Inverstors, What's Your Strategy?

[stevehaigh]

i have all my retirement money locked up in mutual funds. I tried stock picking for years and lost every year, even in the high tech bonanza years of 1997-99!

anyhow, i've been doing pretty well on funds this year, up about 15% on the year overall. my best performers were RYPRX ROYCE PREMIER FUND (most US stocks) 15% YTD and FSENX FIDELITY SELECT ENERGY 48% YTD. i also have some internation stocks and latin america which are doing ok.

but now i'm a bit nervous. i'm wondering if i should cash out some of the funds and sit on cash or something very low risk for a while.

what are your long term investment strategies fokes?

Edited December 2, 2005 by stevehaigh

[jrincon17]

i have all my retirement money locked up in mutual funds. I tried stock picking for years and lost ever year, even in the high tech bonanza years of 1997-99!

anyhow, i've been doing pretty well on funds this year, up about 15% on the year overall. my best performers were RYPRX ROYCE PREMIER FUND (most US stocks) 15% YTD and FSENX FIDELITY SELECT ENERGY 48% YTD. i aslo have some internation stocks and latin america which are doing ok.

but now i'm a bit nervous. i'm wondering if i should cash out some of the funds and sit on cash or something very low risk for a while.

what are your long term investment strategies fokes?

<{POST_SNAPBACK}>

long term ? how long five years ? IRA

[stevehaigh]

long term ? how long five years ? IRA

<{POST_SNAPBACK}>

i'm 45 so i have 15 years to retirement; well when the US govt will let me get my money out anyhow. i guess i'm semi retired now.

[stevehaigh]

i neglected to tell you my strategy in my OP.

about every 3 months of so, i see which of my funds are underperforming.

then i use the fund evaluator at www.fidelity.com and look for funds with a YTD return of greater than 15%. i look for well performing funds in sectors that i'm not already in. i also look for no transaction fee and low management fees. i also look for a morning star rating of 4 stars or higher. if i see something i like, i switch the underperforming fund to the new one.

so i guess i'm pretty agressive about portfolio management but it seems to be working for me.

[pnustedt]

about every 3 months of so, i see which of my funds are underperforming.

then i use the fund evaluator at www.fidelity.com and look for funds with a YTD return of greater than 15%. i look for well performing funds in sectors that i'm not already in. i also look for no transaction fee and low management fees. i also look for a morning star rating of 4 stars or higher. if i see something i like, i switch the underperforming fund to the new one.

About 65% of my portfolio is also in mutual funds. My strategy in the past has tended to be the opposite of yours - I look for underperforming funds which appear to have potential, e.g. after the hi tech crash I started investing in hi tech because some of the funds looked cheap, likewise Thailand and S. Korea after the Asian crisis. Can be a bit scarey sometimes but seems to work in the long term. Most of my investments are considered "high risk" too.

I will not have any pension when I pack up work and most of my assets will be in cash. I do not want to buy an annuity, from what I see they are inefficient ways to invest, but I do propose to buy bonds with say 30% of portfolio (perhaps 10 yr US treasury or something) to give me a reliable income - then I do not have to watch the CNBC ticker so anxiously every night.

[Thaiquila]

I think the OP was either very wise or very lucky with the energy fund.

However, I think in the long term with mutual funds dumping the low performers and buying the high performers, especially so often, is a lot of activity that is likely to backfire.

It is very common for the best performers one year to next year be the dogs.

For example, REITS have gone up wildly in the fast few years (I was lucky enough to buy some) but I wouldn't touch buying them now.

I am not expert enough to have the holy grail, but I think concentrating more on overall balance and hedging is a better long term strategy. I prefer low cost indexes when possible. In other words, some in large cap, some in mid cap, some in small cap, some in short term and medium term bonds (not much at your age I think), some in European, some in Asian, some in growth stocks. Once you determine your desired balance for these, you can rebalance if one sector grows more than the others. Over long term, it is my opinion you would be ahead vs. your approach and much less work, however, if you are so bright as to always be able to pick the big winners like the energy sector of late ... well, that is another story.

Edited December 2, 2005 by Thaiquila

[Firefan]

Good advise from Thai. Personally I hold a globally diversified, low cost (mostly indexed) portfolio and maintain the allocated %-split with re-balancing from the winners to the losers.

Naturally I have done my research in advance and chosen a portfolio risk level I can live with (50% global equity/30% bonds globally/20% commodities/gold/mining) no matter what. I have also already chosen good funds - so even the losers I will not consider selling - I just fill up while they are on sale!

If you have fears like you mention you should instead re-adjust your portfolio towards less volatility (more fixed income/cash) as you are then obviously too agressively allocated, and then stay the course. You can STILL leave a chunk of the portfolio for timing/gambling but I have yet to see proof of anybody who can do timing and win in the long run.

Cheers!

[stevehaigh]

I think the OP was either very wise or very lucky with the energy fund.

