spectrum live™ portfolio select monthly report november · pdf filespectrum live™...

Spectrum Live™ Portfolio Select Monthly Report November 2013

Informed Investors Make Better Choices

Spectrum Live Capital Management Pty Ltd (ABN 67 149 351 986) is an authorised representative (No 433 450) of Gleneagle Asset Management Limited (ABN 29 103 162 278) (AFSL 226 199).

Investment Report: November 2013 | Spectrum Live Capital Management © 2013 | P a g e 1

1 Investment Report: November 2013

Contents

Income Portfolio ............................................................................................................................... 2

Market Overview: ............................................................................................................................. 3

Dividend and Growth Stock Opportunities ....................................................................................... 4

Current Holdings – Dividend and Growth Stock Strategy ................................................................ 6

Capital Gains Strategy ..................................................................................................................... 7

Current Holdings – Capital Gain Strategy ........................................................................................ 9

Capital Gains Strategy – Split into classes..................................................................................... 10

Monthly and Weekly Option Writing Strategies .............................................................................. 11




Income Portfolio

The Income Portfolio bounced back 0.52% this month as the unit price reached 1.067. The performance is still slow compared to other months as rising bond prices held back the performance in the capital gains strategy. The dividend and growth strategy continues to make steady gains as the market drifts higher and the option writing strategy also made a decent gain despite low option volatility premiums this past month.

We allocated around 50 percent weighting to the Dividend and Growth strategy to take advantage of the bullish trend in equity markets. The monthly and weekly option writing strategy has a combined weighting of 30 percent and the capital gains strategy has approximately 10 percent weighting.

Below we will discuss a general market overview, and the three major strategy components to the Income Portfolio:

• Growth and dividend stock investing strategies • Capital gain strategies • Monthly and weekly option writing strategies.




Market Overview:

Major US equity markets broke to new highs for consecutive sessions as recent comments by Janet Yellen as Chairman designate fuelled confidence of continued FED support. Yellen reiterated that the economy is still ‘far short’ of potential and an early tapering would only hurt the recovery. Ironically, the most recent GDP figures and unemployment report both indicate a strengthening US economy that surpassed analysts’ expectations.

On the earnings front, most companies managed to beat analyst estimates which gave investors’ confidence in the rally. The positive sentiment in the markets showed in the VIX as it traded down to low levels. Market breadth indicators are also suggesting that most stocks are part of the rally, providing reassurance that the bullish sentiment is broad based.

In China, the country’s third plenum (government leadership meeting) failed to satisfy the market as reports fell short of providing concrete plans for reform. Nonetheless, the meeting did agree on letting the markets play a more ‘decisive’ role in money markets and exchange rates. Despite the subdued momentum and criticism, the country is still on track to meet its growth target for the year. On the downside, there are early signs that the People’s Bank of China is tightening liquidity as the government targets a sustainable growth. If this continues it may have an adverse effect on emerging markets and commodity prices (this would suit us well, as we have put options on EEM and DBC).

In Europe, the European Central Bank (ECB) yielded to market pressure as it cut rates by 0.25 percent after annual inflation fell to 0.7 percent in October. GDP growth has also been lacklustre as periphery countries provided the greatest drag. On the other hand, the UK economy has been surging along with improving economic indicators, prompting the Bank of England to maintain its current monetary policy stance.

Central banks elsewhere have either maintained or stepped up their loose monetary policy. The RBNZ only made comments calling for rate increases next year, whilst the RBA made no changes. Overall, the sentiment seems to be positive and economic indicators continue to improve.




Dividend and Growth Stock Opportunities

Objective

The main objective of this strategy is to invest in strong dividend paying stocks that are fundamentally sound and offering good value. It is not our intention to try to pick stocks for short term capital gains.

In this strategy we look for stocks of companies that have a fundamentally sound business, strong balance sheet and are actively looking to return excess cash flow to shareholders in the form of dividends and buyback programs. We want to know that these companies have consistent cash flow and are able to pay dividends with a positive outlook for future dividend growth.

In any given month whether the stocks rally or fall should be of little concern to us as long as their fundamentals remain strong. The investment horizon on this strategy is medium to long term and we aim to avoid being caught up in short-term swings in sentiment.

