Finance – Page 79

Anatomy of a trade decision

As I indicated previously, I am interested in trimming my long-term bond positions since I believe the market for less-than-stellar debt is becoming expensive for the risk taken.

Although I am adverse to income taxes, you should never let income taxation be the overriding factor in the decision to sell – valuation should be the primary consideration, along with your portfolio considerations, and then income taxes should be a secondary consideration.

An example today was trimming a trust preferred (which held a corporate bond) position in Limited Brands (NYSE: LTD) that I have held onto since late 2008. The security is due to mature in 23 years from now (March 1, 2033) and pays a 7% coupon semi-annually. The underlying company’s equity is trading relatively high, has a moderate amount of debt ($2.6 billion debt vs. $1.2 billion cash on hand), good income ($560M in the last 12 months) and an excellent brand name. So the underlying company, in the short and medium run, is likely to be solvent and be able to raise money and retain their cash generation abilities. It would not surprise me if they were able to be solvent in 23 years to pay off the underlying debt. My cost basis on the units are 35 cents on the dollar, which represents one of the best trades I have done in some time, but this will also represent a large capital gain when liquidating.

Back then, 35 cents on the dollar meant you got to collect a 20% current yield, and another 4.5% implied capital gain by waiting patiently. Now, the market has taken all of those coupon payments and gains and transformed them into a higher unit price – so instead of waiting 20+ years to realize that money, you can do it now. What I am trying to say here is – your cost basis is irrelevant except for factoring in the cost of capital gains taxation. The current market value that you can liquidate the securities with is the relevant factor – if I have $X that I can liquidate from this security, can I deploy it elsewhere more efficiently than the implied 7.7% it is paying me?

So why trim the position? 7.7% sounds pretty good over 23 years, doesn’t it?

There are a few reasons.

– The valuation appears high. At the current trading price (94 cents on the dollar) it is significantly higher than the underlying bond’s price that is available through TRACE. At 94 cents, your current yield is 7.4%, and your implied capital gain (which is the 6 cents of appreciation you earn upon maturity) is another 0.3%, so your total yield is 7.7%. While a 7.7% yield is about 4% higher than you can get with underlying treasury bonds, it still is not a sufficient threshold.

– I want to increase my cash balances. While I believe the next big macroeconomic move in the economy will be an inflationary cycle, it will completely depend on the timing of US politics. Right now the US economy is dominated by political considerations and this is why most businesses are choosing to hoard cash – since in times of political uncertainty you do not know the return on investment. A more business-friendly administration would result in a large inflationary spike. Right now we have the exact opposite of a business-friendly administration.

– I want to shorten the duration and term of my bond portfolio, for pretty much the point I made above.

– I do not need the yield, but apparently others do. They are willing to pay for liquidity, so I am willing to give it to them for a cost – they have to meet my asking price on the exchange.

– I am afraid that interest rates, while very low by historical standards, may increase. I am also not concerned to waiting a longer period of time for those rates to rise, and get to hold onto my capital in the meantime to perhaps deploy to a better area.

– Maybe the underlying business will face a downturn. It is in the consumer fashion industry, and while the Victoria’s Secret brand is unlikely to degrade anytime soon, maybe consumers will be a little more fickle in the future. I have no clue when it comes to retail fashion which trends will stay and which will not and can only evaluate these companies from a financial perspective. A great example is Coach (NYSE: COH), which to my neanderthal male mind, mainly makes handbags and accessories. But somehow this company produces insane amounts of cash. Will this trend continue? Who knows. But what I see financially there is a cash machine. I generally ask fashion conscious women for insight on these various names once in awhile to see what the intangible aspects of the brands are.

I am giving up a further potential upside of about 6% capital appreciation (since the trust preferreds contain a call provision they will not trade much above par value) in exchange for the safety and security of cold, hard cash. Right now I do not have any targets for my cash, so I will continue to be patient. Eventually the equity markets will contract and some opportunities will present themselves. It is unlikely it will ever be like late 2008 for awhile, but we will see.

Credit card review – MBNA Smartcash Platinum

I have been using the MBNA Smartcash (3% off groceries/gas (5% in the first 6 months), 1% off everything else, paid in $50 increments) for the last five months and I generally am impressed that it has worked as advertised. They have an online interface where you can review your transactions and it is a functional, no-frills site. The two $50 cheques they have sent to me so far come in the mail a couple weeks after the statement date, and slightly to my surprise, have not bounced or come with ridiculous conditions and such.

I am guessing they send cheques instead of crediting the account automatically because they anticipate a certain fraction of people will not actually cash in their $50 cheques.

