Middle-East Opens Weak: Dubai Stocks Slump To 2-Year Lows As Financials Tumble
Following Friday's further freefall in crude oil prices, The Middle East is opening down notably. Abu Dhabi, Saudi, and Kuwait are lower; Israel is weak and UAE and Qatar are tumbling, but Dubai is worst for now. Dubai is down for the 6th day in a row (dropping over 3% - the most in a month) extending the opening losses to 2-year lows. The 11% drop in the last 6 days is the largest since the post-China-devaluation global stock collapse. Leading the losses are financial and property firms.
In a replay of August, Middle-East equity markets are tumbling as China allows the Yuan to weaken...
Sending Dubai stocks to 2 year lows and breaking critical support...
Financials and property firms extend and accelerate their recent losses...
Stone Lion halts redemptions from $400m credit fund
A gloomy bookend to a gloomy day for the credit markets, news that the hedge fund group Stone Lion Capital Partners is barring redemptions from a $400m credit fund.
The decision to put up gates comes after the firm received what it calls “substantial” redemption requests, reports Stephen Foley.
The message from Stone Lion to its investors is that they will be better off if it does not have to dump positions on to the market quickly, after months of weakening prices and growing concerns about illiquidity in the credit markets.
Here’s the public statement confirming it has put up gates on its $400m Stone Lion Portfolio fund, the firm’s oldest fund:
Stone Lion Capital Partners manages approximately $1.3bn of assets under management. After receiving substantial redemption requests in Stone Lion Portfolio, Stone Lion concluded to suspend redemptions in the fund to ensure fair and equitable treatment for all of the fund’s investors.
New York-based Stone Lion is run by former Bear Stearns high-yield bond traders Gregory Hanley and Alan Mintz.
The return of gates in the hedge fund industry will unnerve investors, who were infuriated by their use during the credit crisis last decade.
The news comes after Third Avenue on Thursday shut a high-yield mutual fund, putting up gates on a fund available to retail investors and sold as offering daily redemption options. Third Avenue’s move caused a sharp selloff in high-yield on Friday.
Barrons Summary: Positive on XL and retailers; cautious on KMI
Cover story: Ten market strategists surveyed by Barron's see moderate gains for the market in the year ahead; Based on their mean forecast, the S&P 500 will end next year at 2220, up 10 percent from Friday's close of 2012; Overall, the group was more cautious than in recent years past; Top picks include AVGO, GILD, V, GOOGL, COF, ROST, DIS, MMM.
Features: 1) Positive on M, JWN, RL, BURL: Shares of retailers have been marked down as the sector struggles, but they are likely to rebound next year because of strong long-term prospects; 2) Cautious on KMI: Oil- and gas-pipeline operator has long been considered the industry bellwether, but now that its business model has been proved flawed, industry bulls argue it is an outlier because of its high level of debt; 3) Positive on OAK, FMC, EQC, TRCO, HRG, ENR, CVA, ATU, KRNY, CKEC: Companies are Barron's favorite small- and mid-cap picks for 2016, with some on the list having potential upside of as much as 40-50%; 4) Positive on XL: Shares of global insurer, which has pared down its operations and raised fresh capital in the wake of the financial crisis, could rise by as much as 25% next year.
Tech Trader: Tiernan Ray looks at activist investing in the tech sector, noting that such investors "have no real ideas to contribute with regard to the development of great products and services, only tactics for creating noise to boost stock prices."
Trader: The cost of capital is going up for corporate America, says Peter Boockvar of The Lindsey Group, along with tightening credit and monetary policy, and weaker earnings; Cautious on MW: Debt is a problem for clothing retailer following its acquisition of struggling Jos. A Bank, but the core Men's Wearhouse brand remains strong, and spinning off or shrinking Jos. A Bank could improve the balance sheet; Cautious on TEVA: Company still has to prove that asthma drug Reslizumab is safe for teenagers, but with a strong pipeline and the growing focus in the U.S. on price-friendly generics, shares could rise; - Anglo American: Shares have plunged by more than 70% since last spring amid an overall commodities rout, but more near-term risk means investors should stay away despite the low price.