However, I think in the long term with mutual funds dumping the low performers and buying the high performers, especially so often, is a lot of activity that is likely to backfire.

It is very common for the best performers one year to next year be the dogs.

For example, REITS have gone up wildly in the fast few years (I was lucky enough to buy some) but I wouldn't touch buying them now.

<{POST_SNAPBACK}>

i agree that jumping into a fund that has already had a big run up seems counter intuitive. my rational is that since it's the best performing fund in it's sector, then the managers presumably know what they are doing and will continue to do so even if the sector runs into trouble.

but who know!

[Firefan]

That is true Steve - the Vanguard Medical fund is an example of doing well even in bad times for the sector. So is the Vanguard metals and mining fund.

BUT you previously said that you re-evaluate them every 3 months(!) - even the best managed funds can have a few bad months - and you would then exchange the Fidelity energy fund for the CURRENT hero on the energy block.

That does not seem too consistent if your analysis of the Fidelity fund showed it was a "good" fund (beyond recent performance) be it long term performance, manager style, risk profile, expense ratio, underlying stock holdings, cap sizes, value twist or whatever you liked about the fund in the first place.

Anyway; I think you are holding some good fund choices but just adjust your portfolio a bit towards more safety rather than selling the lot. Cheers!

[cclub75]

so i guess i'm pretty agressive about portfolio management but it seems to be working for me.

You might be agressive as you stated, but there is flaw in your method I think : you assume that you will always find a fund who performes at +15% to replace another fund...

What I mean is that you assume that past performances could be always matched in the future.

What if the market turn down completly ?

Internet crash was not (i know that with stocks, 1 year looks like an eternity) not too long ago... We could experience another kind of crash (real estate ?) in the future, but with same or even greater effect.

Expert advise to diversify any portolio. But it could be wise too to diversy the means or vehicules and not to put all your money in funds or stocks only.

As for mysef my strategy short term, mid and long term : CASH !

I sold everything (stocks, real estate). I just kept a few funds on gold/commodities.

There are way too many conflictings signals in the economy (US, Europe, and even here in Thailand). So I assume that something is going to happen, something bad, and since it's difficult to guess on wich side the rock will fall, i prefer to stay in the middle for the moment : CASH, liquid...

[pluto_manibo]

Euro Fidelity funds have been performing well(I like them very much). MAN global is another interesting one as well. However I would definetely diversify your portofolio, as you are taking a big risk. The Long term bond market is interesting at the monent....if you are buying that is....Asian stocks, especially Japanese are sound choice, for little more aggressive approach, I found Brazilian government bonds(US$) to be very worthwhile in the past year....7.875% (+ 10% increase in face value)....

[Butterfly]

Picking a mutual fund can be as tricky as picking stocks. I prefer to build my own portfolios. I have the tools and the database to do so, why would I bother with "random" performance numbers ?

btw, looking at past or current performance of a mutual fund makes as much sense as looking at past prices of a stock to forecast future prices. You really can't tell unless you believe in price charting.

And I agree, picking the winners of the year is a dangerous strategy. They might have shot their load with that YTD performance so you might pickup the fund at the worst possible time and getting flat return for your year end performance

[Gary A]

I made some big money in the stock market some years back. I decided it was so easy that I went in big time. I managed to lose it all and then some more. That was when I decided that I was in over my head. After that I put all I could into a 401K and let my financial adviser manage it. At this point I am retired and manage my portfolio myself. I look at the Morningstar ratings and pick minimum four star rated funds that are rated low risk and high return. I prefer global funds and stay diversified. The final thing is they must have a consistent year to year return. I like to see at least five years of no down years. I'm satisfied with a 10% yearly return. I did quite a bit better than that this year.

[Butterfly]

I'm satisfied with a 10% yearly return. I did quite a bit better than that this year.

<{POST_SNAPBACK}>

Even if you look back 5 years or 10 years, this is a dangerous strategy. Many times a change in management policy or a change of a porfolio manager can have a great impact on the fund. I know too many examples when money managers left, the fund value crashed with poor performance. The only thing saving the fund from liquidation was the good 5 years number from the portfolio manager legacy. Sucker investors would go in or stay in "lured" by the historical performance without realizing that the "star" portfolio manager responsible for the good performance left. You need to do your research and know the story before buying a mutual fund these days. Same as you were investing into a company stock.

[Thaiquila]

Hey,

10 percent stable return is pretty darn good in today's world.

One thing not mentioned here, for US people anyway, it makes a big difference whether your money is in taxable or non-taxable retirement accounts. If you are in taxable, indexes funds are much better because they don't churn the stocks creating taxable events every year.

As far as bubbles, everyone has an opinion, but barring a world economic meltdown, the US stock market is certainly not in a bubble, but the real estate market in select areas clearly is. Putting all money into cash pretty much guarantees you will fall behind due to inflation, but on the other hand, the people who did that before the stock crash a few years back are happy campers. But remember, Alan Greenspan pretty much announced that bubble and crash if you cared to listen.

