I found a paper addressing the effect of the Stimulus Bill of 2009 on jobs and job creation: "The American Recovery and Reinvestment Act: Public Sector Jobs Saved, Private Sector Jobs Forestalled" by Timothy Conley and Bill Dupor, economics professors from University of Western Ontario and the Ohio State University, respectively. The best estimate of the study is that ARRA created/saved approximately 450,000 state and local government jobs, while it destroyed/forestalled about one million private sector jobs. The authors discuss the margin of error for their estimates and the differences with the conclusions of others in assessing the effectiveness of the program. I am comfortable with the rigorous methodology applied to empirical data, and the impartiality of the authors.
The major conclusion to be be drawn is that the results of this traditional Keynesian prescription were not realized. The theory is that the government sector, with its unlimited borrowing and taxing authority, should take up the slack in generating aggregate demand in the economy. In this case, though, the policy had a negative effect of 550,00 net jobs lost.
This is not meant to be a criticism of the policy embodied by ARRA. Rather, I bring it up to inform future economic analysis in the investment decision making process when similar policies are pursued. That is, Keynesian spending can not be counted on to preserve private sector jobs, though it can offset those losses somewhat with public sector employment.
Special Thanks to: QandO.net
Wednesday, May 18, 2011
Wednesday, May 11, 2011
New Rules for Money Market Funds
According to an Investment News article, the SEC is heading a a review of the regulations governing money market funds. The immediate objective is to stem any run on the fund that breaking the buck might cause. A couple of proposals adopt a kind of "loss reserve pool" mechanism to allow for defaults and provide liquidity when markets dry up. The most disruptive is a proposal to have money market fund NAVs float on a daily basis.
On the surface, these proposals seem reasonable. The sanctity of the $1 NAV is one feature that has made money market funds so popular. Investor confidence in the security of the funds invested. However, the new regulations would be costly. And in an era of 0.1% yields, it is not clear that the new costs could be born by the funds and still offer investor an attractive yield.
Perhaps the experience with The Reserve Fund is an indication that we are asking too much of a mutual fund. After all, most money finds rely on an arcane accounting methodology (called income equalization) to maintain that $1 NAV as it is. Most brokerage firms now offer an FDIC insured cash management option, often with comparable services and higher yields than their money market funds. Even the plain cash balance accounts at brokerage firms are insured by the SPIC, even if they don't pay interest. Money funds could be merged into short-term bond funds, which is what they would become under floating NAV proposals.
Update: FDIC Corp. Chair calls money market fund stable NAV a "fiction," and is not overstating the case.
On the surface, these proposals seem reasonable. The sanctity of the $1 NAV is one feature that has made money market funds so popular. Investor confidence in the security of the funds invested. However, the new regulations would be costly. And in an era of 0.1% yields, it is not clear that the new costs could be born by the funds and still offer investor an attractive yield.
Perhaps the experience with The Reserve Fund is an indication that we are asking too much of a mutual fund. After all, most money finds rely on an arcane accounting methodology (called income equalization) to maintain that $1 NAV as it is. Most brokerage firms now offer an FDIC insured cash management option, often with comparable services and higher yields than their money market funds. Even the plain cash balance accounts at brokerage firms are insured by the SPIC, even if they don't pay interest. Money funds could be merged into short-term bond funds, which is what they would become under floating NAV proposals.
Update: FDIC Corp. Chair calls money market fund stable NAV a "fiction," and is not overstating the case.
Monday, May 9, 2011
10-K Season - Inland
10-Ks have all been filed and the scrutiny just begun. I have run a basic financial statement analysis on the most recent Inland offerings - Inland Western Retail, Inland American, and Inland Diversified - and present a summary below.
Inland Diversified opened its offering in August 2009 and is raising funds at a reasonable pace. At December 31, 2010, the REIT had $450 million of assets including $313 million of real estate owned directly. The company generated $19 million total revenue and a $2 million net loss. The shareholder 6% dividend is 46% covered by Funds from Operations and 69% by Modified Cash Flow. While subsidizing dividends is common during the capital raising phase, especially this early, continuing the practice of distributing funds in excess of those generated will result in the dilution of shareholder equity.