Interview: Ayako Hirota Weissman, co-manager, Horizon Asia Opportunity, likes Minor International, Genting Hong Kong, and Internet Initiative Japan.
Profile: Chuck Bath, portfolio manager, Diamond Hill Large Cap fund, uses a forecasting technique to determine a company's intrinsic value (top 10 holdings: AIG, ABT, C, PFE, PG, UTX, JPM, MS, SYY, MDT).
Follow-Up: Cautious on DIS: Company's new Star Wars movie is expected to be a major hit, but anything short of a stellar opening weekend could send the shares down; Cautious on JNS: The departure of head of fundamental fixed income Gibson Smith is a huge blow to the firm, where bond outflows could begin just as the equities division has turned a corner.
European Trader: Positive on Unipol Group: Investors could see a windfall if financial-services holding company completes the simplification of its shareholding structure, while a tie-up with UnipolSai Assicurazioni could also boost shares.
Asian Trader: Cautious on Lufax, Yirendai: Chinese peer-to-peer lending firms are "unicorns," and the sector has huge potential in China, but investors should be wary because they are managed with the same opacity that has created concerns about other Chinese companies.
Emerging Markets: "Market-friendly political change may be happening fast in Latin America, but earnings at many companies won't catch up for a while in Argentina and Brazil."
Commodities: Copper prices are already down because of lower demand in China, but some industry observers say a flood of new supply will drive prices down even further.
Streetwise: GMCR's announcement it would be acquired by JAB Holding is good news for shareholders, but continues a ten-plus-year trend of stock market shrinkage.
CHINA NOV INDUSTRIAL PRODUCTION Y/Y: 6.2% (5-month high) V 5.7%E; INDUSTRIAL PRODUCTION YTD Y/Y: 6.1% V 6.1% PRIOR
- Power generation: 466B Kwh v 445.4B Kw prior, y/y: +0.1% v -3.2% prior; first rise in 3 months
- Crude Steel production: 63.3Mt v 66.1Mt, y/y: -1.6% v -3.1%prior
- Steel product output: 94.0Mt v 94.3Mt, y/y: +2.0% v -0.2% prior
- Crude Oil: 17.7M v 18.1M tons, y/y: -0.5% v +0.2% prior
- Natural gas output: 11.1B v 10.4B cubic meters, y/y: +0.2% v +1.4% prior
Stocks Have Room to Rise 10% in 2016, Market Strategists Say
The pros’ mean forecast puts the S&P 500 at 2220 at year-end 2016, propelled by modest earnings growth. Why financials and tech could lead.
Stay positive about the third-longest bull market on record—but curb your enthusiasm. That’s the memo from Wall Street’s top investment strategists about the prospects for U.S. stocks in 2016. With the Federal Reserve expected to start raising interest rates as soon as this week, and earnings growth likely to be restrained, the 10 strategists Barron’s surveyed this month see moderate gains for the market in the year ahead.
Based on their mean forecast, the Standard & Poor’s 500 index will end next year at 2220, an increase of 10% from Friday’s close of 2012. An advance of that magnitude is more reflective of the market’s rout last week, however, than undue exuberance among our prognosticators. To the contrary, the strategists were more cautious in their comments than in recent years past.
Any advance would be superior to this year’s 2.3% loss (through Dec. 11). A year ago, the pros predicted stocks would rally 10% in 2015; that target seems far-fetched today, with just 13 trading days left in the year.
BARRON’S SURVEYS a group of prominent market strategists at big banks and major investment firms each September and December, to gauge their outlook for stocks, bonds, and the economy in the months and year ahead. Our latest inquiry came just ahead of this Wednesday’s near-certain rate hike, and amid increased market volatility, in a year that has yielded few rewards for investors across multiple asset classes.
The S&P 500 reached an all-time high of 2131 in May, and the Dow Jones Industrial Average, a peak of 18,321. Stocks suffered a correction of about 12% in August and September—the first in four years—when China took steps to devalue its currency to counter decelerating economic growth. The averages have regained lost ground this fall, but the strategists see few catalysts that could push the market sharply higher, especially with a three-decade slide in interest rates coming to an end. The outlook for energy, metals, and mining shares is particularly bleak, unless and until the bear market in commodities ends.
