments (394) | Send Message
     
    excuse my lack of intelligence, just couldn't figure out what you are getting at.
    <<you are left with one fund with a value of almost $1400, and the other fund with a value of almost $3150. >> ??
    12 Jul, 11:14 PM Reply Like
  • Darren McCammon
    , contributor
    Comments (848) | Send Message
     
    Author’s reply » Hi Medusa,

     

    I also didn't really understand the point you are trying to make from what you wrote.

     

    I'm guessing however, you wanted to show that by re-investing the dividend in whichever did worse, you actually make more money in the poor performing volatile fund than in the steady eddy better performer?

     

    Re-investing dividends into whichever component is doing the worst, tends to turn volatility into your friend provided of course that the component does eventually revert back to the mean.
    13 Jul, 03:52 PM Reply Like
  • mrmedusa
    , contributor
    Comments (236) | Send Message
     
    Yeah, the columns didn't work so well. If you put the same $100 a month in to EACH fund (or stock), EVERY month, after a year you have 99 shares of fund/stock A at 14.00 per share, or $1400 (or so). On the other hand, you would have 315 shares of stock B, at a price of $10 a share, or $3150.
    Just think of July, where the stock price of stock B was only $1, and you bought 100 shares. By December, those 100 shares were worth $1000. I was trying to show the stock that took you on the roller coaster ride actually did you better, which I think was your point, too.
    13 Jul, 05:29 PM Reply Like
  • liusing
    , contributor
    Comments (394) | Send Message
     
    I see, but if a share fell from $10 to $1, I am not sure if I have the strong mind to buy in. Is this real case ?
    14 Jul, 06:44 AM Reply Like
  • MisterJ
    , contributor
    Comments (587) | Send Message
     
    Thanks for the post.
    11 Jul, 02:26 PM Reply Like
  • Darren McCammon
    , contributor
    Comments (848) | Send Message
     
    Author’s reply » You are welcome.
    11 Jul, 03:35 PM Reply Like
  • Be Here Now
    , contributor
    Comments (3797) | Send Message
     
    I am interested in seeing how MLPL would work in this portfolio. Any chance you can include it?
    11 Jul, 02:41 PM Reply Like
  • Be Here Now
    , contributor
    Comments (3797) | Send Message
     
    I followed your link and created a portfolio with BDCL, CEFL, DVHL, MORL, and MLPL. I am a complete beginner at this so I am not totally sure about what I am seeing.
    11 Jul, 03:04 PM Reply Like
  • Darren McCammon
    , contributor
    Comments (848) | Send Message
     
    Author’s reply » Over the last 8 months MLPL has .2-.3 correlation with MORL, BDCL and SDYL. It has essentially 0 correlations with EFF, CEFL and DVHL. The 0 correlation with DVHL is somewhat surprising since 15% of DVHL is invested in MLPs. I can only guess the other 85% is offsetting it.

     

    I can't post pictures in a comment but from an overall portfolio point of view, adding MLPL raises the return but also the risk. There is an improvement on return per unit of risk, but it is not large. This during a period of time (8 months) when MLPL has been doing very well and MLPs seem fully priced. Right now, I'm not inclined to add it.

     

    But don't rely on me, you can go to macoraxis.com, create your own test portfolio's for free and make up your own mind.
    11 Jul, 03:33 PM Reply Like
  • Darren McCammon
    , contributor
    Comments (848) | Send Message
     
    Author’s reply » Awesome, my primary purpose is to educate. You just made my day! :)

     

    I encourage you to keep looking until you do understand. Look up terms and other things you may not understand on Wikipedia and Investopedia. Spending 10 - 20 hrs understanding what is going on here is not unreasonable or a waste of your time. I have a degree in economics and an MBA and can say both combined taught me less about investing than you are likely to learn spending 20 hrs understanding what is going on here.

     

    However, I must caution that just because you spend a lot of time on something does not mean you should do it. Most people equate familiarity with a lack of risk and have trouble walking away from anything they spent more than a few hours on. Spend some time on it, let it sit for a few days. Spend some more time on it, then let it sit again. If the concept is worthwhile, it will still be there 3 - 6 months from now. This particular portfolio may not be right for you. What will likely be more important is truly understanding the concepts behind it for yourself.
    11 Jul, 05:33 PM Reply Like
  • Dividends#1
    , contributor
    Comments (2237) | Send Message
     
    Hi Darren,

     

    I read your posts yesterday. If I recall correctly you have a small %, 3% of your entire portfolio in the 2x leveraged products. That is not a lot of risk for you.

