Mini Tenders

Investment News carried an article about the tender offers for shares of American Real Estate Investment Trust and Apartment Trust of America.  The gist of the article is that these "mini tenders" (so called because they are the offer is for less than 5% of the outstanding shares) take advantage of the illiquidity of the shares of a non-traded REIT, and the limited information on share value from the REIT, to purchase shares for a price that is well below some fair value.  To his credit, Bruce Kelly, the author, writes a much more balanced story than the headline implies.  He quotes representatives of both organizations making the offers.  Don DeWaay of DeWaay Financial Network makes a sober and compelling case in favor of the practice of mini tenders.

These mini tenders are not inherently good or bad.  Some combination of illiquidity for the security, incomplete valuation information, and market conditions create an environment in which an aggressive opportunistic investor believes that he will be able to buy a sufficient number of shares at a discount to current value large enough to justify the expense of compiling a contact list and communicating the offer to investors.  For example, I would wager that shares of Inland American Real REIT have a current value much closer top the $8.03 that insiders paid recently than the $4.00 being offered in the tender.  The tenders may point out negative issues and items, including the fact that the shares are expected to be illiquid for an extended period, but most of these issues should have been reasonably foreseeable at the time of investment.  Generally speaking, investors need to be concerned with a mini tender only if that investor's circumstances have changed so drastically that the investment must be liquidated immediately, and then only after exhausting all other potential liquidity sources.

A good friend publishes The Rational Realist, a blog with a focus on real estate investing especially syndicated funds.  He notes that Total Realty Trust was able to meet (on a pro rata basis) just 7% of liquidation requests during 2010.  This ahead of the required share valuation that is scheduled in 2011.  The REIT's inability to meet the demand for liquidity is likely to signal to a tender fund an opportunity to pick up some shares of Total Realty Trust on the cheap.  Get ready to field the calls from your clients who own shares in this REIT.

Floating Rate Funds Making a Comeback

An article published January 12 in the online version of Financial Advisor cites an inflow of capital into funds investing in floating rate loans.  The expectation is that these funds will hold their value better than fixed income securities, such as Treasury bonds.


The funds invest in floating rate leveraged loans.  They are typically less than investment grade, though senior in the capital stack to term loans and bonds.  The interest rates on these loans tend to lag the general movement of rates due to loan terms (adjustment period and choice of reference rates) and payoff as credit quality improves.  Thus, the dividend will stay fairly stable in both rising and falling interest rate environments.  The principal value tends not to fluctuate with changes in interest rates, but can change dramatically with general economic conditions.  Witness the decline in NAVs among some of the oldest and largest of the funds in 2008: Eaton Vance Floating Rate Advantage B (EBFAX) - down 43%; Invesco Van Kampen Senior Loan IB (XPRTX) - down 54%; Black Rock Senior Floating Rate I (XMPFX) - down 34%; Invesco Prime Income Trust (XPITX) - down 41%.  The NAV for the Eaton Vance and Invesco Van Kampen funds have returned almost entirely to their December 2007 levels.


The bottom line is this: these funds will tend to reduce volatility due to interest rate fluctuations.  However, they are highly exposed to credit risk.  They can work to enhance returns in a rising interest ate market, (which is often associated with improving economic conditions). They are not simple trade off for Treasury securities.

Another "Can You Trust Your Advisor?" Article

SmartMoney published another article on the subject of public trust in advisors. Then twist in this case is that it compares financial planners to mortgage brokers and college financial aid consultants as well as insurance agents. The conclusion is that college aid consultants do not add much value beyond assisting the completion of standardized forms, and that commissions create conflicts of interest. The money quote:

A surprising number of people believe -- sometimes mistakenly -- that financial professionals are acting in their best interest: 76% of investors said so for financial advisers and 60% said the same for insurance agents, according to a September 2010 study co-authored by the Consumer Federation of America.

So the vast majority of the public is inclined to place their trust with an advisor. It is up to the advisor to nurture that trust and encourage its proliferation. Articles like this are read by target market of the advisory industry.  The perception is accurate: fee-based practices generally have fewer conflicts.  Full disclosure of all compensation and how it is earned promotes continued advisor confidence.

The Great Muni Bond Meltdown?

Investment News recently had two items on the coming crisis in the municipal bond market.  On December 29, the publication linked to a Kudlow Report video of a conversation between Peter Schiff and Donald Luskin.  On January 2, IN published an article based on comments made by Josh Gonze, manager of the Thornburg Limited Term Municipal Bond Fund (LTMIX).

Color me firmly in the Don Luskin camp.  There will be an uptick in defaults, likely significant.  The federal government is is not likely to bail out the issuers.  Investors will experience losses in those issues that do default.

On the other hand, most issues will not default.  Those that do will provide some payoff to investors.  And right now,  muni bonds are priced with higher yields than Treasuries across the yield curve.  This suggests opportunity.

The recommendation is to address the credit risk in two ways:  very broad diversification through index investing and selection through investment only in AAA rated bonds.  In both cases, professional market participants are monitoring the bonds to ensure that expectations continue to be met. -- reflecting bond market conditions in the case of the index, a very high probability of meeting contractual obligations in terms of the credit raters.  This would appear to be a very efficient way to implement the bond portion of a diversified portfolio, especially in a taxable account.

Quantitative Easing Explained

A simple, if irreverent, explanation of QE2.

Adding Value in a Muni Bond Portfolio

A little while ago, an advisor queried his study group for suggestions for a half million dollar municipal bond portfolio.  The usual mutual funds were suggested.  One respondent suggested a separate account manager with a good track record.  These are all good recommendations.

I made the recommendation that the bulk of the portfolio be indexed using two ETFs,SPDR Nuveen Barclays Capital Municipal Bond ETF (TFI) and SPDR Nuveen Barclays Capital Short Term Municipal Bond ETF (SHM).  A 20/80 mix would produce a portfolio with a weighted average maturity of 5.2 years, a duration of 4.2 years, an SEC yield of 1.70% and a Yield to Maturity of 1.98%.

The remainder of the portfolio could then be invested in a laddered portfolio of one to five year bonds with characteristics addressed specifically to the client's needs.  the portfolio could be customized on characteristics like credit quality, state tax exemption, type of issuer, and use of proceeds.  A quick check of the Charles Schwab inventory indicated that individual bonds were available in $25,000 lots across the maturity spectrum providing a yield advantage of 100 to 150 basis points over the generic yield curve yields published by Bloomberg.

This portfolio provided the following values to a client that a typical mutual fund/separate account allocation would not:

1. Fully diversified exposure to the municipal bond market;
2. Management cost of about 14 basis points;
3. Full control of interest rate exposure with easy implementation of policy changes;
4. Annually programmed liquidity events;
5. A significant and visible portion of the portfolio customized specifically for the client.

I recognize that this solution will entail more work on the part of the advisor than the simple managed money option, especially up front.  However,  I would expect the value added through lower cost, higher returns, greater risk control, and a very high degree of customization to enhance the client/advisor relationship.

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