Strategy Discussion

The dividend strategy climbed higher along with global equities, but underperformed the S&P500 as the strategy is to invest in global stocks for geographical diversification. Equities outside of the US were slightly weaker this month partly due to tightening liquidity in China. Although diversification does not guarantee outperformance month over month, we generally find that it helps to smooth out returns and often outperforms a poorly diversified portfolio over the longer term.

As advised in last month’s report, we sold out of Garmin, KLA-Tencor and Societe BIC stocks last month because the valuation based on their earnings to enterprise value has gotten quite expensive. We then allocated the proceeds to China Mobile and Kuraray in Japan. Both companies have long track records of strong and stable returns with potential for growth in the future and are valued cheaply at an EV/EBITDA of 3.38 and 5.54 respectively. On top of capital growth potential, China Mobile also offers an indicative dividend yield of 4.12% and Kuraray with 2.92%.

The best performer this month was Guess (GES) which rallied 10.33% during the month. Supporting the stock’s strong performance was the recovery in Europe and the European Central Bank’s surprise rate cut during the month which should promote greater spending over the Christmas season. The stock has broken out to a new high and should continue to accumulate positive momentum. Valuation is still relatively cheap as the stock has a Price to Sales ratio of just 1.1.

Another very strong performer has been Northrop Gruman (NOC) which has made a capital gain to date of 23%, not including the dividends earned to date. Other strong performers include Apple (14% capital gain to date), Norfolk (14.9% capital gain to date), Xerox (13% capital gain to date), Michelin (11% capital gain to date) as well as many others.

The only stocks which are in a current loss position are Cisco (-12.5% to date), TGS (-13% to date), Canon (-1%), and China Mobile (-1%)…all of which we are comfortable holding as their fundamentals and valuations are still strong.

The worst performer this month was Terra Nitrogen as the stock fell -11.48% on the last two days before the unit price was struck. Fortunately we had a small allocation to this stock so it did not have a significant impact on the portfolio. Until now we are still bewildered by the extent of the stock’s selloff as there was no apparent news responsible for this sudden selloff. It might just be a few large investors selling out of the stock which caused a ripple effect as other investors reacted to the sharp price decline. If this is the case then the stock should rebound after the fear settles. However, as conservative investors, we have to be suspicious of the unknown and given that the selloff was accompanied by huge and increasing volumes, there is a possibility of a “black swan” type event happening here (an out of character event that could have a prolonged detrimental effect on the stock price) where only a few insiders have knowledge of it. In trading and investing, we believe that when in doubt, we should stay out as we do not have enough information to make an informed decision. Therefore we closed our position on Terra Nitrogen shortly after the unit price was struck.




The table below summarises the dividends that the Income Portfolio collected (or is entitled to collect) this month:

Code Name Average

Entry Price Dividend per Share

Yield on Entry Price

AAPL APPLE INC 450.26 3.050 0.68%

CVX Chevron Corp 120.34 1.000 0.83%

SDIV Global X SuperDividend ETF 22.40 0.124 0.55%

INTC Intel Corp 23.31 0.225 0.97%

NSC Norfolk Southern Corp 74.90 0.520 0.69%

RDS/B Royal Dutch Shell Plc - ADR B 68.35 0.900 1.32%

TNH Terra Nitrogen Company LLP 207.37 2.020 0.97%




Current Holdings – Dividend and Growth Stock Strategy




Capital Gains Strategy

Objective

The allocation of this section of the Income Portfolio is deep value equity, bond and commodity options, where we feel a probability exists for significant capital gains in the long term (we define long term as trades lasting longer than 12 months and in most cases over 2-5 years).

The key objective here is to target an asymmetric return where we risk a small limited amount but expose the portfolio to the possibility of making a large return payoff.

To achieve our objective, we aim to meet three broad criteria when selecting trades in this strategy:

1) Market value of the underlying equity or commodity is significantly mispriced. 2) Implied volatility is low, which gives us a better reward to risk ratio. 3) In situations where we employ options, we aim to have long enough time to expiry to allow our outlook to likely

come to fruition.