     

    You stated you wanted to learn, here are some of my findings. Your thoughts?

     

    UPDATED 7/21/2014

     

    Correction to the opening price on day 1 of trading:

     

    I took the opening price of MORL on 10/17/2012 from Schwab's web site, which stated it was $24, I have since found out UBS lists the opening price on 10/17/2012 at $25, so that would change my first result, however NOT my conclusions. I also did confirm that 10/17/2012 was the actual first day that MORL traded on the exchanges. It was priced at $25 at the close of 10/16/2012.

     

    To all readers,

     

    Here is some of my research on MORL.

     

    My key point is that MORL is attempting to achieve 2x the returns of a given index (MVMORTTG) and will NOT achieve it. The model is flawed.

     

    UBS stated that the first trading day for MORL was 10/16/2012.

     

    However, I can only retrieve data from the next day 10/17/2012. MORL opened at $24 and closed at $25.88. The next day on 10/18/2012 MORL closed at $26.38. So from day 1 open to day 2's close MORL increased in price by 9.9%.

     

    The index that MORL is attempting to replicate a 2x return of is MVMORTTG. The index closed at 1,233.99 on 10/17/2012 and it closed at 1,239.48 on 10/18/2012 an increase of .44%

     

    There is a large discrepancy in what the MORL is attempting to achieve. Instead of a 2x return they provided an almost 23x return. This shows a flaw in the design of the index or the financial instruments they used to achieve their intended results.

     

    What would stop this occurrence from happening in the reverse, a 23x negative return.

     

    Now lets look at the performance over a longer time frame: a little over 14 months.

     

    On 5/8/2013 MORL closed at $30.44 and on 7/18/2014 MORL closed at $22. They paid $5.59 in dividends and they owe shareholders $0.9642 payable on 7/22/14. So a good rough estimate of the performance of MORL would be to add the dividends to the current stock price. $22 + $5.59 + $0.96 = $28.55 a negative return of ( 6..2)%

     

    The MVMORTTG ( index) closed at 1,427.87 on 5/8/2013 and closed at 1,426.19 on 7/18/2014 a total performance of a negative (.11)%.

     

    Again a large discrepancy in the intended 2x return. The index dropped .11%, therefore MORL was supposed to drop 2x which = .22%. The FACT is MORL declined 6.2%. This is large difference, much greater then the FEES of .4%.

     

    One last case:

     

    On 12/12/2013 MORL closed at $17.49 and on 7/18/2014 MORL closed at $22. They paid $3 in dividends during this timeframe + the $0.96 owed = $25.96. Therefore the price increase was 48.4%.

     

    The index closed at 1,170.93 on 12/12/2013 and it closed at 1,426.19 on 7/18/14. This is an increase of 21.8%.

     

    Therefore the 21.8% increase of the index x 2 = 43.6%. So, MORL should have returned 43.6%, however it outperformed and returned 48.4%.

     

    This again shows a flaw in the intended achieved returns.

     

    *** Also, Have you considered the simple math of any security that attempts to track an index?

     

    Example:

     

    {In a perfect world, which of course it will not trade as, it will underperform or outperform this example, however this mathematical fact is very important and should be understood by all investors in 2x leveraged products}.

     

    The index starts at 100, MORL starts at 100
    The index drops 25% which is supposed to cause a concurrent drop of 50% to MORL.
    So the index is now 75 and MORL is 50.
    The index increases 33.3% which is supposed to cause a concurrent increase in MORL of 66.7%
    So the index is back to 100 and MORL is at 83.3

     

    The index did not move, but because of volitility and the mathematical consequenses of this product, MORL has lost 16.7% of its value

     

    These are facts.
    21 Jul, 03:25 PM Reply Like
  • Darren McCammon
    , contributor
    Comments (848) | Send Message
     
    Author’s reply » Interesting information, thanks for the post.

     

    ETN's can trade at premiums or discounts to intrinsic value. I'm guessing this may be the reason for the first discrepancies you outline. The ability for large investors to redeem shares should limit this somewhat. To big an arbitrage opportunity and large investors will take advantage of it.

     

    Your second example is mathematically correct. In my opinion, the main concern regarding the original leveraged ETN's was tracking degradation caused by daily resets. This is why MORL has monthly resets, significantly reducing the issue.

