Year-End Strategy
The new Portuguese government is the first since the Cravos (Carnation) Revolution of 1974 to include Communists in coalition with the more moderate left. Unfinished Portuguese business after the 2008 global economic crisis includes deciding what to do about the Espirito Santo banking clan whose bailed-out bank, renamed Novo Banco, is proving to be hard for the Lisbon government to sell at a high enough price to recoup its outlays.
BES bank before the crisis funneled cash raised with bond issues from small depositors to Espirito Santo family holdings (most incorporated in Luxembourg, the nearest Euro-zone tax haven). The bank was allowed to issue these bonds by the Portuguese central bank, which then had no alternative but to rescue the Portuguese bond-holders. Foreigners and institutions were left hanging out to dry. And the Espirito Santo family managed to cash out of non-financial holdings, in hotels, hospitals, Brazilian land, and Portugal Telecom, whose shares we recommended. The family won bankruptcy protection from a Luxembourg court and the looted assets were sold to investors from Brazil, Thailand, Luxembourg, and Mexico. The central bank and the shareholders of PT (mostly Portuguese, but there was also an ADR) got nothing, nada. The present family head. Ricardo Espirito Santo Salgado, which masterminded much of the fake bond issue, retained his posh seaside residence at Boca do Inferno, in a Lisbon suburb.
The Espirito Santo clan's rescue reminded my husband of their earlier role, before and during the Second World War, during the reign of dictator Antonio Salazar, an economist. The then head of the bank, the English-speaking Ricardo Espirito Santo, did nothing without Salazar's approval. He began by providing a haven for the recently deposed Duke of Windsor and Mrs. Simpson in Boca do Inferno (which goes with the job) and ferrying them around nightspots at his expense. When the war broke out, they were removed to Bermuda to stop Nazi plots to use him against his brother who had become king. Espirito Santo was an intermediary between Germany which needed Portuguese tungsten for its war machine, and its miners. He and the Portuguese central bank were paid with Nazi-imprinted gold bars, most stolen from conquered territories or dead Jews.
Portugal was formally neutral in World War II, allowing two of my German Jewish grandparents who fled Nazi Germany to embark for America from Lisbon. While the British and later the Americans did not need tungsten, they wanted something else from Portugal: to lease a port and later an airbase on its Azores islands in the mid-Atlantic. Again wealth flowed to Portugal with the Espirito Santo's taking a cut.
Not too surprisingly, after Salazar's death and the Cravos Revolution, the Espirito Santo family took refuge in Brazil before being welcomed back when the center won elections against the left. Family head Ricardo Espirito Santo Salgado got a stake in Portugal Telecom by organizing its privatization---and then wheedled his way into control of its finances.
I got PT very wrong. We wound up with only pennies from our ADRs. My mistake was assuming that shareholders in the troubled Portugal telco would be given the same level of protection as we had received earlier from Telefonica of Spain over its troubled sub, Telefonica de Argentina. I assumed shareholder protection in mother countries was as high as it was in former colonies.
Now the chickens have come home to roost. The CB, having funded Novo Banco with money it cannot extract from any likely buyer, is as embarrassed by letting the BES borrow as it would be if anyone looked closely at the markings of its gold bars. The stock exchange regulators are still facing claims from PT shareholders in Portugal. The center-right government which let all those family assets go has been defeated. And the Luxembourg prime minister who created the country's haven laws is now head of the European Commission in Brussels. There will be more sequels in the EU and Lisbon.
Yesterday's broad global stock market rallies were to show up ISIS which was trying to scare investors. Today's moves are internally generated.
We have news from Switzerland, Britain, Canada, Mexico, Colombia, Australia, Brazil, Panama, Israel, and Italy.
Funds
I was only joking when threatening to sell Pershing Square Holdings (PSHZF). I am sticking with it to see how a hedge fund manager like Bill Ackman manages a disaster, in the hope of learning something. Right now he is having to figure out whether Valeant is worth sticking with after today's widely-reported failure in its first month of its Addyi drug, the “female Viagra” which VRX paid $1 bn to acquire. What turns the ladies off is that you cannot combine it with alcohol.