Inland American closed its offering in April 2009. At December 31, 2010, the REIT had $11.4 billion of assets including $9.6 billion of real estate owned directly. Inland American realized $1.2 billion total revenue and a $176 million net loss. The shareholder 5% dividend is 60% covered by Funds from Operations and 106% by Modified Cash Flow. The company reported approximately $168 million of asset impairments during 2010, partially offset by about $22 million of realized gains. The REIT appears to be managing its cash flow prudently, having already reduced its dividend to 5%. However, it has recorded significant impairments and losses over the past three years. Therefore, it would not be a surprise if share values are significantly lower than the original $10 share price, or even the current $8.03 DRIP price.
Inland Western has filed a Form S-11 with the SEC indicating its intention to list the shares on a stock exchange.
In Millions | Inland Western Retail | Inland American | Inland Diversified |
Total Assets | $6,387 | $11,392 | $450 |
Total Liabilities | $4,090 | $5,864 | $224 |
Equity Raised | $4,595 | $8,325 | $260 |
Net Real Estate | $5,686 | $9,563 | $313 |
Direct Debt | $3,603 | $5,532 | $193 |
Leverage Ratio | 63.3% | 57.8% | 61.5% |
Revenue | $647 | $1,232 | $19 |
Net Income | ($85) | ($176) | ($2) |
FFO | $135 | $253 | $3.9 |
Mod Cash Flow[1] | $153 | $442 | $5.8 |
Dividends | $95 | $418 | $8.4 |
Yield ($10 share) | 2.0% | 5.0% | 6.0% |
Inland Diversified opened its offering in August 2009 and is raising funds at a reasonable pace. At December 31, 2010, the REIT had $450 million of assets including $313 million of real estate owned directly. The company generated $19 million total revenue and a $2 million net loss. The shareholder 6% dividend is 46% covered by Funds from Operations and 69% by Modified Cash Flow. While subsidizing dividends is common during the capital raising phase, especially this early, continuing the practice of distributing funds in excess of those generated will result in the dilution of shareholder equity.
Inland American closed its offering in April 2009. At December 31, 2010, the REIT had $11.4 billion of assets including $9.6 billion of real estate owned directly. Inland American realized $1.2 billion total revenue and a $176 million net loss. The shareholder 5% dividend is 60% covered by Funds from Operations and 106% by Modified Cash Flow. The company reported approximately $168 million of asset impairments during 2010, partially offset by about $22 million of realized gains. The REIT appears to be managing its cash flow prudently, having already reduced its dividend to 5%. However, it has recorded significant impairments and losses over the past three years. Therefore, it would not be a surprise if share values are significantly lower than the original $10 share price, or even the current $8.03 DRIP price.
Inland Western Retail completed an internalization of its management in November 2007 and therefore has no formal affiliation with The Inland Group. At December 31, 2010, the REIT had $6.4 billion of assets including $5.7 billion of real estate owned directly. Inland Western realized $647 million total revenue and a $85 million net loss. The shareholder 1.96% dividend is 142% covered by Funds from Operations and 162% by Modified Cash Flow. The REIT's operations have been severely adversely affected over the past three years by economic and market conditions. Over this period, Inland Western has recorded impairments and realized net losses on the order of $659 million, partially offset by realized gains of $50 million from the sale of properties associated with discontinued operations. The company also worked through significant debt refinancings over 2009 and 2010, and continues to negotiate with lenders on the remainder of the debt portfolio. Close maturities include a $154 million line of credit due in 2011, $646 million of fixed rate and $26 million of variable rate debt in 2011, $411 million fixed and $88 million variable due in 2012, and $320 million of fixed rate mortgages due in 2013. While the REIT's management has worked diligently to preserve the value of the company's assets, it would not be unreasonable to estimate share value approximately equal to book value of $4.81 per share.
Inland Western has filed a Form S-11 with the SEC indicating its intention to list the shares on a stock exchange.