[Khun ?]

Here is a post from an investment forum that I read. These guys know their stuff and this is just one on Mortgage REITS. Hundreds of post each day on CANROYS

and other energy plays. This is one reply to an ongoing conversation that has lasted a few days if not weeks.

I would tell you what would really help this board on NFI. And it would probably take

a couple of people with expertises on subprime MREITS to actually put it together.

Provide for the readers a financial model for the next 3 years that shows taxable income

and gaap income under a couple of difference scenarios for interest rates and mortgage

originations/securitizations. Maybe use scenarios from three or four people knowledgeable

on this market. >>

( other member, answer)

Great idea, lots of work. I don't intend to tackle it but here's something that I ran across that I would think might have some interest to the VF community. It is another primer that was written by an individual that I regard as a guru in the MREIT business. This particular individual saved me a ton of money some years ago when he beat the drum about the impending collapse of AXM (and I got out) and made me some money when he pointed out to me on another message board that if I liked IMH I might really like NFI and got me interested in doing some due diligence on NFI (and I got in).

Anyway, the original of what I'm posting below had the indiviual's real name attached to it which I've deleted as I don't know that he would want it bandied about. He's one of our leading VF guys, a New Yorker, knows a lot about energy and financials and it's not X. That should narrow it down for everyone .

It's fairly long so I thought posting it on Friday evening when individuals possibly had some free time on Saturday or Sunday without having to pay attention to the tape would make it easier reading. Without further comment, here's the primer. It contains a lot of helpful ways to look at MREITs and even offers some suggestions on which MREITs could be interesting depending on an individual's tolerance for risk. I found it to be helpful but, it does not pretend to be a model.

A Primer on Mortgage REITs

Table of Contents

Part I: Introduction to Mortgage REITs

Part II: A World of Pain for MREITs in 2005

Part III: Playing the Mortgage REIT Sector

Part IV: More Pain on the Way for Mortgage REITs

Part V: Conclusion: My Picks in the MREIT Sector

Introduction to Mortgage REITs: Playing the Carry Trade

Understanding property REITs is essential for high-yield investors.

Property REITs

Most investors are familiar with Real Estate Investment Trusts (REITs). The vast majority of REITS use debt and equity capital to buy real estate that is rented out. The proceeds are used to pay down debt, with any remaining money used for dividends. (Most REITs pay no taxes at the corporate level.) This standard REIT is known as an equity or property REIT, and about 90% or more of all REITs today are property REITs. If you look at the iShares Dow Jones U.S. Real Estate Fund (IYR) for REITs that I like to follow, only about three of the top 50 holdings are not property REITs.

Mortgage REITs

The rest of the publicly traded REITs are known as mortgage REITs or MREITs. They are identical in structure and tax treatment to equity REITs, but their assets are mostly bonds and debt, and they typically employ more leverage either via huge borrowings or via credit bets. But this is where the similarity ends rapidly, and we see MREITs are really like Howard Johnson's ice cream -- there truly are 28 flavors.

Passive MREITs

MREITs all fall into two categories: Passive MREITs simply buy bonds or debt in the secondary markets, and borrow against those assets to earn a spread margin. I tell folks this is nothing more than a bond hedge fund in a public shell. They create large portfolios typically of adjustable-rate mortgage-backed securities issued by FNMA or FHLMC. The passive MREIT then uses these securities as collateral to borrow in the repo market, and the firm collects the spread. This is the carry trade that you read so much about. The leverage is usually somewhere between 6:1 to as much as 13:1. Thus, if you buy adjustable-rate mortgages at a yield of 4% and you can borrow at 2%, you collect a 2% differential. If you lever this up by 10 times, you can earn a 20% return on your cash, which is not bad. This also explains how the passive MREITs can pay yields of 10% to 15% even though the bonds they own have rates of 5% to 6%. This is the magic of leverage.

Lender MREITs

Then there are the lender MREITs, whose primary business is making loans in the residential markets. (There are also a few that specialize in commercial real estate loans.) These firms typically warehouse loans as they make them, earning a positive carry. Then the firms securitize the loans once they have a big package of, say, $500 million. The firms typically sell off all the AAA-rated portions of these securitizations, and retain the first-loss pieces, which can have yields as high as 20% to 30%. The lender MREITs also retain interest-only bonds (IOs), which can also generate extremely high yields. Think of a typical situation where a lender packages up to $500 million of their loans. They sell off, say, $475 million in mostly AAA to BB rated securities, and they retain the first-loss bond and the IO bonds. The lender MREIT has funded most of these loans to maturity, so the firm only needs enough equity to cover the two highest yielding bonds of the securitization. The firm is also likely to book a profit on the cost of the bonds they created vs. the sale price of the bonds.

