William Shakespeare is credited with writing “neither a borrower nor a lender be.” We believe investors should consider this adage at this time. In February the Wall Street Journal reported that U.S. retail investors currently have borrowings of $642 billion against their stock portfolios. Goldman Sachs reports the amount of money on margin was worth 1.31 percent of the total value of all stocks on the New York Stock Exchange. The previous peak was 1.27 percent, which occurred just prior to the tech bubble bursting in 2000. This is a noteworthy watermark in the intermediate term of attempting to project asset prices.
When a retail investor accepts a margin loan from a bank or broker such as Goldman Sachs, they pledge the stocks in their account as collateral. If the stocks in their portfolio decline significantly, the broker gives the investor a margin call; if the investor does not quickly post additional collateral, the broker will sell the investor’s pledged shares to ensure they will be repaid. The sale occurs regardless of the current stock price or the recent movement of the stock.
Margin loans are excellent for investors in an upward moving stock market because gains in their stock portfolio are magnified by the leverage. This leverage further boosts the market by fueling demand. However, leverage cuts both ways, and during periods of extreme volatility or a bear market, it can induce investors to sell shares at the worst possible time. While we are not predicting an economic recession, investors should be wary of leveraging their portfolios. That margin loans are at an all-time high is concerning because, historically, a high level of margin debt has been an indicator of a future market downturn. Needless to say it is imperative to be patient and diligent on any prospective new investment.
On a more positive note, we are excited to announcement the continued growth of our partnership with Fidelity Institutional. We are enclosing is a letter explaining what you can expect with the new agreement and the ways in which it will allow us to serve you better. This has been a long time coming and there will be more developments to report to you over the next several months. We are grateful for your continued support; this new opportunity with Fidelity would not have been available without you!
Please review the following updates from some of the existing positions that we manage:
Scorpio Bulkers Bond maturing 9/15/2019 (SLTB) – The second quarter results came out on the morning of July 23rd and they were strong. Revenue is up over 10 percent quarter over quarter. More importantly, quarterly EBITDA (earnings before interest, tax, depreciation, amortization) are at the highest level ever, $28 million. The common equity stock price was up 2 percent as a result. In our opinion, the outlook for the bonds remains strong, with about 14 months until maturity.
Whitehorse Financial Bond maturing 7/31/2020 (WHFBL) – We received notice this month that the Whitehorse is going to call bonds early (“early” means before their scheduled maturation date). It is disappointing news to see one of our most consistent performers get called two years earlier than expected. The call date is scheduled for August 9th and we will receive cash back (par value and accrued interest).
TPG Specialty Lending Common Stock (TSLX) – We invested a half position in the common stock in the middle of June in order to collect two healthy dividends; one common and one special dividend. Since then the stock price of the more volatile common stock has risen several percentage points, excluding the dividends that were paid out last month. On June 28th, Keefe, Bruyette and Woods published a report saying their target price for the BDC is $21.00. Before the market opened on July 23rd, JP Morgan updated their price target to $19.50. Both of these target prices are materially above our initiation price of $18.18 (which does not include the $0.45 dividends already paid to us). If there is any short-term weakness in the stock price, we will look add to get to a standard, full allocation of 1.5 percent.
We continue to monitor common equity positions for certain client accounts. We will always be responsible stewards of client capital and allocate diligently into these more volatile positions. One way to accomplish this is by allocating in half positions. This practice is generally reversed for common equity/stock positions and bonds as they are a more conservative investment vehicle.
As always, please feel free to reach out to us with any questions that you may have. We are grateful for the trust that you place in us.