Monday, 30 July 2012

Closed End Funds: July 2012 High Discounts - Anything Worth Buying?

Last week we looked back at the most heavily discounted Closed End Funds of December 2008 to see how things turned out. Most of those big discounters made investors a lot of money though a minority lost big. This week, let's scan the current list of CEFs with the biggest discounts, again using the Globe and Mail's Closed End Fund report to find and sort the funds. We've taken a screen snapshot of the result and post it below.

R Split III Corp (TSX symbol: RBS) 45.8% discount of shares to Net Asset Value (NAV)
The largest apparent discount of all is a data error. The Globe's NAV figure is the sum of the capital share (RBS) plus the preferred share (RBS.PR.B). The actual discount of the capital share RBS is only about 3.8%, as can be verified from the fund's info page posted by managers Scotiabank. That makes sense given that the fund invests only in the common shares of the country's biggest bank, Royal Bank of Canada, and only the presence of leverage in the form of the preferred shares complicates the situation. The lesson is that even good data sources such as the Globe can have errors. When investing, always check numbers, especially when they look strange!

Urbana Corp (URB or non-voting shares URB.A) 38.3% discount
This fund's holdings have until recently concentrated on investing in shares in stock exchanges such as the NYSE and the TSX. Various commentators have detected a potential value in this stock - e.g. the Globe and Mail's February 2012 article Finding blue chip bargains in closed-end funds, Frank Voisin who tracks Urbana's value and holdings in a spreadsheet on his blog, Barel Karsan blog's 2011 post Urbana: I Snooze, I Lose, Alpha Vulture's recent Urbana Update and ValueWalk's Urbana Corporation: A Net-Net Value Trap?. The opinions are mixed, with the discount set against poor returns of the last four years. There is also the issue of the recent move by URB to invest in Caldwell Financial, which happens to be URB's major shareholder. Both Caldwell and Urbana are headed by Thomas Caldwell who is the controlling shareholder. This snake eating itself move, though minor in proportion of the fund, raises questions about management's motives and interests. To cap matters, in the last few days, the stock has made a major move upwards, gaining 21% in the last five days. Could the love affair with stock exchanges and URB be returning to the point of 2007 where Urbana traded at a 60% premium to NAV?

Brookfield Soundvest Split Trust formerly called the Brascan SoundVest Rising Distribution Split Trust (BSD.UN) 34.2% discount
This fund displays a number of factors that could well justify a large discount - the steady shrinking NAV over the years; the suspension of redemptions and dividends on capital shares, the low credit rating (Pfd-4 by DBRS) on the preferred shares, which indicates shaky prospects for these shareholders who get paid before capital share owners. The investor looking at this situation may wonder whether the fund will shrink to nothing before the intended wrap-up date of 31 March 2015.

United Corporations Ltd (UNC) discount 34%
It would be a surprise on the other hand to see this fund disappear anytime soon. In existence since 1929, this large fund with $860 million in assets looks to be conservatively managed. It has continued to pay a dividend on common shares (it also has preferred shares in its capital structure) since forever and its total return looks comparable to the mix of Canadian and world indices matching its investment portfolio. The management fees are low enough to be ETF-like at 0.46% plus another 0.1% or so service fee to E-L Financial. The fund can understandably appeal to investors who subscribe to the fund's objective to achieve long term growth in common equities worldwide.

On the hand there are some caveats. The large discount is seemingly more less permanent. Going back to at least 1996, there has been a discount of anywhere from 20% to 45%. Mechanisms that might reduce the discount such as share redemptions, retractions or buybacks are flat out ruled out by fund policy. There is no automatic wrap-up date for the fund. Another fact, a limitation to some and an advantage to others who trust their ethics and judgment, is that the fund is controlled by E-L Financial, which is in turn controlled by the Jackman family.

With respect to the discount, though it might not go away, its historic range is quite wide and an investor could well see some lessening of it, leading to stronger returns if that happens, since the 34% is in the mid to upper historic range. It would be ironic to make trading profits on a fund with a hard-fast non-speculative philosophy.

Economic Investment Trust (EVT) 32.8% discount
This fund is very much like UNC. It is very old (1927 launch), low MER (only 0.32%), forever trading at a significant discount to NAV, big ($420 million in assets) and controlled by the same family with the same long term equity appreciation investment objective. EVT's discount has also seesawed, ranging from as little as 15% in 2006 to as much as 46% in January 2001. An eyeball look suggests that the discount has been greatest in times of economic and market turmoil. The biggest difference is that EVT has no leverage at all, no debt and no preferred shares either. Perhaps another discount reversion play while collecting dividends?

