Investor Insights

October 2017 Investor Report

Published: October 4, 2017Updated: April 25, 2019

After a very strong September, we continued our appreciation path as we had several investments pay dividends and interest. This influx of cash, supplemented a general appreciation in asset prices which assisted in generating unrealized capital gains.

Taking a break from our normal conversation points (the economy, the unrest on Capitol Hill, etc.), we are going to focus on a question that I get from clients often. Which is: “Why do you invest in individual bonds rather than investing in bond ETFs or mutual funds?”. It is a fair question, and one that deserves a clear and concise answer. The question and answer is amplified by the fact that we have a specific focus on decreasing asset price volatility and increasing portfolio projectability.

As discussed, our fixed income strategy focuses on selecting and investing in individual corporate bonds, rather than bond funds. An individual bond enjoys a fixed interest rate and a fixed maturity date. When held to maturity, a bond investor can ignore the price movement of the bond, collect interest, and expect repayment at maturity. A bond fund, however, has no fixed interest rate and no maturity date, thereby removing the best features of a bond. A bond fund’s returns are also subject to the buy and sell actions of unknown investors who often act irrationally, frequently forcing the bond fund manager to buy and sell in response to the moves of these investors. At its core, investing in individual bonds provides what we are looking for and that is more projectability.

As mentioned earlier, the month of October was another solid month for us. While performance from the portfolio was fair, there are still a few metrics that require monitoring. The 10‐year Treasury Rate grew almost 50 basis points in the last thirty days, as Wall Street is now expecting another interest rate hike in December. If this rate continues, the economy could come under pressure towards the end of 2018. The reason for this: as credit becomes expensive, asset values become less attractive. For example, if you are a business owner and your interest expenses go up because your credit/debt is more expensive, you are less profitable. This takes time and interest rates are still trading at historical lows, however this does require monitoring.

The debt crisis in Puerto Rico is another variable to watch. There is a lot of capital invested in Puerto Rico’s municipal bonds. If no resolution is reached soon, Puerto Rico will be out of cash. This is going to put a spotlight on how Washington, D.C. handles a “state” bankruptcy. This could have ramifications in the recent future as there are several states that are coming under some fiscal pressure.

Lastly, crude oil prices moved above $50 per barrel on strong volume. There are several events that occurred in the month that gives us a sense of calm with our energy related investments. First, Saudi Arabia leadership travelled to Russia for the first time in a long time. The unofficial leaders of OPEC and non‐OPEC countries met to discuss the possibility of extending production cuts for another year. This would be a bullish event for crude oil prices as we are discussing two of the largest crude oil producers

in the world. Separately, the United States in exporting liquid energy (crude oil, natural gas and liquified natural gas) at levels that we have never seen before. This is good for our midstream energy companies as they draw their revenue from the movement of the commodities from Point A to Point B.

Please review the following updates from some of our existing positions held in most of our accounts that we manage:

Targa Resources (NGLS‐A) – One of our largest positions continues to provide significant monthly cash. The company announced a deal with Kinder Morgan who agreed to a letter of intent over a development of the proposed Gulf Coast Pipeline Project. Under the letter of intent, Kinder Morgan will build, operate and hold 50% equity in the project. Targa will hold a 25% equity in the project but provide minimal capital towards the deal. We like these types of deals for our holdings because the cash investment is minimal, and the returns could be very good. Now, the common equity shareholder is the major beneficiary of this news, but, we are the preferred shareholder. We do benefit, as the company is expanding without taking on additional, material debt. This helps the credit profile of the business, which helps us!

Bay Bancorp (BYBK) – This regional bank was a common equity investment position for moderate clients, who joined more than 8 months ago. It was announced in early October that the company was getting bought out by Old Line Bank for $11.80 per share. Overall, the investment produced an approximate 60% gain.

Seaspan Corporation Bond (6.375% due 04/2019) – The company’s bond has been a very good investment for us and we will continue to look at holding the bond until it’s maturation date in April of 2019. The company announced that they did a new offering of 10‐year bonds at north of a 7% yield. We are not buyers of the bond, as we believe it is too long of a timeframe for a business that relies on good shipping rates. It is a good sign for our 2019 bonds though, as it increases liquidity for the short‐term time horizon as shipping rates are looking at continual improvement.

As always, 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.