The strategists’ individual year-end targets for the S&P 500 cluster around 2200. Remove the single forecast for a 2500 close—a statistical outlier of sorts—and the group’s mean prediction for 2016 falls to 2190.
The Street’s seers expect S&P 500 earnings per share to rise just 5% next year, from this year’s estimated $118. Their mean forecast for 2016 is $123.50. Last December, these seers were more upbeat, expecting earnings to climb 8% in 2015. Industry analysts typically are more optimistic than strategists, and that is the case this year, as last. The analysts anticipate S&P earnings of $128 in 2016, representing an 8.5% increase over current-year targets.
On an aggregate basis, corporate earnings are flat this year, and could turn negative when all of the data are in. Profit gains haven’t looked so punk since the bad old days of 2009. Excluding the hard-hit energy sector, S&P earnings could rise 5% to 6% in 2015. Even so, that isn’t much to brag about.
The strategists expect earnings growth to be the key driver of stock prices in the new year. Few foresee an expansion of the market’s price/earnings multiple, and some think the P/E will contract. The S&P 500 currently trades for 15.7 times analysts’ consensus 2016 estimate, on par with a forward P/E of 15.8 a year ago. Stocks aren’t cheap; nor are they rich, given a long-term forward P/E of 15 and today’s low interest rates.
THE STRATEGISTS’ measured view is apparent, as well, in their newly narrow focus on just two industry sectors—financials and technology—that seem poised to outperform in the coming year. Worries about a persistently strong dollar, sluggish global growth, and plunging commodity prices have weakened the attraction of most other sectors.
Wall Street’s experts see little likelihood that the U.S. economy will reach “escape velocity” in the months ahead. Instead, they think industry and investors will have to learn to live with relatively meager annualized growth of 2.5% in gross domestic product.
“Investors are more saturnine than sanguine,” compared with 12 months ago, says Adam Parker, head of U.S. equity strategy at Morgan Stanley, who has an S&P 500 index target of 2175 for 2016. The recent correction is fresh in investors’ minds, and they are worried the Fed’s tightening will cause more volatility, he says.
Tobias Levkovich, chief U.S. equity strategist at Citigroup’s Citi Research, notes the presidential election also could produce a “wobbly market” next year. Levkovich has an S&P target of 2200 for 2016.
IN MANY WAYS, the Fed’s final act of 2015 could call stocks’ tune all through next year. The U.S. central bank’s policy-making committee is widely expected to nudge its federal-funds target rate up this week to 0.25% to 0.50% from a longstanding 0% to 0.25%. The fed-funds rate, or the overnight lending rate that banks charge one another for funds maintained at the Fed, helps shape the short end of the bond-market yield curve.
Although incremental, the move would represent the first step in the normalization of U.S. interest-rate policy after years of quantitative easing and near-zero rates—policies designed to spur economic growth following the financial crisis of 2008 and the ensuing recession. The strategists expect that the fed-funds rate will climb to 1% to 1.25% by the end of next year, as the Fed follows its first hike with successive increases.
What higher rates might mean for equity valuations is a matter of debate, however. David Kostin, Goldman Sachs’ chief U.S. equity strategist, says the market is underestimating the number of rate hikes likely to follow next year. Goldman looks for four increases in 2016, bringing the fed-funds target to 1.25% to 1.5%. If that forecast is right, he says, the market’s P/E multiple will contract as others come around to this view.
Kostin expects the S&P to wind up next year at 2100, just 4% above Friday’s close; that’s the lowest forecast in the group. He thinks the benefit of a decent rise in earnings will be offset by higher interest rates and tepid economic growth. While higher rates present a “clear risk” to equity valuations, they are only a modest threat to corporate profits, he notes.
