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  • FDN - A Lesson In Very CREATIVE PE Computation

    First Trust DJ Internet Index ETF (NYSEARCA:FDN) seeks investment results that correspond generally to the price and yield (before the fund's fees and expenses) of an equity index called the Dow Jones Internet Composite Indexâ„ .

    A quick look at the fund's positions shows some major positions that either carry an EXTREMELY high PE ratio, or are not profitable at all so the PE Ratio is inapplicable (names like AMZN,NFLX,CRM and LNKD appear in the top 10 holdings which comprise some 57% of the total ETF capitalization).

    Yet, FDN lists on its web site a seemingly benign PE Ratio of just 23.06 as of 8/31/15 :

    Looking at the numbers, any person with a sharp inquisitive mind would wonder how does First Trust comes up with such a low PE number for the entire ETF.

    If we just examine the 4 positions mentioned above which account for about 23% of the entire fund's capitalization we see the following last FY PEs:

    AMZN - PE NA (losses in 2014)

    NFLX - 182 PE

    CRM - 137 PE

    LNKD - 96 PE

    One might think that First Trust (NYSE:FT), a reputable organization, would apply a forward projected PE in order to account for future potential earning in this portfolio (after all, the past is the past..) - so I looked up consensus estimates for the current fiscal year and came up with the following:

    AMZN - 333 PE

    NFLX - 439 PE

    CRM - 98 PE

    LNKD - 87 PE

    Doesn't help us much, does it?

    Any way you slice it (and I tried, I really tried), whether you use weighted based PEs, simple average PEs, even if you just eliminate all losing companies PEs - you don't get to such a low PE of 23 - not by a long shot!

    So how does FT come up with such PE, which intuitively seems wrong to any neophyte with a rudimentary understanding of the Internet Sector valuation?


    FT gets its PE data from S&P CApital IQ and chose to omit any position with no PE (companies who lost money) from the equation.

    They then applied the Harmonic Average (or Mean) to the remaining set of positions.

    In essence the Harmonic Mean of a list of numbers tends strongly toward the least high elements of the list, it tends (compared to the arithmetic mean) to mitigate the impact of large outliers and aggravate the impact of small ones.

    As such, positions with HUGE PE values , no matter what their weight in the fund, are far less important for the purpose of establishing the fund's PE than companies with much lower PE ratios.

    As an aside, there is a school of thought that believes the Harmonic PE is actually the right way to express PE ratios when the population (or sample) has a few data points that are much higher than the rest (outliers), the harmonic mean is the appropriate average to use. But what happens if outliers are the norm in your sample group, when the mean is very high to begin with and there are a few very low PE outliers that get a much weightier significance, does this help the investor or masks true characteristics of the portfolio?

    For a bried discussion of means in finance see the link below :

    So for example, YHOO with a FY 2014 PE of about 20 and a weight of just 3.19% in FDN, would be infinitely more important than AMZN which carries no PE for that year (losses) and has a 11.06% weight in FDN.

    As an exercise let us examine just those two positions with a 2015 projected PEs (based on consensus estimates):

    AMZN - 333 PE

    YHOO - 46 PE

    The average of the two PEs would be 189.5

    The WEIGHTED average of the two PEs (given the current weights in the FDN portfolio) would be :

    (333 X 11.06 + 46 X 3.19) / 14.25 = 268.75

    What would be the HARMONIC average?

    1 / (0.7761 / 333 + 0.2239 / 46 ) = 138.827

    As you can see, this Harmonic weighted average PE is dramatically lower than the simple weighted average PE and gives a lot more weight to low PEs than it gives to very high PEs.

    FT is well within its right to use any metric it chooses but I find it very odd that they do not publish the methodology for deriving their PE number on the website, Fact Sheet or Prospectus.

    I strongly suspect the vast majority of FDN holders or buyers would benefit from knowing what the weighted average of the portfolio really is and eliminating companies with no PE from the equation further distorts the picture.

    While losing companies have no PE to speak of, a portfolio must somehow account for them if it publishes a PE ratio.

    If I had to evaluate this portfolio, since its results would be capitalization based (different weights will affect the portfolio differently) , I would use a weighted average PE and would arbitrarily assign a PE of 100 (or the average between 100 and the current year expected PE, if one wants to rid of complete arbitrary assumptions and give some weight for future EPS for companies with no EPS during the last FY) to the companies with no PE as of last FY results.

    Granted, one can choose his own arbitrary PEs for companies with no earnings based on one's own valuation preferences but I think FT method in assigning PE ratio to the FDN portfolio is lacking in many ways and masks a lot of useful data to investors.

    Comments, as always are cherished.