A Big Difference

Thus, one can see that lender vs. passive MREITs are as different as night and day. The similarity is that both types of firms create debt portfolios that aim to continually generate a positive carry between net borrowing costs and the portfolio yield.

The Classic Passive MREIT Is Annaly Mortgage

Annaly Mortgage (NLY) does nothing but buy securities issued by the government agencies and then borrow against them in the repo markets and collect the spread. Other lesser known names are Capstead Mortgage (CMO), Bimini Mortgage Management (BMM), Luminent Mortgage Capital (LUM), American Mortgage Acceptance (AMC) and MFA Mortgage Investments (MFA). These MREITs are all basically running leveraged bond portfolios playing the carry trade.

___________________________________________

A World of Pain for Passive Mortgage REITs

MREITs have been pummeled in 2005 by rising rates.

In my last post, I discussed passive mortgage REITs, or MREITs. These funds buy FNMA and other bonds with borrowed money to earn a spread. Unlike passive MREITs, the lender MREIT space is a bit more crowded.

Some well known ones are New Century Financial (NEW), Novastar Financial (NFI) , Impac Mortgage Holdings (IMH), Saxon Cap Inc. (SAX) and the grand-daddy of the sector, Thornburg Mortgage Asset Corp. (TMA).

Hybrid REITs

Some of these firms only do sub-prime lending, while others focus on prime lending. Some, like Anworth Mortgage (ANH), were passive MREITs that started mortgage-lending subsidiaries. These firms still hold typical passive MREIT portfolios of mortgage-backed securites issued by Fannie Mae (FNM) or Freddie Mac (FRE). The firms play the carry trade but also look to make money on the lending side, too (I call these hybrid REITs). Thornburg Mortgage Asset (TMA) is the oldest in the sector, and may be as well known as Annaly Mortgage Management because TMA has a long track record of success in prime lending and at running a large portfolio of adjustable-rate mortgages (ARMs).

There are also a few mortgage REITs specialized in commercial real estate portfolios. This includes such well known names as Istar Financial (SFI), Anthracite Capital (AHR), and Rait Investment Trust. These firms usually buy commercial mortgage-backed bonds (CMBS), as is the practice at Anthracite Capital. Others like to focus on direct loans at the junior or mezzanine level to achieve high yield returns.

Poor Performance of MREITs This Year

A quick glance at the MREIT sector shows its been annihilated in 2005. The main culprit has been the relentless Fed rate hikes and the low rates on the long end. This is known as Greenspan's conundrum. Rising short rates hurt all MREITs, since the firms borrow at short rates and lend or buy assets at slightly longer terms. The lender MREITs have been killed even as housing and loan demand has stayed strong. The lender MREITs have suffered even though their dividends have remained high because of fears that delinquencies and defaults are going to rise.

Sagging Earnings and Dividends at Passive MREITs

For example, dividends at Annaly Mortgage (NLY) have fallen from 50 cents in the third quarter of 2004 to just 13 cents in the latest quarter. In fact, the firm might have to eliminate its dividend if the Fed raises rates close to 5%. MFA Mortgage (MFA) has cut its dividend from 23 cents quarterly to 5 cents over the last year. Current dividend levels at both MFA and NLY are at lifetime lows for each company.

Rising Borrowing Costs

The same thing has happened to varying degrees at all the passive MREITs. This is because these folks are pretty much plays on the yield curve, and many have loaded up on longer adjustable rate mortgages (ARMs). ARMs with durations of 5/1 and 7/1 were all the rage in 2003 and 2004, but not anymore. With the Fed Funds now up from 1% to 4%, the passive MREITs have seen their borrowing costs skyrocket (4% is about the level at which these guys can borrow). So they are stuck with many fixed-coupon ARMs that won't reset higher for another one, two, or three years, and this is killing many passive MREITs.

Bailing Out of ARMs In addition, these firms also hold many mortgages with fixed rates that are not much higher than ARM rates, so many home mortgage borrowers are bailing out of their ARMs to lock in a fixed rate. This is another problem for passive MREITs, which paid premium prices for their portfolio of ARM bonds only to see the holders refinance faster than expected. This has led to premium amortization losses, another problem for passive MREITs.

______________________________________________

Playing the Mortgage REIT Sector

I'm waiting for the last Fed rate hike before buying into the group.

Are dividends sustainable? That depends on your view of the housing bubble.

In my last post, I discussed the recent carnage in the mortgage REIT sector.

So How Am I Playing the Sector Now?

I am monitoring about 20 mortgage REITs at the moment that are a mix of lender, passive and hybrid MREITs. Many of the stocks are now at significant discounts to book value and some folks would argue to buy now and wait for this anomaly to correct itself. After all, most of these stocks were at good premiums to book a year ago. But my response is you don't shoot 'til you see the whites of their eyes! And that's what we might see in the face of sellers if rate hikes keep coming.