     

    Professor Lance Bronfman has put out some articles that explain it more thoroughly than I can in this comment, here's one of them:
    http://bit.ly/1nv56Cf

     

    Best Wishes,
    Darren
    21 Jul, 04:44 PM Reply Like
  • Dividends#1
    , contributor
    Comments (2237) | Send Message
     
    Hi Darren,

     

    Because of the arbitrage opportunity MORL trades within pennies of its NAV in real time every day.

     

    The monthly reset only keeps MORL from having large discrepancies monthly, however over longer time frames as you can see from my example above, over a 14 month period it has a large discrepancy.

     

    Now lets look at the performance over a longer time frame: a little over 14 months.

     

    On 5/8/2013 MORL closed at $30.44 and on 7/18/2014 MORL closed at $22. They paid $5.59 in dividends and they owe shareholders $0.9642 payable on 7/22/14. So a good rough estimate of the performance of MORL would be to add the dividends to the current stock price. $22 + $5.59 + $0.96 = $28.55 a negative return of ( 6..2)%

     

    The MVMORTTG ( index) closed at 1,427.87 on 5/8/2013 and closed at 1,426.19 on 7/18/2014 a total performance of a negative (.11)%.

     

    Again a large discrepancy in the intended 2x return. The index dropped .11%, therefore MORL was supposed to drop 2x which = .22%. The FACT is MORL declined 6.2%. This is large difference, much greater then the FEES of .4%.
    21 Jul, 08:24 PM Reply Like
  • Rob1492
    , contributor
    Comments (215) | Send Message
     
    Very interesting article thanks! Like the idea of building the portfolio with those out of favor first! Have owned by MORL and BDCL when segments have been out of favor then sold when specific market perception improved.
    13 Jul, 02:59 PM Reply Like
  • Darren McCammon
    , contributor
    Comments (848) | Send Message
     
    Author’s reply » Here's an article StockBuzz did on MORL:

     

    http://bit.ly/1nv731I

     

    He comes out with essentially the same conclusions as I.

     

    Here's an article done by Dividend#1 on MORL:

     

    http://bit.ly/1nv71a0

     

    He concludes that MORL is too good to be true.

     

    Read both and decide for yourself. Professor Lance Bronfman has also done a number of articles on MORL and other UBS 2x ETN's which I would recommend.
    21 Jul, 04:58 PM Reply Like
  • Darren McCammon
    , contributor
    Comments (848) | Send Message
     
    Author’s reply » Q2/June dividends were received yesterday. Per plan they were re-invested in the component which has performed the worst so far, BDCL (-4.75% from average purchase price).
    23 Jul, 04:01 PM Reply Like
  • Darren McCammon
    , contributor
    Comments (848) | Send Message
     
    Author’s reply » There has been lots of back and forth on the book value of MORL in recent seeking alpha articles. Sometimes it's quicker to just figure it out instead of debating it. Taking the top 10 holdings in MORL, 70% of the ETN, the current weighted average P/B of MORLs holdings per Yahoo is 1.08. We see once again, assuming MORL equates to NLY and AGNCE can lead to the wrong conclusions. NLY and AGNC are trading below book value, MORL is not.
    24 Jul, 05:33 PM Reply Like
  • Darren McCammon
    , contributor
    Comments (848) | Send Message
     
    Author’s reply » A 2 hour example of the correlation between SPY and REM

     

    http://yhoo.it/otpxl0;range=1d

     

    At about 10:45am today the market heard that the Ukraine had shelled a Russian column which was invading Ukraine. In fear people hit the sell button, SPY immediately dropped 1%, REM about 1/2%. 2 hours later SPY was still at about the same lower value but REM had fully recovered. Why?

     

    When people hit the sell button in fear they also fled to safety, buying treasuries. This greater demand for treasuries increased treasury prices which reduces the effective interest rate you get for buying one. Buyers were willing to take a lower interest rate in return for the safety of a treasury. This in turn effected mortgage backed bonds the same way, people suddenly wanted them more and they became more valuable. The mREITs hold portfolio's of MBS so the main assets they hold are now more valuable which makes them more valuable. mREIT prices recovered. Apparently this whole process takes about 2 hours.
    15 Aug, 07:28 PM Reply Like
  • mrmedusa
    , contributor
    Comments (236) | Send Message
     
    Thanks, Darren. I doubt I would EVER have figured that out, but when you think about it, yeah, I can see how it works.
    15 Aug, 08:01 PM Reply Like
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