Canadian World Fund Ltd (CWF) 32.6% discount
This is another fund with many similarities to EVT and UNC - a chronic discount, a controlling shareholder, the Morgan family in this case, a long history (1994 foundation) and long term investments in a diversified portfolio. The big difference is a much higher MER at 2.3%, which reduces investor returns. The Morgan family also own the fund's managers Morgan Meighen so they get paid both ways. Investment returns have been poor with declining NAV, so perhaps the discount is in part the result of investors extending that trend.

Canadian General Investments Ltd (CGI) 27.7% discount
We've put this next in our rundown, though it isn't next in terms of largest discounts, because CGI is also controlled by the Morgan family. It sports a lower MER at 1.6% (includes 1% management fee plus 0.6% other expenses in 2011), though the overhead for CGI capital shares is 3.0% if the cost of leverage in the form of preferred shares is added. Investment returns based on its almost totally Canadian equity composition, have been much better than CWF's. The fund has a policy of making a constant $0.06 quarterly dividend payment then flowing through any remaining capital gains for the year in a one lump sum each December. The fund boasts of 25 year compound returns of 11.0% vs 8.2% for the TSX up to the end of 2011, though of course the leverage increases volatility as 2008 amply demonstrated. Given that the current discount is at the upper end of those of previous years, which has varied from 8% to 35% since 2008, maybe this is a chance to make a short-term trade or a long-term investment on the cheap.

CMP Gold Trust (CMP.UN) 31.9% discount
This is an another fund that has always experienced a very large discount to NAV since its 2008 launch. Compared to the year-end 2010 48.6% discount, today's figure is low! The fund has gone through huge swings in market price relative to the TSX. Management expenses have varied from a low of 2.53% in 2011 to 21.84% in 2010 as the incentive portion of the fee structure kicked in. Maybe investors are saying through the big discount that they aren't as sure of making money from this fund as the managers are.

Copernican British Banks (CBB.UN) 25.9% discount
We noted this fund last week because it was amongst the most discounted funds of 2008. It still is today in 2012. Though managers Portland Investment say that "...The discount is largely attributable to the redemption fee which expires in January 2014" and that "...investors will ultimately put fundamentals first and notice that this portfolio includes, what we believe, are substantially undervalued banks" the burden of bad bank history and the appreciable presence of European banks in the portfolio could well still be holding back investor belief. Or perhaps it is the hefty 3.08% expense ratio.

MBN Corporation (MBN) 23.7% discount
This fund's discount could well be called a confusion, uncertainty and complexity discount. From its start focussed on investing in oil and gas companies, it expanded after a merger this February to add mining and uranium. Now the Annual Information form says the "fund may make any investment which the Board and/or the manager determine to be appropriate".  Another statement says it intends to expand through acquisition of financial services companies and investment funds. Meanwhile the NAV return since 2007 inception is a minus 7.6% compounded.

Bottom Line
Several of these funds look attractive. UNC and CGI look best both short- and long-term. EVT and CWF look less attractive though still reasonably so. URB and CBB.UN are more speculative buys. BSD.UN, MBN and CMP.UN look dangerous. The February 2012 Globe article Seven closed end funds worth considering included CGI, CWF, UNC, EVF and CBB.UN in their attractive fund list.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Friday, 20 July 2012

Deep-Discount Closed End Funds of 2008: How Did They Do?

Way back in December 2008, when we described how Closed End Funds work, we copied the Globe Investor list of CEFs with the biggest discounts at that moment of market price compared to the net asset value of holdings inside the fund. Our screen capture snapped 13 CEFs with huge discounts ranging from 48% to 92%. This admittedly was the time of utmost fear in markets at the peak of the credit crisis but was the market overdoing it in pricing the extra risk factors we listed in our post? We thought back then that there might be some bargains amongst the heavily discounted unloved CEFs. Let's see how those CEFs evolved since then and see whether the market reconsidered its estimates. We exclude one of our 2008 list, the Bayshore Floating Rate Senior Loan fund since it was already announced for shutdown when we wrote the 2008 post.

Equity Benchmarks Up 42-47%
Let's remember that equity markets recovered strongly after those frightful days of late 2008. The CEFs were invested in a large variety of markets so the number can only be a rough measure but the TSX Composite Index Total Return from late December 2008 to today is just under 42% and the USA's S&P 500 Total Return Index, translated into Canadian dollars, is up about 47%. To get these numbers we used GlobeFund's handy graphing tool which lets us pick any of a range of benchmarks in the "Compare vs benchmark" drop down box.