Jeffrey Knight, head of global asset allocation at Columbia Threadneedle, also thinks that rising rates could lead to a compression of the market’s P/E multiple. A 25-basis-point (25 hundredths of a percentage point) increase “isn’t terribly significant economically, but it matters as a psychological marker,” he says. “The Fed is saying to the market, ‘You are on your own.’ ”
The monetary punch bowl—that is, the combo of Fed asset-buying and ultralow interest rates—has been an important catalyst for higher stock prices, says Knight, who has a 2016 S&P target of 2200. “Even if it is the most gradual removal ever, it matters,” he says.
HOW DOES THE MARKET perform after the interest-rate cycle turns and rates begin rising anew? Kostin notes that after the initial rate hikes of 1994, 1999, and 2004, the S&P 500 averaged a gain of 6% in the succeeding 12 months. Yet, the forward market multiple contracted by an average of 10%.
History is only a partial guide to current circumstances, however, as the Fed isn’t planning to tighten monetary policy so much as “normalize” it after a long period of abnormally puny rates. That distinction might be lost on some investors, says John Praveen, chief investment strategist at Prudential International Investments Advisors.
“It’s a very different rate cycle,” adds Russ Koesterich, global chief investment strategist at BlackRock. Of most importance, the current round of policy tightening is likely to end with short-term rates at around 3%, not the 4% or 5% seen in prior cycles, he says. Although the market’s P/E is lower than at previous peaks, a reversal of monetary stimulus creates “a world where higher P/E multiples are hard to come by,” he adds.
Koesterich expects the S&P to round out 2016 at 2175.
STEPHEN AUTH, chief investment officer of Federated Investors, was last December’s most optimistic forecaster. Although the market failed to cooperate, he remains so today. Auth expects the fed-funds rate to end next year at 1%, after which Fed Chair Janet Yellen and her team will pause. He thinks the Fed eventually will stop at 3%. Yet, unlike Koesterich, he says “lower for longer” means stocks are cheap now.
Although the averages are down slightly this year, the market’s resilience in the face of 2015’s heavy blows is impressive, Auth says. “Land mines,” including proof of China’s slowing economy, plummeting oil prices, a rising dollar, and the coming Fed hike, will “soon be behind us,” he says.
Auth, who has a 2016 S&P target of 2500, says corporate earnings and the market’s multiple will both head higher next year, resulting in a big move in the index. He expects the P/E ratio to drift up to 18 from 16, and reach 20 times forward earnings “before this bull market is over.”
Auth believes that S&P earnings growth is “almost built in to increase substantially,” perhaps by 15% or more, due to “solid 2.5% to 3% GDP growth and a dramatic improvement” in the earnings of the decimated energy sector. In the oil patch, heretofore huge declines in earnings, and in many cases, losses, will be rolling out of quarterly comparisons next year. Indeed, without the energy sector, S&P 500 earnings would be up 6% this year, instead of flat to down.
Prudential’s Praveen sees earnings growth of 8%, fueled by an expanding economy. He, too, is a longstanding bull, and has an S&P forecast of 2250. But he has pulled in his horns a bit, predicting a slight contraction in the P/E multiple because of impending rate hikes. “Measured and modest” moves in the fed-funds rate will result in similar moves in the S&P 500, he predicts.
Stocks are cheap relative to bonds, Praveen says, citing the earnings yield gap. The earnings yield, the inverse of the P/E ratio, is now 5.9% on a trailing 12-month basis, compared with a yield of 2.14% on the 10-year Treasury bond. The spread, at 3.76 percentage points, has narrowed from roughly four points a year ago, but is still much wider than the 1.2-point average of the past 20 years.
Jonathan Glionna, head of U.S. equity strategy at Barclays Capital, is less exuberant about the market’s prospects than many peers. Both Glionna and Goldman’s Kostin predicted a year ago that the S&P would end this year around 2100, and are looking pretty prescient.
ALTHOUGH THE MARKET’S P/E is slightly elevated, it isn’t inconsistent with an expansionary environment, Glionna says. But certain other valuation metrics, such as the price-to-sales ratio, suggest the need for caution. The S&P 500 is currently selling for 1.8 times trailing sales, compared with 1.7 times sales a year ago. It has been above 1.5 times for more than a year, but rarely stays there long term. It is no coincidence, he says, that the market has been unable to gain much in the past 12 months.