Strategy Discussion

The performance of the capital gains strategy was again mixed as European equities and banks continued to rally but bond yields fell. Bond yields move inversely to bond prices and because the portfolio has put options on bonds, falling yields have a negative effect on the strategy. We also added a new two year put option on the AUDUSD which has become quite profitable as the Australian dollar weakened. Overall this strategy resulted in a small loss this month.

Bond yields suffered a double whammy this month from the FED and the ECB. Firstly from Janet Yellen, the FED Chairman designate who testified in front of the Senate saying that the economy is ‘far short’ of it’s potential and that any tapering would cripple the fragile economy. Investors interpreted this to mean that the FED would likely not engage in tapering of the quantitative easing (QE3) program anytime soon, which will delay the date the FED actually starts to raise US interest rates.

On top of that, the ECB surprised the market this month with an unexpected rate cut of 0.25 percent citing a falling inflation rate and a weak economy. This has a direct impact on bond prices as it affects the yields directly. Given that bond investors are constantly balancing their portfolios and favouring bonds with similar risks that have the higher yields, falling European bond yields also causes the US bond yields to fall and vice versa.

Fortunately yields on the Sterling did not fall as much, as Great Britain seems to be demonstrating economic resilience. The greater risk there appears to be rising inflation which could prompt the Bank of England to raise rates quicker than the FED and the ECB.

Although the put options on bonds that are in the Fund have lost a fair bit of value over the last two months, we still think that it is an attractive trade for two reasons. Firstly, we think that rising yields are inevitable as the global economy continues to improve. Just like there are laws in physics, economics is also governed by its own sets of laws… even though the consequences may not be felt immediately. The longer the central banks hold out on raising rates, the more significant and abrupt their actions will have to be when inflation eventually gets out of hand. Secondly, trading against the crowd has its merits; as the expectations of low yields become built into the price, there is little downside to go whereas any surprise would be to the upside and would likely be abrupt when it does happen.

Furthermore, the structure of the put options is such that as the puts trade further out the money, the leverage becomes smaller as delta decreases. That means that any move against us would result in a smaller marginal loss whereas any move in our favour would gain more leverage and the marginal profit would increase. Therefore these positions can become very attractive asymmetric trades and fit perfectly the objective of the capital gains strategy. Given the long dated expiry dates we have on the puts (Dec 2015, June 2016), we also have the luxury of a significant amount of time for the trades to work in our favour.

In a different trade, this past month we entered into a two year put option on the AUDUSD. The AUDUSD rallied up to $0.96 and we felt that it was an excellent time to take a bearish view on the Australian dollar against the US. The Australian economy has been slowing over the last year and we think the trend could continue given weak macro factors such as falling commodity prices, tightening of liquidity in China and eroding labour competitiveness. This could prompt the RBA to hold rates low whereas in the US as long as the economy continues to improve, the FED will likely have to raise rates sooner rather than later. The narrowing interest rate differential would cause the Australian dollar to fall against




the US. The implied volatility on these options is near the lowest in five years making option trading very attractive as the portfolio is able to acquire these options at a relatively cheap price. Currently these puts are in a profit as the Australian dollar has fallen against the US dollar since our entry.




Current Holdings – Capital Gain Strategy




Capital Gains Strategy – Split into classes




Monthly and Weekly Option Writing Strategies

Objective

With the option writing strategy, we aim to generate a consistent stream of income by writing options on stocks (CFDs) and ETFs. We generally allocate a larger portion to the monthly expiry options and a smaller portion to the weekly expiry.

When we consider option writing opportunities, we are looking for stocks with a relatively high implied volatility and then look for strike prices that we think are likely to hold during the option period that are offering attractive yields. We use a combination of fundamental analysis and technical analysis to determine whether or not we think a particular strike price will hold.

The margin utilisation in this strategy could vary significantly from week to week because we do not always find attractive opportunities in the market. When the market is complacent and has little regard for risks, the premiums on options can be low while the risk of a significant and unexpected move is high. In such circumstances, we would prefer to be patient and tone down our allocation while we wait for better opportunities and higher premiums.

Strategy Discussion

We entered few trades this month due to the low implied volatility which in turn leads to low option prices. We kept writing weekly options throughout the four weeks to increase the income derived from the strategy.