Outstandingly Better Than the Market
  • First Asset Power Generation (PGT.UN at the time, no longer quoted) - The $5.74 per unit market price of 2008 was worth $9.13 by the October 26, 2010 agreement to merge with Sprott Power, a nifty 59% increase, more than double the TSX index's total gain up to then. That would have been the time to sell since Sprott Power (SPZ), whose shares First Asset owners got in exchange in the merger, has dropped back from $1.71 to $0.95 today.
  • Global 45 Split Corp (formerly GFV) - This is another fund that has fallen by the wayside through redemption by the managers, in September 2011, but Global 45 holders would have been very happy with the 107% increase in market price from $2.15 in 2008 to $4.44 at the end (see the Yahoo chart).
  • International Financial Income and Growth Trust (formerly FIT.UN) - This CEF stopped trading in December 2009 at $4.60 a share, a rather impressive 184% gain in a mere year.
  • Acuity Small Cap Corporation (formerly ASF) - This is starting to be a familiar story ... ASF disappeared as a separate entity in May 2011 when it was merged by Acuity into its Acuity Canadian Small Cap fund. The $8 or so price at the time gave the 2008 buyer a 397% gain
  • Split REIT Opportunity Trust (formerly SOT.UN) - The storyline continues as SOT.UN was merged into the Criterion REIT in December 2011. SOT.UN's market price at merger was $18.65, up a princely 729% in the three years.
  • Sentry Select Primary Metals Corp (PME) - This fund still exists as it did in 2008 but the market price underwent a huge turnaround. PME is actually down since a peak of around $12 in late 2010 but its current price of $7.37 per TMX Money still represents a very healthy 238% gain since 2008. Interestingly, the latest Globe CEF report shows that instead of trading at a huge discount to NAV, the current price is a 9.5% premium! Is the market fickle, or what? 
  • Global Diversified Investment Grade Trust (DG.UN) - This is another fund still in existence. The market price has risen to converge with the NAV such that the discount gap is now only 8%. That has allowed 2008 shareholders to receive a 358% gain to date on top of a regular stream of attractive dividends (TMX informs us the yield is now 6.8%). Manager National Bank Financial must be doing something right running the "portfolios of mortgage-backed securities, asset-backed securities, synthetic corporate exposures and other fixed-income securities". The Google Finance price chart below shows the very bumpy ride of DG.UN's blue line to the huge increase - by contrast, the orange line of the TSX Composite, which on most chart scales looks like a bumpy ride itself, seems to be smooth as a T-bill.
About as Well as the Market
  • Global Banks Premium Income Trust (GBP.UN) - The 46% gain of this fund more or less matches the market performance. A combination of NAV decline and price rise has almost eliminated the discount. In 2008, the price vs NAV discount was over 50%, now it is only 6.3%.
  • Energy Split Corp Inc (formerly ES) -Before this fund was redeemed and shut down in September 2011, it's 2008 price of $10.32 had recovered to $15.19, a 47% gain.
Worse Than the Market
  • Copernican British Banks (CBB.UN) - The market price has only risen some 27% since 2008 and the discount has narrowed but there is still a hefty discount of about 25%. A February 2012 Globe and Mail article by Martin Mittelstaedt included CBB.UN as showing interesting promise.
  • Copernican International Financial Split Corp (CIR) - This is a true disaster amongst the 2008 crop. The NAV is exactly zero i.e. the portfolio holdings are worthless, and the market price is $0.03 a decline of 92% since 2008. Any remaining money is going to the preferred shareholders, though the prefs (CIR.PR.A) trade at a 15% discount themselves. Is manager Manulife going to put this fund out of its misery soon?
  • Copernican World Banks Split (CBW) - This is another disaster, also it happens, managed by Manulife. The fund's NAV is zero, though the market price is $0.045, a decline of 85%. Similarly to CIR, the prefs (CBW.PR.A) trade at a 15% discount. Manulife should bury this dead fund.
  • Deeply discounted CEFs seemed to offer huge gains or giant losses, with few in the middle. Buying such funds is a high risk, high reward endeavour. An investor in deep-discount CEFs is likely better to own several and not put all eggs in one basket. A limit on how much money in total goes into such volatile funds makes sense too.
  • The price ride is very bumpy along the way. We showed one chart, for DG.UN, but others we looked at were just as hair-raising.
  • The worst outcomes have been with funds tied into banks outside Canada as the banking crisis has endured. The future was worse than even the market price in 2008 had indicated.
  • The best outcomes have occurred when the market price vastly overdid the negative view of the fund itself. The fund may have been in trouble, as evidenced by subsequent close down or merger, but the contents, as expressed by the NAV, were still worth far more than the market price. Value assessment is a worthwhile discipline to apply to these funds.
Disclosure: we did not actually buy any of the above funds ourselves, so we cannot now boast about how smart we were.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Friday, 13 July 2012

Olympic Champion Canadian Stocks

The Summer Olympics are about to start in London and many Canadians will be cheering on Canadian athletes, so we decided to piggyback on the sports idea this week. Our theme revolves around what is perhaps the most gruelling discipline, the track and field event for men called the decathlon and for women the heptathlon. Both require excellence across multiple disciplines requiring various combinations of strength, speed, stamina and timing.