Glionna, who carries an S&P target of 2200 for 2016, says greater inflation is likely to aid revenue growth next year. At the same time, the dollar’s strength could act as a drag. With the Fed lifting interest rates, the dollar could continue to rise against other currencies, albeit at a slower pace than in the year about to pass.
Dubravko Lakos-Bujas, chief U.S. equity strategist at JPMorgan, lists a stronger dollar as one of the biggest risks facing the market next year. A 5% to 6% change in the dollar’s trade-weighted average price is roughly equivalent to a 3% change in the S&P 500’s earnings per share in the next 12 months, he says.
Even if the dollar doesn’t rise another 10% to 11%, as it did in 2015, it will cause erosion in per-share earnings growth through transactional effects, he says. That will prevent the P/E multiple from rerating higher. Lakos-Bujas expects the S&P to rally to 2200 next year.
WALL STREET’S STRATEGISTS have long favored technology shares, but financials are first in their hearts for 2016. In large part that’s because banks’ net interest margins will widen if interest rates rise, while loan growth could improve as the economy grows. Financials are inexpensive compared with other sectors, and are a good hedge against the risk that the Fed raises rates more aggressively than expected, says Lakos-Bujas.
Among financials, Goldman’s Kostin likes Visa (ticker: V) because the company’s Visa Europe acquisition will help it capture the accelerating shift toward electronic payments on the Continent, and drive up earnings estimates for 2016 and 2017.
Morgan Stanley’s Parker prefers Capital One Financial (COF), and says the company could deliver robust credit-card growth with low charge-offs. He is also the lone fan of consumer-discretionary shares, which he says will benefit from rising employment and wages. That should help Ross Stores (ROST), an off-price apparel and home-fashions retailer that Parker expects to reward investors in 2016.
The strategists still like tech stocks, especially as the tech industry continues to offer top-line growth in a world with otherwise muted prospects. Valuations are reasonable, profit margins are high, balance sheets are strong, and the stocks tend to do well in a rising interest-rate environment, Koesterich says.
Avago Technologies (AVGO) is one of Auth’s top picks, as the maker of semiconductor chips for wireless devices will be helped by the proliferation of smartphones. Auth is also a fan of health care, which led the market for the past five years until it recently fell out of favor.
The health-care sector offers long-term growth, and investors need to accumulate shares in periods of disfavor, he says. Gilead Sciences (GILD) is one of the strategist’s top picks; the company owns the hepatitis C franchise, he says. It has several other promising drugs in its pipeline, and trades for a mere nine times 2016 expected earnings.
SOME STRATEGISTS expect that value stocks, which have underperformed growth stocks for years, could outrun their snazzier cousins next year. Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America Merrill Lynch, isn’t focusing on conventional sector analysis this year, but says investors should favor value stocks generally, as they are on the cusp of being rerated upward. Big-cap dividend growers are especially cheap, she says, citing Walt Disney (DIS), and 3M (MMM).
If a sector doesn’t have macroeconomic risk, or business disruptions, or headline risk, it is crowded and expensive, Subramanian says. She prefers picking individual stocks, based on quality, liquidity, valuation, growth, and dividends.
When profit growth is scarce, she notes, growth stocks rule. But, since 1930, annual earnings gains of 5% or more have coincided with outperformance by value stocks. She expects S&P 500 earnings to rise by 5% in 2016, and the index to hit a year-end target of 2200.
As for the coming hike in interest rates, Subramanian calls it “the end of the Fed put,” which was thought to place a floor under stock prices. “There will be no more IV bag for the patient, and the market will get rational” as rates normalize, she says.
The strategists haven’t much changed their view of sectors to avoid in the new year. They are still negative on utilities—the stocks are down 12% year to date—and consumer staples stocks, up 2%. Both sectors are defensive and often regarded as bond proxies. The outlook for growth is poor in 2016.
BARRING AN ELEVENTH-HOUR RALLY, the year now drawing to a close could go down in the books as one of the most frustrating for investors. If the S&P 500 ends the year in the black, it probably will do so by a slight margin only, owing to gains in a handful of stocks.