The only issue that we had relating to this strategy during the month related to the tapering-non-tapering conundrum. At the beginning of the month it looked like quantitative easing was going to continue for years to come and bond prices rose. However, more positive economic data pushed interest lower and inversely the ETF TMV (short bond fund) lower. Consequently we closed our naked put position to avoid further loss.

20% of the overall portfolio was allocated for the monthly strategy and 10% for the weekly. Please note that these are margin trades so of the overall capital allocated we invest only a fraction of it to allow for market conditions, costs, and available opportunities.

Monthly options:

Our seventh month of the monthly options writing strategy once again ended in profit. The return for the month was in line with the previous months however capital utilisation for margin was very minimal due to lack of opportunities/caution. Capital protection is paramount for us in the short volatility strategy. Following this principle we closed TMV naked put while the ETF price was trending towards our strike.

Stock Strategy Strike Return on margin Notes on the trade

DE Naked put 75 7.06% Strike considered very safe as well below strong resistance at the 80 level.

GLD Naked put 105 5.40% Strike well below this year low. With QE to infinity news circulating Gold is still holding well above the year low. Strike considered safe.

HD Naked put 70 6.95% Strike below the 72.5 resistance level which has held since May.

SJM Naked put 95 7.21% Strike below recent resistance at the 103 level. Stock showing strength.

SPY Naked put 155 5.08% Equity markets in general are showing strength. We chose a very conservative strike at around 10% correction level.




TMV Naked put 62 -0.39% We entered this trade when TMV was trading above 70 a couple of months ago. Recent news pushed TMV below 65, our line in the sand to close the trade. Sentiment rapidly changed after we closed reversing the move in bonds. The loss is due only to commission costs.

Return on total margin incurred: 4.44%

Weekly options:

Four weekly option cycles were traded this month all ended at a full profit. Due to the lack of diversification reduced amount of capital was used for trading weeklies, following the same trend we experienced for the monthlies.

Expiry 25/10/2013:


AMZN Naked put 250 1.31% Strangle. Earnings play. Tech stocks have been strong during the recent earnings season. We believed AMZN will follow same path.

AAPL Naked call 550 1.26% After recent bounce the stock has lost steam. Strike above 1 year resistance.

GOOG Naked call 1,075 1.28% Stock rallied 100 dollars on earnings and then lost steam. Strike considered far enough for the week.

AMZN Naked call 380 0.89% Strangle. Earnings play. Tech stocks have been strong during the recent earnings season. We believed AMZN will follow same path.

AMZN Naked call 380 3.23% Quick daily play at market open after earnings announcement taking advantage of the high volatility of a gapping stock. Strike 10% away from the gapped opening price. Stock lost steam during the trading session.


Expiry 01/11/2013:


AMZN Naked put 245 1.25% Strike sold before earnings announcement. Unusual move but strike more than 20% away from current price at the time. We believed it was a case of excessively priced volatility for the stock.





Expiry 08/11/2013:


AMZN Naked put 330 1.33% We consider the 320-330 area as the new support for AMZN after the earnings. We will sell those strikes until we will find good premiums.

GMCR Naked put 55 3.05% Stock looked holding after recent slide. Stock had a further plunge after we entered which was recovered the following day. Volatility expected for the high weekly return.

PCLN Naked put 920 0.44% Strangle. Earnings play. We closed the trade 2 days before the announcement as we were already satisfied with the return (well above the 2% target). The stock ended between strangle strikes at expiry.

PCLN Naked call 1200 2.31% Strangle. Earnings play. We closed the trade 2 days before the announcement as we were already satisfied with the return (well above the 2% target). The stock ended between strangle strikes at expiry.


Expiry 16/11/2013:


AMZN Naked put 310 1.10% Stock dropped after entering the strangle. Sold more premium at a safer strike, defensive move (more revenue) in case share price dropped to higher strike causing us to close that put.

AMZN Naked put 320 1.13% Strangle. Strike on the range we consider current support.

IBB Naked put 187 1.01% This ETF is showing a bit of volatility in the premiums during the current earnings season. Strike below recent support.

AMZN Naked call 390 1.16% Strangle. Strike 10% away. Considered a too big move for 1 week in steady conditions.


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