We have such big losses with PT, discussed above, that year-end tax planning doesn't require that we sell anything that has gone down horribly. Other shares in that boat include Brazilian iron miner Vale, of which more below; and Benitec which recovered a bit after the hepatitis C panic yesterday. If you are in a different situation I am not going to tell you not to sell anything.
We are in the tax-loss selling period in November. This is a season to buy—not turkeys or holiday gifts but closed-end yield funds trading well below their net asset values. The most appealing in my view are the ones invested in emerging markets debt, because the sell-off has been extremely overdone. Yes, we all know that the Fed is likely to raise interest rates. Yes, emerging market govts and companies over-borrowed in dollars during the long ZIRP period. Yes, we are now in the red on most of these funds.
There are good reasons to stick with them. First of all, they are trading at serious double-digit discounts from the assets they hold, Western Emerging Markets Income EMD at 18%; its stablemate Western Emerging Markets Debt, ESD, at a similar discount; Aberdeen Global Income Fund, FCO, at ~15% despite going up 1% today. The average closed-end emerging market yield fund according to Lipper data trades at a 13% discount to NAV.
(Large operators of open-end and exchange-traded funds tend to act to reduce the discounts as for Pimco Dynamic Income Fund and its fellows, or Templeton funds. You want to buy the double-digit-discounted ones.)
Now for the logic. Operators of closed-end funds are not tracking an index and not buying into every bit of emerging market paper out there, unlike the various exchange-traded funds which track by prospectus. Moreover, being relatively small players, they can move in and out of bonds without turning the market against themselves.
Being closed-end funds under law they are allowed to use leverage to increase our yields without issuing more shares, nice but also causes the discount. But they are not like ETFs which create and destroy shares depending on market trends. Nor are they like open-end mutual funds which are never at discounts because when holders redeem they sell some bonds. November tax-selling feeds on itself. Exits from a closed-end fund push down its trading price.
Unlike some of the slick offerings recently, CEF managers invest in many countries, not just the big BRICs. Moreover not every emerging market is in disaster. Even Argentina may resume paying bond-holders if the Peronists lose the election. Already some emerging market bonds look good. Mexico and Colombia are being tarred with a fear of Latin countries. India and Pakistan are growing and appealing. Eastern European emerging markets are in good shape. Thailand, for all the uncertainties Paul Renaud wrote about yesterday, has attractive bonds.
They can invest in local currencies, in high yield shares, in floating rate or convertible bonds by prospectus in some cases. Usually they are not required to stick to sovereign debt or corporate, unlike the ETFs which spend a lot of time differentiating themselves from one another. They are not confined to single sector like bonds for retailers or tech firms. They are not required to buy bonds from small caps or large caps. They are usually allowed to hedge currencies but not required to, again unlike ETFs which either do or do not. And of course none of the CEFs invests only in BRIC countries.
And while how it works is highly esoteric, bond funds use derivatives, swaps, futures, hedges, and reversed interest vehicles to protect bond holdings from interest rate risk. That is why their performance may lag that of an unleveraged indexed ETF in the same emerging markets, but also why they are better places for your money in a crunch. The same institutions that provide the leverage also often provide the hedges. No retail investor buying an emerging market bond gets these offers, why our portfolios hold no individual emerging market bonds.
Another reason to buy now is to get the last 2015 interest payment. Most bond funds close out their year in November so as to celebrate Christmas and New Year's like everyone else. So you may well get a payout not just of regular interest but of special interest if you buy now. The tax-sheltering sellers are worried about that extra loot; we want it.
So you are not buying into yield funds to benefit from the discount falling. You are buying to get the yields with less cash than is normally needed. And after the year-end sell-off in closed-end funds for tax losses, in most years the new year brings new buying to replace the income. January is usually a good month for closed-end income funds.
You should not buy close-end yield funds using a tax-sheltered account like an IRA. You have to be prepared to pay taxes on the yield, and also on the occasional net capital gain your fund might have booked in the course of the year. Many CEFs distribute to shareholders at year end a return of capital which reduces your basis (cost of buying the fund) but which also incurs taxes. The ones we highlighted probably will not but there is no guarantee. We also own one fund which deliberately distributes return of capital, which I am not not talking about today.