Meanwhile, a recent Goldman Sachs report notes that 74% of large-cap core mutual funds are trailing the S&P 500 in 2015. Granted, that is a notable improvement over last year’s 85% that lagged behind, but it’s nothing to be proud of.
While stocks delivered little in the way of gains, the bears have also taken a shellacking. Several prominent hedge funds reportedly took big hits when stocks they had bet against rose instead of fell. The Morningstar Bear Market Fund category is down about 6% for the year.
“In a cross-section of assets, very little worked this year, whether stocks, bonds, or currencies”—apart from the dollar, Columbia’s Knight says.
The bond market stymied strategists and investors, as well. Although most Wall Street strategists called for bonds to lose value in 2015, they look to be ending the year flat.
The yield on the 10-year Treasury bond was 2.17% at the end of 2014. The 10-year sported a yield of 2.14% last week. (Bond prices move inversely to yields.) The U.S. bond market has been supported by global fixed-income investors, who have sold lower-yielding German and Japanese government paper to invest in Treasuries. Demand for Treasuries has helped to push up the dollar.
MORE THAN ONE STRATEGIST extolled U.S. stocks as the best asset class in the world, but Knight is troubled by investors who think the only opportunities lie close to home. With the Fed about to raise rates and only a handful of stocks holding the market aloft, “that’s a worry,” he says.
Valuations overseas are generally more reasonable, says BlackRock’s Koesterich, and foreign central banks have more room to ease. Also, other nations’ weak currencies are advantageous for their exporters. The iShares Currency Hedged MSCI EAFE exchange-traded fund (HEFA) is one way to gain exposure to non-U.S. stocks without currency risk. The ETF has edged up 1% this year, and yields 3.8%.
The year ahead will bring many risks, including the risk that political posturing will slam stocks in various sectors. Already, talk of drug-price reductions by certain presidential candidates has hurt health-care stocks. The Street’s strategists are less bullish than in several years. Even so, they expect the old bull to trot on.
Merger Mania Could Spell Trouble for Stocks
Peaks in deal activity often coincide with peaks in the S&P 500.
You might say Doug Kass is piqued about peaks.
Presiding over the portfolios of Seabreeze Partners Management in the warm and sunny clime of Palm Beach, Kass is spying peaks everywhere. To a long list that includes peak stock prices, peak global bond prices, peak liquidity and peak price/earnings ratios, not to mention peak share buybacks and peak market breadth, he has added peak China and peak Apple. Talk about a peak in peaks.
It doesn’t end there. During a week in which deal frenzy reached fever pitch as chemical giants DuPont (ticker: DD) and Dow Chemical (DOW) announced plans to combine, Keurig Green Mountain Coffee Roasters (GMCR) agreed to be taken private by JAB Holding, and rumors abounded that Jarden (JAH) and Newell Rubbermaid (NWL) were on the verge of merging, Kass was compelled to add mergers and acquisitions to his inventory. As we hurtle towards year end, there have been $4.4 trillion in announced global deals, easily surpassing the previous record set in 2007.
That last point caught the attention of the always insightful Jim Bianco, whose Bianco Research specializes in macroeconomic investment analysis. He couldn’t help but note that peaks in M&A typically coincide with peaks in the Standard & Poor’s 500 and have been historically bearish for the stock market, as witnessed not only in 2007 but 2000 as well.
Lest all this put a damper on the holiday season, some may take heart from Kass’s latest observation: Peak Trump.
Third Avenue Focused Credit Closes
The once-lauded fund’s closure raises questions about the high-yield market, and what happens when hard-to-trade bonds are owned by mutual funds and ETFs.
In a shocking failure of a fund, Third Avenue Management is liquidating its Third Avenue Focused Credit fund.
Until the high-yield market faltered, the fund (ticker: TFCVX) had been a bright spot for the deep-value firm, founded by legendary investor Marty Whitman, as I wrote in a Barron’s feature in the spring (“Can Third Avenue Get Back on Track?” May 11, 2015). But with a downturn in distressed debt, the fund’s assets had slumped to just $788 million, a loss of two-thirds in seven months. The fund’s performance has been abysmal: It is down 27% for 2015, ranking dead-last among high-yield funds, according to Morningstar.