This sector is going to bottom probably at some point right before the last Fed rate increase. The problem is that nobody knows when that will be, and I won't try and pick the bottom myself. I like to sleep at night, and doing so means missing the last 20% and the first 20% in price movements. I try to catch the middle 60%.

A Picture Is Worth a Thousand Words

Let's look at some of the pain in the sector. Click here to see a nasty chart of one-year returns for a group of MREITs. Almost all these MREITs own nothing but AAA rated bonds, and most of these were issued by Fannie Mae (FNM) and Freddie Mac (FRE). Thus, this pain is almost solely a function of rising short rates and a flattening yield curve. Each one of these stocks has some distinctive characteristics, but these are the ones I am looking to re-enter after exiting in 2004.

Mortgage REITs on the Lender Side

Looking at the MREITs on the lender side, or those firms whose primary business is making loans in the residential real estate markets. Click here for a chart of the one-year returns for these stocks. It's a pretty nasty chart, just like the passive MREITs. But look at the dividend yields on some of these stocks -- 20+%! And this is after annualizing the third-quarter dividend (in some cases the dividends have already been reduced from peak levels). Obviously the markets don't see the dividends as maintainable, but now you've crossed into the spectrum of whether we are in a housing bubble or not, and that's a whole separate column unto itself. (Editor's note: Please reference the last 257 notes from Doug Kass on the housing bubble. You can't say you weren't warned.)

_________________________________________________________

More Pain on the Way for Mortgage REITs

The sector is cheap, but don't expect a rebound until after the rate hikes are over.

So the stocks are still not at the bottom.

In my last post, I began to explain how I am playing the mortgage REIT sector. The sector is cheap, but I'm waiting for the end of rate hikes before dipping my toe in the water. Now I want to turn to valuation of the mortgage REITs (MREITs).

Lessons from Orange County

What will you see if you do some dividend discount analysis on the stocks I previously mentioned? The passive MREITs are trading at single-digit yields, and the lender MREITs are at very high yields. The argument by some is that the passive MREITs in AAA assets for most part will bounce back strongly when rate hikes end. But if housing markets melt down, the lender MREITs will see losses on their assets rise and will be forced to slash their huge dividends. That credit risk is scarier than interest-rate risk. I think people are sadly mistaken on this front: Orange County went bankrupt owning nothing but AAA-rated securities.

Interest-Rate Risk

The lesson learned was that interest-rate leverage can blow you up just as high as credit problems can. Interest rate problems are now over a year old, with short rates climbing and the yield curve flattening. But credit problems at MREITs are non-existent, and just a fear, reality vs. perception.

The Slump in Lender MREITs

I think it's quite important to note here that the passive MREITs are getting decimated on real news that is crushing their earnings, balance sheets and book values. Meanwhile, the lender MREITs are often paying the same dividends over the last year and in some case have increased their dividends. Nevertheless, their share prices have still gotten killed. I actually sold some of my Novastar Financial (NFI) at $67 when it was paying a quarterly dividend of $1.25. The stock is now below $30 paying a $1.40 quarterly dividend. Go figure.

But the markets seem to assume something really bad going to happen to the lender REIT portfolios. This is true even for names like Saxon Capital (SAX), where the underwriting standards are assumed to be among the best in the industry!

The Bottom Line for Passive MREITs

I think that passive MREITs are now down to the point where we might see some dividends eliminated. Capstead Mortgage (CMO) is down to a 2-cent dividend. Annaly Mortgage (NLY) is not far away, and has seen enormous spread compression during the last two quarters. Anworth Mortgage (ANH) has gone from 27 cents to 8 cents over the last four quarters, and the stock is now below $8. This is despite a share buyback plan announced back when the stock was well above $8, and despite the fact that the book value is now at least 20% greater than the share price.

Clueless Investors

Sounds cheap, right? The problem is that many retail investors own these MREITs for the income, but they have no clue how that income is made. They see that the media says mortgage rates are still low, they see that housing is still strong, and they think down deep that these passive MREITs will turn the corner any day with a big dividend announcement. But the reality is that the pain won't end until probably a whole quarter after the last rate hike, and after spread compression begins to ease.

So with rates likely to hit 4.5 to 5%, we have several quarters to go of 'more pain'.

____________________________________________________________

Conclusion: My Picks in the MREIT Sector

The bottom is approaching, but we risk a major liquidity squeeze in mortgages first.

Anthracite Capital looks like a good stock for Grandma.

Saxon Capital, Thornburg Mortgage, and Novastar look good for speculative investors.

In my last post, I began to explain how more pain is on the way for investors in mortgage REITs (MREITs).

Dividend Cuts and Joe Sixpack

I'm not sure what retail investors do if several dividends get eliminated. After all, many of these stocks are not liquid names, and it could look like 20 fat guys trying to get through same subway door if dividends go to zero. Don't talk to Joe Sixpack about how the huge discounts to book value make these a buy; when their income producer stops paying, it might just get dumped.