I am also not discussing the REIT sub-category of CEFs which are much higher-risk in a rising interest rate environment.
While we are on the subject, note also that singleton funds like Canadian General Investments, CGI in Toronto or CGRIF here, and Mexican Equity & Income Fund are not as quick to use funds from their asset management side to right the balance on their CEFs. Smaller funds also are less likely to have their holdings and NAV closely tracked by UK institutions running funds of funds like City of London (Barry Olliff) or Lazard (Alex Zagoreas). They lack the volume and house money to make it worthwhile to play on the discounts falling. But while they are suffering from year-end tax selling, they are not necessarily going to lure in the January buyers.
We sold our Aberdeen Asia Pacific Fund earlier this year worried about China. Its major investments have been in Australia. I personally am considering repurchasing FAX because of the resilience of the Australian economy and the new government, but again it doesn't quite fit into this strategy.
Stock Trader's Almanac suggests that SPDR Gold Shares, GLD, normally do well from mid-Nov. to the year-end. I am not convinced.
Latins
*Vale with BHP Billiton will top up the reais 250 mn in fines charged by Brasilia last week over the burst tailings dam at their San Marco jv which killed at least 11 people and created an environmental disaster is the Vale do Rio Doce, where Vale got its name from. The fine, worth about $66 mn, will be topped up with another Rs 1 bn ($262 mn) by the partners. BHP is “putting under review” for exiting from other jv's in Latin America after dam breaches which Pres. Dilma Rousseff compared to the BP 2010 Gulf of Mexico disaster. Cleaning up, compensation, civil damages, and new requirements Deutsche Bank estimates may cost over $1 bn. San Marco has a $1.17 bn insurance policy for “operational risk” according to Crédit Suisse but the costs and fines already exceed its civil damages coverage.
*Copa Holdings (CPA) fell yesterday on worries about aviation fuel prices, but then recovered by the close because someone figured out that holidaymakers might stay in America for fear of European terrorism. The Panama carrier flies mostly in the Caribbean and Latin America but also serves NYC, Washington DC, Chicago, La Vegas, Los Angeles, Orlando, Miami, and Toronto. We own it because we expect its US flights to link up to its hub at José Marti Airport in Havana, Cuba. It also gains from lower oil prices, as corrected today,
Drugs
*Novartis (NVS) and local rival Roche (which owns Genentech) are working together on an age-related wet macular degeneration treatment, Fovista (pegplranib). RHHBY is successor to Genentech's deal with Ophthotech (OPTH) which developed the drug and will get up to $1 bn in upfront and future milestones from the pair of Swiss drug firms, who have a deal on eye medications. However they will not work together in the US where OPTH kept the rights, and because of anti-trust rules.
NVS also reported that its Chronic Obstructive Pulmonary Disease Fame trial met its phase III endpoints.
*Teva (TEVA) is back over $60.
Across the Pond
*UBS is buying Santander's Italian private banking unit which has euros 2.7 bn under management for an undisclosed price. The deal will close early next year. SAN is up on the news. I bought more for my personal account yesterday at a nice discount, mainly related to the last horrible attack in Europe, in Madrid. It rose after my buy and is up 2.5% today in Madrid.
*Liberty Media's $5.3 bn deal with Cable & Wireless Communications of Britain means that John Malone's company is now unlikely to also bid for Vodafone. CWIXF, which went for a ~50% premium is active in the Caribbean area and Latin America. VOD is more into developing Europe and Africa. Franco-Moroccan Patrick Drahi's Altice, which picked up the remains of PT on the cheap, is too busy in France, elsewhere in Europe, and the US to snatch VOD.
*Fiat Chrysler sales rose 7.7% in Europe in Oct. FCAU's deal with the UAW it signed is likely to be a base for higher demands to Ford and GM still under negotiation.
*We sold Imperial Tobacco too soon. Rumor has it that it is now a takeover candidate. ITYBY.
Disclosure: None.