[1] Modified Cash Flow is an Clarity Finance measure which equals (1) net income plus (2) depreciation and amortization, plus (3) acquisition fees and expenses, less (plus) (4) any realized or provisions for capital gains (losses) on the income statement, less (plus) (5) income (losses) from unconsolidated entities, plus (6) distributions from unconsolidated entities.
Thursday, May 5, 2011
Supercharged ETFs
As I was catching up on my Forbes reading, I came across this article about leveraged ETFs. Now I have shied away from any of the leveraged funds because their performance has confounded naive expectations. For example, when a particular index would be up 20% one year, one would expect the 2x fund based on that index to be up 40%. Experience showed us, though, that the fund might be up any where from 0% to 50%. when the index registered a single digit gain, the fund may actually have lost money. The key to the disconnect is in the mechanics of managing that leveraged exposure. The fund rebalances to its leverage target every day. That is the leverage on the initial NAV changes each day based on the cumulative gains realized since the inception of the investment. Thus if the index experiences a 50% increase, the fund will take on 50% additional leverage, but the performance will still be calculated on the original investment.
Inn strongly trending markets this can actually work in the investor's favor, delivering performance that is greater than the advertised leverage. In a directionless market with some volatility, the leveraged fund will tend to decline. This result can be traced back to the mathematics of loss and gain that we all learned early on: if an investment loses 50% of its value, it will take a 100% gain to break even.
The article acknowledges all of this and essentially says use them anyway. I would recommend against using any of the leveraged funds, suggesting instead to use a brokerage account and buying your index tracking fund on margin. The investor can maintain his leverage relative to his original investment, according to his own comfort. Also, you can probably find a cheaper fund in which to invest.
Inn strongly trending markets this can actually work in the investor's favor, delivering performance that is greater than the advertised leverage. In a directionless market with some volatility, the leveraged fund will tend to decline. This result can be traced back to the mathematics of loss and gain that we all learned early on: if an investment loses 50% of its value, it will take a 100% gain to break even.
The article acknowledges all of this and essentially says use them anyway. I would recommend against using any of the leveraged funds, suggesting instead to use a brokerage account and buying your index tracking fund on margin. The investor can maintain his leverage relative to his original investment, according to his own comfort. Also, you can probably find a cheaper fund in which to invest.
Hazardous DRIPs
I am constantly amazed at the popularity of distribution reinvestment programs (DRIPs) on illiquid entities such as non-traded REITs. That as much as half of distributions from a non-traded REIT are reinvested indicates that investors are not carefully considering this decision.
First, I understand the rationale for wanting to reinvest. Compounding returns are a very powerful investment force for wealth accumulation, and we are taught that interest and dividend must be reinvested to achieve compounding. Furthermore, the REIT discounts the share price at which the distributions are invested.
However, these benefits do not overcome the major disadvantage of these securities, their illiquidity. These distributions offer a small amount of liquidity from an investment that is not currently marketable, and whose liquidity timing is distant if not uncertain. The bird in the hand principle applies here.
What about compounding? Yes, this aspect of wealth accumulation will be sacrificed. On the positive side, it will avoid compounding negative returns. More to the point, the sensitivity of real estate returns to acquisition and disposition endpoints, along with the relatively large minimum investment commitments required, suggest that time diversification could be more valuable than compounding in this asset class.
The discounted price is an even easier issue to address: it is an illusion. The regular price of a share is typically $10. That price includes say, 75 cents of commission and 25 cents of marketing assistance that is not spent on the the reinvested distributions. So the net proceeds to the REIT (comparable to a mutual fund's NAV) are $9. The dividend reinvestment program will sell shares at $9.50, so those reinvested shares are immediately diluted by 50 cents. Not a good deal.
I have long recommended that investors decline the reinvestment opportunity and accumulate the cash dividends in their investment account. If they are concerned about compounding, an option (albeit imperfect) is to invest in one of the REIT mutual funds or ETFs. Vanguard REIT ETF (VNQ) is a low cost option for tracking the MSCI REIT Index.
First, I understand the rationale for wanting to reinvest. Compounding returns are a very powerful investment force for wealth accumulation, and we are taught that interest and dividend must be reinvested to achieve compounding. Furthermore, the REIT discounts the share price at which the distributions are invested.