Classic Liquidity Squeeze

What's more, some of these passive MREITs might need to de-lever their portfolios if their spreads go negative. If the yield curve inverts, this is all but assured. The MREITs own tens of billions of bonds backed by adjustable rate mortgages (ARMs), but there are only a half dozen traders on Wall Street that really trade the sector. These traders are well known historically for having 'no bid' when too many sellers show up in their sector. That's especially true when the sellers are the guys who have been among the biggest buyers of ARMs over the last five years. So if a few big MREITs tried to reduce their leverage, we might see the ARM sector suddenly cheapen by 2%, 3% or even 4%. This happened back in 1994 when the Fed last raised rates at a rapid pace. That's not a good thing for highly leveraged ARM holders, since it can mean a 20% to 40% drop in portfolio value if the fund is leveraged at 10:1.

Finding the Bottom in Passive MREITs

So I'm looking for what I see as the real 'bottom.' Maybe one of the names blows itself up with some problem and the sector reprices 30% lower in a day and that pushes me in. Maybe a hedge fund like LTCM goes nuclear and we see this sector crater like it did in 1998. I bought a boatload of Impac Mortgage (IMH) in 2000 at $3 per share after it almost went under. This came during the post-LTCM credit crunch with no dividend, and I rode it up to $27 with a 75 cent quarterly dividend.

The Bottom Looks Different for Lender MREITs

The lender MREIT crowd is a different story. The argument can be made that housing is not going to crash and burn. The lender MREIT stocks, meanwhile, are priced for a crash. In fact, there are a number of firms that are paying 20% dividend yields and are still dropping! This includes lender MREITs like New Century Financial (NEW), Saxon Capital (SAX), Novastar Financial (NFI) and Fieldstone Investment (FICC).

Passive MREITs Flourish While Lender MREITs Flounder

While Greenspan has his conundrum, we have one in MREIT land, too. The passive MREITs are getting killed on massive dividend cuts and plummeting book values. The stocks are trading at their lowest dividend yields in history on some mistaken belief that good news is about to arrive. But fundamentals suggest that the pain has been accelerating and might get worse. The lender MREITs are paying in many cases the largest dividends in their history, but the stocks are getting crucified. Many are down 50% to 60% from recent peaks due to the perception that we are about to see a massive jump in mortgage defaults.

The Appeal of Lender MREITs

For the daring, buying some of the lender MREITs can make sense today. This is true especially if you are more constructive on real estate than the media suggests. I would suggest considering stocks like SAX and Thornburg Mortgage (TMA). Take a look at the last dividend announcements by Fieldstone Investment and Thornburg Mortgage. The firms actually increased their dividends to all-time records. Yet the stocks are now trading lower since the last dividend increase. Talk about almost insane pessimism!

Long Novastar and Anthracite

As for me? I still have a small position in Novastar Financial (NFI) and a somewhat bigger position in Anthracite Capital (AHR). I have less than 1% of my portfolio in NFI and about 2% in AHR. In both cases, I'm letting an ultra-low cost basis keep me in the game. I am holding off adding in this sector due to some queasiness about where the real estate markets are headed.

Levels to Buy Some Passive MREITs

Passive MREITs, on the other hand, call for patience. I want to buy the passive sector once I can see the light at end of the tunnel for rate hikes. I will gladly miss the bottom since I know many who bought into the sector earlier this year declaring that the Fed was done. They had to bail out after losing 5% to 10%. Somehow I don't think its unreal to hope for buying Anworth Mortgage (ANH) under $5, vs. $8 today. I also hope to buy Annaly Mortgage (NLY) below $9 (vs. $11.25 today) and Thornburg Mortgage (TMA) below $20 (it's $24.65 now).

How I Played the Last Cycle

In 1999 after LTCM blew up, I made inquiries to buy some commercial mortgage bonds in my own personal account that had dropped from $75 to about $30. The credits were good, but there were just no bids and lots of scared sellers. A client of mine at Goldman suggested buying Anthracite Capital at $6 instead. AHR mostly owned commercial mortgage backed securities (CMBS). These were junk bonds yielding about 20%. I then added some Impac Mortgage (IMH) at $3, and some Annaly Mortgage (NLY) later at a price below $10. I'll let you check where they went to by 2003-2004.

Editor's note: AHR went from $6 to over $12, IMH went from $3 to over $27, and NLY went from below $10 to over $20.

This Opportunity Is Coming Again!

Rate hikes will not go on forever, and the fear and selling is reaching a crescendo. I will keep watching the sector and let you know when I think the time is right even for chickens like me. For those who just gotta have 'in' today, but just want to know the safest play, may I suggest:

1. For safety, there's Anthracite Capital (AHR). The firm has wisely funded all their assets with collateralized debt obligations (CDOs), so it has no exposure to yield curve risk and rising interest rates. AHR is a pure play on commercial real estate credit strength, which is pretty good of late. They are managed by Blackrock. This is the one to put some of Grandma's money into -- it was up over $13 earlier this year and has done far better than most in the sector. But AHR has equally limited upside, and is really just a safe yield of nearly 11%.