The stock equivalent of multi-dimension success is that separate ETFs and  stock selection criteria lead to the identification and inclusion of certain stocks in the winners circle. The theory is that if certain stocks keep emerging as worthwhile choices, they must be good. The criteria we use today are those we have previously posted about:
The multi-event winners
Similar to the decathlon and heptathlon where consistency and the total over all disciplines determines who wins, our selections are based on which stocks show up again and again. They are stocks which look good no matter which way the selection criteria are sliced. They may not be the outstanding winner in any category but they are always good enough to make the grade and they get picked for the stock list or the ETF.

Gold medals:
Three Canadian stocks show up in every Canadian dividend ETF (except the one actively managed ETF Horizons Dividend ETF (HAL), which we did not like at all per our previous post) as well as the 49 stocks that comprised our amalgamation and combination of the stocks that showed up repeatedly according to various evaluation methods in the above posts.
Silver Medals:
Four companies are within the holdings of five out of six dividend ETFs as well as showing up in the composite list of 49 good stocks.
Bronze Medals:
Ten companies make the grade of inclusion in four out of the six dividend ETFs along with being in the list of 49.
Durability and long term track records are a distinguishing feature
Many of the selection criteria themselves emphasize longer term past performance, whether it is earnings, dividends, or merely survival. In addition, our own posts looking at the various investing angles go back over several years. The lesson is that good companies and good stocks carry on doing good things, there is persistence and momentum, just like past champion athletes.

iShares S&P / TSX Equity Income ETF (XEI) is an outlier
One thing this further analysis of the holdings of the various dividend ETFs has revealed is that XEI has built an ETF that is quite different than the others. Its holdings contain far fewer of the good past performers - only 19 of its 75 holdings, or 25% , overlap the composite list of 49 solid stocks. The other dividend ETFs overlap anywhere from 40% to 60% of the list of 49. We think that makes XEI look a bit riskier.

Proven past performance does not guarantee a gold medal next time
As any sports fan knows, The fact that someone has consistently won in the past does not ensure a gold medal on the day of the competition.

Recent training, injuries, an in-form season, an athlete coming into prime or in decline and unexpected events can change things for this current Olympic competition or forever. It's a worthwhile analogous thought process for the investor to use in assessing these stocks.

To our athletes as they undergo the final weeks of preparations for London 2012, we say, "Go Canada, Go!"

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Friday, 6 July 2012

Canadian Dividend ETFs: Which is the Best?

ETFs made up of dividend paying Canadian stocks have gained popularity and the offerings have proliferated. The first one was created in 2005, then another in 2006 and then five more in the last two years. Though they all have the same basic idea of holding dividend stocks, it is no surprise that beneath the surface there are marked differences. So this week we look at them to winnow out the good from the not-so-good.

Why dividend stocks and ETFs?
There are several possible reasons an investor could be particularly interested in dividend stocks:
  • Steady and higher income - Investors, like retirees, who seek income find the idea of stocks that pay out regular cash an attractive proposition (see Stingy Investor's links to many news articles on dividends and our own post Three Reasons to Love Dividends), especially nowadays when bond or GIC interest rates are so low, often lower than dividend yields. The fact that the dividend ETFs select only companies that actually pay dividends (many do not) and most pick companies that pay higher dividends than the average heightens the appeal of dividend ETFs. In addition, all but one of these ETFs pay out monthly (though most companies that pay dividends do so on a quarterly basis), which helps some people budget their cash flow. The usual ETF benefit of spreading the risk by holding many companies helps their appeal too.
  • Tax advantaged income - For holdings in a non-registered account (this consideration does not matter in RRSPs, TFSAs and other registered accounts), the investor benefits from much lower - compared to interest income - tax rates on dividends, as well as the capital gains and return of capital ( see our post on differentiating good from bad ROC) that the ETFs also generate. 
  • Possibly higher returns and less volatility - The notion that dividend stocks generate better returns gets some credence from the fact we pointed out in our recent post on Long Term Returns that most of the return from stocks comes from dividends. Most companies only start paying dividends when they are confident of being able to maintain the payout so one would expect that mature stable companies dominate the dividend space. We'll have a look at this idea in the performance of our candidate ETFs during their short, and admittedly inconclusive, history.
The ETFs