However, these benefits do not overcome the major disadvantage of these securities, their illiquidity. These distributions offer a small amount of liquidity from an investment that is not currently marketable, and whose liquidity timing is distant if not uncertain. The bird in the hand principle applies here.
What about compounding? Yes, this aspect of wealth accumulation will be sacrificed. On the positive side, it will avoid compounding negative returns. More to the point, the sensitivity of real estate returns to acquisition and disposition endpoints, along with the relatively large minimum investment commitments required, suggest that time diversification could be more valuable than compounding in this asset class.
The discounted price is an even easier issue to address: it is an illusion. The regular price of a share is typically $10. That price includes say, 75 cents of commission and 25 cents of marketing assistance that is not spent on the the reinvested distributions. So the net proceeds to the REIT (comparable to a mutual fund's NAV) are $9. The dividend reinvestment program will sell shares at $9.50, so those reinvested shares are immediately diluted by 50 cents. Not a good deal.
I have long recommended that investors decline the reinvestment opportunity and accumulate the cash dividends in their investment account. If they are concerned about compounding, an option (albeit imperfect) is to invest in one of the REIT mutual funds or ETFs. Vanguard REIT ETF (VNQ) is a low cost option for tracking the MSCI REIT Index.
Tuesday, May 3, 2011
Home Sweet Home
Smart Money examined the question of the value of home ownership as an investment. The article challenges the conventional wisdom that home ownership is always and everywhere a good economically and socially. There is little evidence presented, and I would daresay that there is little agreement among social scientists, about the societal value of a populace of home owners versus renters. On the other hand, the article does not shy from drawing the conclusion that home ownership is weak mas an investment. The story arrives at this judgement based on flat home prices between 2000 and 2010. In fact, the return on home ownership is more complex than just whether or not the property has appreciated.
Home ownership has three elements to its return. First is the appreciation of the asset. While prices were flat over the first decade of the current century, the article notes that "the rate of appreciation in housing seems likely to return to its long-term historical average, which is only slightly higher than the rate of inflation." While this growth of capital pales in comparison to the long term return to common stock, for instance, it is competitive with returns to Treasury securities.
Home ownership has three elements to its return. First is the appreciation of the asset. While prices were flat over the first decade of the current century, the article notes that "the rate of appreciation in housing seems likely to return to its long-term historical average, which is only slightly higher than the rate of inflation." While this growth of capital pales in comparison to the long term return to common stock, for instance, it is competitive with returns to Treasury securities.
Municipal Bonds Revisited
Bloomberg has a story a bout how "dumb" money is fleeing municipal bond mutual funds. Later in the article, though, do it yourself investors are credited with aggressively buying individual bonds. Advisors and brokers are also buying on behalf of their clients, but at about half the rate as DIY investors, according to BondDesk Group.
Municipal bonds may be the best value in the fixed income marketplace today. Muni bonds are trading at 40 to 90 basis points higher yields than treasuries, depending on the maturities. They usually trade at parity on a taxable equivalent basis. The pricing is suggesting that munis are expected to default at a rate of 1% per year, a rate six time higher than since July 2009 and 15 times the rate since the 1970s.
Right now, the muni market appears to be offering free money. There are some opportunities overseas as well, with European gilts trading at 100 basis points over Treasuries, and Australian governments at 200 basis points. These yield advantages assume no turnaround in the value of the dollar, which can not be assured. Certainly, the bonds on the taxable portion of client portfolios should be in tax exempts.
Municipal bonds may be the best value in the fixed income marketplace today. Muni bonds are trading at 40 to 90 basis points higher yields than treasuries, depending on the maturities. They usually trade at parity on a taxable equivalent basis. The pricing is suggesting that munis are expected to default at a rate of 1% per year, a rate six time higher than since July 2009 and 15 times the rate since the 1970s.
Right now, the muni market appears to be offering free money. There are some opportunities overseas as well, with European gilts trading at 100 basis points over Treasuries, and Australian governments at 200 basis points. These yield advantages assume no turnaround in the value of the dollar, which can not be assured. Certainly, the bonds on the taxable portion of client portfolios should be in tax exempts.
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