2. For appreciation, try some of the lender MREITs. On the lender side, speculative investors should consider positions in Saxon Capital (SAX), Thornburg Mortgage (TMA) and maybe Novastar Financial (NFI). NFI has a mysterious monster short position, with 33% of the stock now sold short. NFI also has continual "fails to deliver," so it offers unique upside potential if this whole "naked shorting" story ever turns out to be real.

[Gary A]

Seldom does an established mutual fund "crash". That's why mutual funds are relatively safe. One of my funds, Templeton TEDIX got a new manager in May. I can't see any difference in strategy or fund value as yet. I use Yahoo home page and have my portfolio set up there. One of the highlights of my day is clicking on Yahoo first thing in the morning to see what has happened. Fund managers seldom manage the fund alone. Anyways it works for me. I don't buy load funds because it is too expensive to trade them.

I'm satisfied with a 10% yearly return. I did quite a bit better than that this year.

<{POST_SNAPBACK}>

Even if you look back 5 years or 10 years, this is a dangerous strategy. Many times a change in management policy or a change of a porfolio manager can have a great impact on the fund. I know too many examples when money managers left, the fund value crashed with poor performance. The only thing saving the fund from liquidation was the good 5 years number from the portfolio manager legacy. Sucker investors would go in or stay in "lured" by the historical performance without realizing that the "star" portfolio manager responsible for the good performance left. You need to do your research and know the story before buying a mutual fund these days. Same as you were investing into a company stock.

<{POST_SNAPBACK}>

[Butterfly]

Seldom does an established mutual fund "crash". That's why mutual funds are relatively safe. One of my funds, Templeton TEDIX got a new manager in May. I can't see any difference in strategy or fund value as yet. I use Yahoo home page and have my portfolio set up there. One of the highlights of my day is clicking on Yahoo first thing in the morning to see what has happened. Fund managers seldom manage the fund alone. Anyways it works for me. I don't buy load funds because it is too expensive to trade them.

I'm satisfied with a 10% yearly return. I did quite a bit better than that this year.

<{POST_SNAPBACK}>

Even if you look back 5 years or 10 years, this is a dangerous strategy. Many times a change in management policy or a change of a porfolio manager can have a great impact on the fund. I know too many examples when money managers left, the fund value crashed with poor performance. The only thing saving the fund from liquidation was the good 5 years number from the portfolio manager legacy. Sucker investors would go in or stay in "lured" by the historical performance without realizing that the "star" portfolio manager responsible for the good performance left. You need to do your research and know the story before buying a mutual fund these days. Same as you were investing into a company stock.

<{POST_SNAPBACK}>

<{POST_SNAPBACK}>

Crash as getting 5% over 2 years instead of getting the "advertised" 10%

That's what happened to me on 3 different funds with a long term performance.

I might as well buy an index fund.

[Taggart]

David Swenson is the manager of Yale University's endowment fund.

Swensen originally set out to write a book to show investors how all that he learned making huge bucks for Yale University could be used by America's 95 million Main Street investors. He discovered just the opposite: That will never, never happen if you invest in actively managed funds.

Swenson says an index portfolio is the only kind that America's investors should "engage" if they want decent returns and not just "line the pockets of mutual-fund managers at the expense of individual investors." Here's Swenson's recommended portfolio asset allocation with index funds for U.S. investors.

Fund/category Allocation

Total Market Index/equities VTSMX 30%

Total International Stock Index/equities VGTSX 20%

REIT index/equities VGSIX 20%

U.S. treasury bond index/bonds VFISX 15%

TIPS bond index/bonds VIPSX 15%

Swenson's model portfolio for Canadian investors is as follows:

Domestic Equities (TSX Index) 30%

Other Developed-World Equity (S&P 500 and EAFE) 15%

Emerging-Market Equity Index 5%

Real Estate Stocks (REITS) 20%

Gov't Bonds 15%

Real-return (Inflation protected) Government Bonds 15%

My own portfolio in a tax shelter is almost identical except due to risk factors I've lowered the REIT allocation from 20% to 10% and added to the bond portions by 5% each.

Don't do market timing, re-balance one a year, no sweat.

Outside of the tax shelter I only invest in Canadian high yield dividend growth stocks. The dividend must be growing faster than inflation. Mostly in financials and utilities.

Works for me.

[Khun ?]

is you tax shelter selling you in units. Better hope they don't disappear

with your cash at some time when you thought you had money in funds.

Let the tax man take your pension and put you in jail for avoiding taxes

unless it is an approved shelter. Most of the time these added expenses on middlemen will be as much as paying the taxes.

Remember you only pay taxes on profits not on the amount of the portfolio.