Third Avenue President David Barse announced the liquidation—and the refusal to grant redemptions to avoid fire-sale prices for fund holdings—in a letter on the firm’s Website last week. While the New York Times, Bloomberg, and others focused their headlines on the firm “blocking” investors from withdrawing their money, that is actually the most investor-friendly move the firm could make—although perhaps a bit late.
Had Third Avenue allowed redemptions to continue, a few large investors could have gotten their money back via the sale of the remaining liquid investments, leaving everyone else stuck. Now, all current investors will receive a cash distribution on Dec. 16, plus periodic distributions from the liquidating trust over the next year or so. On a conference call with investors, portfolio manager Tom Lapointe reassured fundholders that not only is he still a major stakeholder in the fund, but also had increased his stake earlier this year. Other Third Avenue employees are invested in the fund, Lapointe added, and he will remain at the firm to liquidate the trust.
Focused Credit owns the debt of firms that are restructuring or in bankruptcy proceedings, making it more akin to a distressed-debt hedge fund (for instance, it owns Lehman Brothers bonds) than a typical high-yield mutual fund. That’s why the fund was unable to sell enough to meet the increasing and anticipated redemptions “without resorting to sales at prices that would unfairly disadvantage the remaining shareholders,” Barse wrote.
For Third Avenue, which has just five funds and rarely launches a new strategy, the failure of Focused Credit—its second-largest fund until midyear, behind Third Avenue Real Estate Value (TAREX)—is particularly shocking. The firm launched the fund in 2009, during the depths of the financial crisis, as a way to leverage the deep-value analysis that was Whitman’s forte. Unlike most stock investors, Whitman, now 91, who made his name buying bonds of bankrupt railroad Penn Central, always begins with the balance sheet. “Marty is everyone’s mentor, but his process has the most correlation to what I do,” Lapointe told me in February.
That correlation didn’t shield the fund from troubles, and its liquidation is a big blow. The firm’s assets have been shrinking, from a peak of $26 billion in 2006 to $10 billion last spring. At the end of November, they’d fallen to $8 billion.
The flagship Third Avenue Value fund (TVFVX), which Whitman ran until 2012, is on its second manager since he stepped back, and has seen its assets shrink to $1.5 billion. Third Avenue International Value (TVIVX)—once run to acclaim by Amit Wadhwaney, who recently set up his own firm—has a piddling $162 million. The fund has had similar, if less severe, liquidity problems in struggling to sell trade-by-appointment securities after his departure, as its assets shrank due to redemptions.
Third Avenue has long been grappling with how to transform itself from the “cult of Marty” to a more streamlined enterprise. Whitman sold 60% of Third Avenue, most of it his family’s stake, to Affiliated Managers Group in 2002. Affliliated declined to comment last week. He now spends much of his time managing his own money in the Whitman High Conviction fund, a private fund with no impatient investors to satisfy. “It’s been tough,” he told me earlier this year. And now, it’s a whole lot tougher.
FOCUSED CREDIT’S CLOSURE also raises questions for investors who have poured billions of dollars into other funds that own hard-to-trade assets. To be sure, Third Avenue’s portfolio was far riskier and more concentrated than the average junk-bond mutual fund. More than 50% of its assets were unrated by credit agencies, while another 28% of the fund held bond issues rated CCC. That’s nearly triple the proportion held by high-yield peers, according to S&P Capital IQ. “These are the most illiquid bonds in an already illiquid market,” says Morningstar senior fixed-income analyst Sumit Desai. “In hindsight, the strategy probably shouldn’t have been in a mutual fund wrapper.”
Still, the fund’s unorthodox liquidation plan comes at a time of acute anxiety about whether funds will be able to meet a surge of redemptions in times of market stress. In September, the Securities and Exchange Commission proposed new rules that would require both mutual funds and exchange-traded funds to adopt a 15% cap on securities that can’t be sold within seven days.