    Sep 15 2:42 PM | Link | 2 Comments
  • JGH - A Discounted Opportunistic Choice In The CEF Arena

    JGH is a new fund created by merging two long tenured funds (JGG and JGT) by Nuveen.

    Nuveen combined the two funds, tweaked with the funds' investment mandates and used economies of scale to create JGH as a larger, more focused and more liquid fund in the global high income arena.

    With the recent weakness in the fixed income Closed End Fund universe, not surprisingly, JGH has seen both its NAV and its market price go lower since inception a few weeks ago.

    I believe the current weakness is attributable to both general weakness in the High Yield arena and some tax loss selling ahead of the year end by investors who wish to offset losses againt their realized capital gains.

    As such , JGH closed at a 9.44% discount to its NAV last night.

    While we often see a snap back higher in the CEF after December pronounced weakness due to tax selling, JGH offers a unique opportunity to take advantage of something hardly any other funds offer right now.

    Nuveen has anounced that as part of the funds merger discussed above, it will initiate a Tender Offer for up to 25% of the JGH shares at a price of 98% of NAV.

    Indeed the Tender Offer was declared effective on December 4th, 2014 and will expire January 9th,2015:

    The fund has not declared its first dividend yet but is expected to declare a dividend rate which would be higher than 7% (probably closer to 7.5%-8% given the price weakness lately).

    Buying the fund at current levels at over 9% discount would enable investors to get an exit for 25% of their shares (assuming full participation) or even more than 25% (if a smaller part of all shares will be tendered).

    Due to the above I view JGH as a very good buy opportunity either for new money to be deployed in the Global HY arena or as a swap into from other CEF's who would be sold to harvest tax losses before the end of the year.

    Dec 11 9:17 AM | Link | 14 Comments
  • Is BKN Worth The 3.1% PREMIUM Over NAV? In Short: NO !!

    Muni Closed End Funds (NYSEMKT:CEF) have rallied nicely from the tax selling before the end of 2013 during December.

    Some funds had been trading at discount to their Net Asset Values (NYSE:NAV) of around 10%, which is quite higher than the long term average.

    Many of the funds we saw trading at premium to NAV until the summer of 2013 turned south during the summer months and reversed course to end the year with a very steep NEGATIVE total return, spooked by the general malaise in the fixed income market following the Fed's infamous "Taper Tantrum" as well as some negative headlines emanating from Detroit and more importantly Puerto Rico (PR).

    December enabled investor to grab Muni CEF at yields in excess of 7% (TAX FREE) and as a bonus, to get them at very high historical discounts to their NAV.

    While some funds still trade at discounts to their NAV's (admittedly, smaller ones but still in excess of 5% discount), other funds, that were mentioned in publications and interviews like this one :, enjoyed a terrific rally that pushed them from undervalued terrain all the way to over-valued valuation with market prices exceeding NAV's handsomely.

    Herein lies the conundrum; BKN is one of those funds and my research tells me there is no fundamental reason for it to differ from other funds in the same arena managed by Blackrock, and for that matter, other funds managed by other well known and respectable fund management companies (Nuveen, Eaton Vance, Invesco etc.).

    At yesterday's close BKN was at a 3.15% PREMIUM to its NAV while yielding about 6.52%.

    Looking at its average valuation of the past 3 and 5 years BKN has been trading at Premiums of 2.35% and 2.02% on average, respectively.

    Looking at a few of the other Blackrock managed funds like BYM,MHD,MQT,BTA just to name a few we see a very stark difference in relative valuations vs. BKN:

    All of these funds (and many more by other managers, the list is too long to place here, but a screen of CEF will uncover those opportunities) offer much better fundamentals than BKN:

    1) Higher dividend payouts , to the tune of 7%-7.15% (vs. just 6.52% in BKN)

    2) Better pricing - those funds (and again, many others) trade at significant discounts to their NAV's to the tune of 5.5% to 7.7% DISCOUNTS.

    3) Much better relative valuations : While BKN trades ABOVE its 3 and 5 years average valuation, these funds trade WELL BELOW their 3 and 5 year average valuations to the tune of anywhere from 4% to 6.5% BELOW their average valuation.

    To sum it up - one can get about 0.60% better yield AND about 8.6% to 10..8% difference in Premium vs. Discount AND about 5% to 7.5% in Relative valuation by selling BKN and swapping into other Muni CEF's that are much more reasonably valued and would provide a much better return going forward should reversion to the mean occurs.

    The best part is that you are not changing even fund managers by staying with Blackrock managed funds (although you can choose other fund families with similar superior characteristics as well)

    Disclosure: I am short BKN.

    Additional disclosure: I am long a host of Muni CEF's some of which were highlighted in this post.

    Jan 14 3:57 PM | Link | 1 Comment
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