I used to use the Starbucks Visa Duetto Card (sponsored by RBC) which gave you 1% in “Starbucks money” which I used as a luxury item since there is no way that I could have otherwise rationalized it. They (either RBC or Starbucks, depending on who you believe) canceled the cards this spring, so when doing my shopping for a better credit card, I settled on the MBNA one.

My only negative is that they send out cheques in the monthly statements, and I always put these through the paper shredder simply because writing cheques off a credit card is hideously expensive and also because of the fraud consideration. I also was very quick to get off of their telemarketing spam list since they were selling useless products (likely “balance protection insurance”), but after that they have been non-spammers.

Note I was not paid to write this, these are my germane thoughts as a retail consumer on the product in question.

Investment Vacation Mode

I have still been somewhat on investment vacation mode – I have not been making any portfolio alterations, and have been letting time pass by.

It is a very, very, very important concept in investing that decision be made with the fullest of convictions, after research. It is usually a good way to lose money to “force” trades, or to try to reduce the cash balance to zero. When you see cash earn a short-term return of 2% sitting in an account, it is frustrating to know that you could invest it, minimally, in some preferred shares that yield 6.5%, but what inevitably happens is that when you want to utilize this cash, you will take a capital loss selling your preferred shares.

I think a lot of retail investors out there are chasing yield and are shying away from non-income bearing equity. You will continue to see inflows in bond and income funds, while equity will be shunned. This is something I will be eyeing a little more closely in terms of taking advantage of the matter.

The one huge advantage of cash is that it retains its principal value and is completely liquid to do whatever you want with it when the opportunity arises. Right now I am just not finding much in the way of opportunity, and hence, I wait patiently and enjoy the Canadian summer, as short as it is. This makes for boring writing, but boring is better than the alternative – permanent loss of capital.

Choosing the right credit card will save some money

For personal expenditures, some shopping around for a credit card that is aligned with ones’ spending profile will result in some savings. It will not be a life-changing amount, but it will be a perk. Some people like to collect airline miles and some like to collect points in their favourite retailers. As long as you cash in the rewards in a timely fashion, it will typically result in a 1-2% payback compared to the amount of money you spent on the card. In other words if you spend $10,000 a year on a credit card, typically you should be receiving something worth $100-200 had you paid for it in cash.

In light of the fact that credit card processors generally charge merchants over 2% for the privilege of having people use credit cards, they are still profiting, but the price you pay at retail inevitably reflects this premium. Merchants and people are essentially locked into using credit cards given that there is currently no differential payment (i.e. reduced prices for cash purchasers). You have to choose carefully in order to claim back the implied increase costs at retail. If you are not using a credit card that has some sort of “rewards” feature, then you are typically missing on a slight reduction in expenses.

Currently MBNA is offering a credit card that gives you 3% cash back in groceries and gasoline (5% for the first 6 months), and 1% on everything else. They pay it in $50 increments when you have accumulated the necessary credit. I have found this card quite beneficial to my own spending profile, which tends to be concentrated with the gas and grocery types of expenditures. The couple hundred dollars a year savings is certainly better than choosing a method of payment that does not give you a small kickback.

What will be interesting to see is if merchants start offering 2% discounts for cash purchases. The Government of Canada recently enabled this ability for merchants in their Code of Conduct that was adopted earlier this year. Item 5 is the most relevant.

Canadian Tire is the only major retailer that I know of that has some form of this – they give 1% Canadian Tire money for cash purchases. One wonders if other retailers will give point-of-sale discounts for cash purchases.

Canada Pension Plan not happy with Magna

Magna International is a dual-class stock that retained control of the corporation in the Stronach family.

The Canada Pension Plan is unhappy that the corporation recently agreed to a deal with the Stronach trust to convert their class of voting stock into regular common stock, at a very high premium – $300 million in cash, plus 9 million class A shares. At today’s prices for class A shares, this works out to approximately $920 million in exchange for the voting rights of the company.

Suffice to say, shareholders are not too happy about the matters, including the Canada Pension Plan.

However, this should be a huge lesson to those that invest in majority-controlled companies – your interests have to line up with the interests of the majority holder in order for you to make any headway on your investment. In the case of Magna, its majority holder (Stronach) clearly wants as much cash and liquidity out of the corporation as possible – and the common shareholders, including those invested in the Canada Pension Plan, will be paying the price.

What is interesting, however, is that the deal was structured in a politically astute manner – common shares went up after the announcement since Magna was already trading at a discount due to the adverse interests of the majority holder. It is the company, however, that will be paying the price to buy out the Stronach voting stake.

If you have shares in companies that are majority controlled, pay careful attention to these agency issues.