[Taggart]

is you tax shelter selling you in units. Better hope they don't disappear

with your cash at some time when you thought you had money in funds.

Let the tax man take your pension and put you in jail for avoiding taxes

unless it is an approved shelter. Most of the time these added expenses on middlemen will be as much as paying the taxes.

Remember you only pay taxes on profits not on the amount of the portfolio.

<{POST_SNAPBACK}>

Khun,

If you're addressing myself, I think you're reading me wrong. The tax shelter is in Canada, an RRSP (Registered Retirement Savings Plan). There are no costs or fees for me to set one up with one of the major banks. All legitimate and approved by the Canadian government.

[Khun ?]

Great move, I made the mistake of doing one of these offshore disasters. Great people but doing nothing but losing money or very poor returns, even less than money market.

Anyone selling you someone elses funds most of the time will not be a good deal. This Emu guy that post some times here seems to have something that would be worth while and he even offered to provide proof on his client returns, fees was based on a performance basis.

[KhunPadThai]

Expert advise to diversify any portolio. But it could be wise too to diversy the means or vehicules and not to put all your money in funds or stocks only.

As for mysef my strategy short term, mid and long term : CASH !

I sold everything (stocks, real estate). I just kept a few funds on gold/commodities.

There are way too many conflictings signals in the economy (US, Europe, and even here in Thailand). So I assume that something is going to happen, something bad, and since it's difficult to guess on wich side the rock will fall, i prefer to stay in the middle for the moment : CASH, liquid...

<{POST_SNAPBACK}>

There certainly are large risks out there. However, when you say you are in cash, do you mean USD? If so, you are concentrated in an overvalued currency. The dollar has been going up lately because of interest rate spreads that may not persist. In addition, over the long term the US government has incentives to inflate the currency. I am currently all in USD myself, but looking for ways to diversify.

[KhunPadThai]

Taggart,

By reducing your REIT exposure you are timing the market. Swenson's portfolio strategy is about NOT timing, only rebalancing periodically (which Swenson's team does daily, by the way.) The theory of an asset allocation approach, as promoted by Swenson and others, is that you can't expect to time the market any more successfullly than you can expect to outperform by picking stocks.

In fact, according to the asset allocation model, if your REIT segment has lost value in the most recent period, you would buy MORE of it, not reduce your position. Asset allocation works, if it does, partly because it forces the investor to act against his inclination to sell losers and buy winners. Since the asset classes in question are mean-reverting, you want to buy losers and sell winners, in general.

I am not recommending that you forbear to reduce your REIT exposure. I only want to point out that now you are doing market timing, not asset allocation.

Khun Pad Thai

[Taggart]

>>>By reducing your REIT exposure you are timing the market.<<<

Khun Pad Thai:

>>>My own portfolio in a tax shelter is almost identical except due to risk factors I've lowered the REIT allocation from 20% to 10%<<<

Perhaps I should have said that I've lowered Swenson's suggested recommendation to 10% for my own portfolio allocation to REIT's. This 10% allocation is permanent, therefore, no market timing.

>>>In fact, according to the asset allocation model, if your REIT segment has lost value in the most recent period, you would buy MORE of it, not reduce your position.<<<

This I fully intend to do.

[Firefan]

Hmmm...seem to me we have some really smart investors here on this board!

Previous threads on investments in this forum have been very trading (gambling?) related but turn a few stones and out we come with words like "index funds", "diversification", "re-balancing", Etc. and references to good books on investing.

Now back to day-trading QQQQ Cheers!

[Khun ?]

A few good funds in the sectors you like, a couple good brokers

doing stocks and 3 or 4 years of living expenses in near cash investments.

Taggart looks to have a very nice auto pilot plan with excellent cost

effective choices.

Both my brokers have made over 20% this year and very little oil stocks at this time. One broker only buys companies with great earnings and the other will short and margin but only when he thinks it best ( very selective and stays cash often). I have a side array of income investments I do on my own that bring in $5K a month or more.

So many ways to do things and what works for one person may keep the next person sleepless.

[Firefan]

Taggerts/Swensons portfolio is very similar to my base portfolio (leaving my trading/gambling money out of the equation).

It is a globally well diversified, low cost postfolio requirering very little handling/time to manage.

I do have some added mining/gold equities+US micro caps as well as a commodities fund and my fixed income money is diversified across both US/developed foreign/emerging debt.

Cheers!

[Khun ?]

Firefan

Sounds like good investments and you don't need some mutual fund guru to add hefty expenses.

One of my brokers the dividends almost pay all of his fee and the other is performance + fee.. Check out Capitalist pig fund, I am keeping 25% with him and other broker 35%. The rest is cash and income and a couple odd funds inflation commodities and Natural resources.

[Firefan]

Checked their homepage but not much info on the fund (as one has to be an accredited investor as you know). Anywhere I can see more on the pig fund? Cheers!