Distribution yield, aka cash payout
Cutting to the central issue of dividends we see a huge range of payout rates by the funds. Note that the dividend yields of the stocks within doesn't matter, it's what left over after management fees and other costs, the distribution yield (obtained from TMX Money), that counts. XEI wins hand down at the moment with an annualized yield of 4.7%. Others that are quite good with yields above 4% are ZDV, XDV and PDC. Progressively less impressive are DXM and CDZ, whose yields are getting down to not much more than the 3.1% of the standard ETF that represents the overall market of large cap stocks, the iShares TSX 60 (XIU). If the ETF can't do much better than the market, why bother? Pulling up the rear with a below-market 2.6% is HAL, a result that denies the name dividend ETF.

Diversification and concentration riskiness
Spread it out is the basic principle for risk reduction. That means more companies across multiple sectors, with no one company / small number of companies, or industry sector, too dominant. This is where the stock selection and weighting methodology seems to have backed some of the ETFs into a corner, though some of them have built in caps on individual stock and sectors as our table details.

CDZ, XEI, ZDV and DXM seem to do the best overall job of spreading things out. XDV and PDC have too many of their eggs in the Financial Services basket and in a handful of companies i.e. the big banks, though some might think that reassuring and if so, it is easy enough to simply buy stocks of the big five bypassing an ETF. HAL is a strange fish with respect to holdings. Not only does it own some US stocks (10% at the latest report) that do not have the Canadian dividend tax advantage, its prospectus allows it to own fixed income, which are not exactly dividends.

Contrary to the image of dividend payers as being large stable companies, most of our ETFs have a small cap bias. The TSX Composite average market cap is about $14,800 million but CDZ's portfolio only averages a quarter of that and ZDV is just over a third that size. At the other end of the scale, HAL and PDC are portfolios of mega cap companies. Does that make the small cap ETFs riskier in the sense of volatility?

Volatility riskiness
How bumpy is the ride along the way for these ETFs compared to the overall TSX and how has their performance compared? We note again that most have been in existence too short a time to draw any firm conclusions but it is nevertheless interesting to see what has been happening. In this Google chart, we see that since the beginning of 2012, the six ETFs we have chosen (excluding DXM, which was only launched in February) seem to have tracked, per the various coloured lines, above the TSX in the black line. Only XEI has done worse than the TSX.

In another Google chart view of the period through the financial crisis of 2008, we see that the two ETFs (XDV and CDZ) that have existed that long both bumped up and down no worse than the overall TSX. CDZ in particular is well ahead on price - down only 2.4% vs the TSX minus 14.3% in the past five years. When we consider also that the Google chart is price only and does not include dividends, which would have been higher for the dividend ETFs, then the dividend ETFs look even better.

Costs - Management Expense Ratio (MER)
Costs reduce net returns to the investor. Principally made up of management expense but also including ancillary trading and administrative costs, the lower the MER is, the better. On this dimension, ZDV is the clear leader with an MER of only 0.35%. The others are appreciably higher in the range 0.5-0.7% with HAL again pulling up far worse - at 0.99%.

Tax Efficiency
Four of the ETFs made it into our list of Tax Champion ETFs of 2011. ZDV made it into the Gold medal category, though this may not be indicative of future years due to short track record. Longer lived funds XDV and CDZ both made it into the Bronze medal category, as did newcomer XEI. Justin Bender of PWL Capital's post comparing XDV, CDZ and XEI came to the conclusion that XDV would likely have the lowest portfolio turnover and thus less future capital gains for investors to report. His post also gives another perspective on risks of these funds.

Bottom line
Which is best? It is easy to say which which is worst - HAL with its high MER, low dividend payout, un-dividend investing strategy, small number of holdings. XDV and PDC are uncomfortably concentrated in the financial sector and in a few companies. Others have good and bad points - CDZ is well diversified but its MER is quite high and its yield is barely above the TSX. XEI pays the highest yield by quite a bit and it is reasonably well diversified but it has a fairly high MER. DXM spreads holdings really well across companies and sectors but its MER is also on the high end (and it will be higher than the 0.60% management fee in a year once trading and admin costs get added in) while its yield is not outstanding. ZDV wins our vote by a hair with its significantly lower MER, high payout ratio and good diversification through low concentration across companies and sectors. Its only drawback is its relative youth and resulting short track record. Some might be put off by its portfolio not holding any of some of the major banks (there's no Scotiabank or TD Bank at all) and its relative bent towards smaller cap stocks. But we like it. And, of course, investors reading this can and should make up their own mind.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.