Shorter term, concerns about Third Avenue’s liquidation stoked heavy selling in a high-yield bond market that already had been hit hard by concerns over defaults in the oil sector and rising interest rates. The $15 billion iShares iBoxx USD High Yield Corporate Bond (HYG) and $10 billion SPDR Barclays High Yield Bond (JNK) suffered their worst one-day performance in four years on Friday, falling 2% apiece. This all sets up a long-anticipated test for ETFs: Both junk-bond ETFs saw record trading volumes last week. Well-known investors, including Howard Marks and Carl Icahn, have fretted that fast-trading ETFs that own hard-to-trade bonds could harm investors, or accelerate a selloff in a stressed market, by trading more rapidly than their underlying securities. Heavy withdrawals could be one red flag. Last week, State Street’s SPDR ETF had shed $739 million through Thursday, although the iShares fund hadn’t seen any redemptions.
Italian Insurance Deal Has Big Upside
The valuation of Unipol Gruppo Finanziario could soar if the financial-services firm combines with its publicly traded insurance unit, UnipolSai Assicurazioni.
Investors could collect a windfall if financial-services holding company Unipol Gruppo Finanziario completes the simplification of its shareholding structure.
A combination of the company, also known as Unipol Group (ticker: UNI.Italy), and its publicly traded insurance unit, UnipolSai Assicurazioni (US.Italy), could boost the shares of Unipol Group, which have been trading roughly 25% below book value.
The likeliest way to do this is for UnipolSai to acquire Unipol Group—which could happen early in 2016. Unipol Group, Italy’s second-biggest insurer after Assicurazioni Generali (G.Italy), owns about 60% of UnipolSai. But UnipolSai is bigger than its parent. UnipolSai’s shares closed in Milan on Friday at 2.28 euros ($2.51), giving it a stock market value of €6.34 billion. In comparison, Unipol Group’s market capitalization is just €3.26 billion, based on its closing price of €4.55. Both companies have American depositary receipts that trade in New York. Unipol Group’s ADRs (UFGSY) ended on Friday at $2.55 and UnipolSai’s (FDIAY), at $10.33
Unipol Group’s stake in UnipolSai alone is worth about €4 billion—more than its market value. Including other insurance and real estate assets, and adjusted for debt and other liabilities, Unipol Group has a book value of €4.46 billion, equivalent to €6.20 a share, according to Verrazzano Capital, whose chief investment officer, Guillaume Rambourg, has said he sees upside of “at least 20%, possibly as much as 40%,” for Unipol Group.
UNIPOL GROUP COULD BE SPURRED into action next year when it presents a three-year strategic plan. Another catalyst could be Italian regulators’ demand that the companies not be led by the same person. Right now, Carlo Cimbri is CEO of both. A merger would nullify those concerns, as well as boost the stock’s liquidity, increase its weighting in indexes, and compel more analysts to follow it. It would also complete the collapse of a shareholding structure that had five different classes less than two years ago.
Unipol Group and UnipolSai were formed in 2014 from the consolidation of several struggling businesses. They sell insurance through a network of 3,000 agencies and 6,000 subagencies. They also own a bank, Unipol Banca, which has a €10 billion balance sheet and a book value of €800 million. The bank is up for sale, and Unipol Group could strike a deal with the buyer to distribute its insurance products.
UnipolSai generates the bulk of Unipol Group’s profits. Unipol Group is expected to report earnings per share of 59 euro cents in 2015, up from €0.27 in 2014, inflated by returns on a portfolio of high-yielding bonds. In 2016, earnings are forecast at €0.51 a share.
UnipolSai’s strength is in the nonlife sector. It is also Italy’s leader in onboard telematics, with more than 2.5 million of its auto policyholders using these systems. Telematics monitor driving behavior, discouraging speeding and perilous maneuvers. This reduces the frequency of claims and helps insurers to offer more competitive pricing. In 2016, UnipolSai is projected to earn €0.21 a share, down from €0.24 in 2015. Both companies boast attractive dividend yields: about 3.5% for Unipol Group and 7% for UnipolSai—one of the highest payouts among Italian blue chips.
If the Unipol Group–UnipolSai combination goes through, investors could do well.