Stock Gumshoe

I hope that everyone who reads the teaser email from StreetAuthority.com for Carla Pasternak’s High-Yield Investing takes their claims of a 35% forward dividend yield with a little bit of a grain of salt. Obviously, there’s no way to get a 35% annual dividend that’s sustainable and/or safe, so there must be something unusual going on here.

And there is, though it’s not necessarily a bad thing.

This “Income Security of the Month” teaser has made the rounds before, thanks to the fact that the security they’re teasing has been a very successful investment in the recent past and has spit out some nice “dividends.”

And I put “dividends” in quotes because this is nothing like the standard dividend you’ll get on a regular income-producing stock, or the coupon on a bond. It’s not to be compared with the 4% yield on Pfizer, or the 3% yield you get with GE stock.

According to the ad, “Although the fund’s upcoming $15.94 payment is a one-time payout, the bottom line is that this fund has a history of making strong annual distributions. For example, last year the fund paid out $7.12 per share, giving the fund a trailing 12-month yield of 15.7% as we go to press.”

Sounds pretty impressive, no?

And yes, this is a fund. They say it has average annual returns of 26.8%, which also sounds pretty nice. It owns a basket of 50 or so stocks, so it is somewhat diversified (though also quite focused, as we’ll see in a moment).

So what is it? Ready to find out? Well, you could go ahead and subscribe to Carla Pasternak’s High-Yield Investor to get the answer, and I’m sure she’ll also supply all kinds of special reports and analysis for you — I’ve never read her stuff, so I don’t know if it’s likely to be helpful or not.

But I do know that if you just want the name of this “income security of the month,” then the Gumshoe’s your man!

This high yield fund is …

Korea Fund (KF)

This is a well established closed end fund that invests solely in South Korean stocks (that’s the focused part). I actually owned shares of this one myself a number of years ago, but don’t currently.

They are planning what Pasternak is calling a “dividend” of $15.94 very soon — but it would be a mistake to think of this as an ongoing dividend. This is somewhat like the capital gains distributions that your regular mutual funds will spit out at the end of the year every year, to spread the taxable income around to shareholders. What it should tell you is that the Korea Fund has had a very good year.

How good?

Well, as you can see from the chart above, just about as good as the underlying index, as measured by the South Korea iShares ETF. The chart is for six months, but if you go back further the pattern looks more or less the same (it’s just that Yahoo didn’t account for their January payout this year, so that skews it a bit and I didn’t want to confuse the issue). Over a longer period, it looks like KF probably did outperform the index on average, though with the difficulty in accounting for distributions in comparing an ETF to a CEF it’s hard to tell (ETF’s generally don’t have distributions, their income is reflected pretty precisely in the net asset value and thus the share price).

Both the Korea Fund and the Korean market overall have had an excellent five years — no losing years going back to 2002. 2001 was pretty ugly for them, and they were both quite volatile before that, but essentially to know the future performance of KF you need to know how the Korean stock market is going to perform in the future. So far it’s been great, and luminaries such as Warren Buffett are investors in Korean companies (Posco in his case), and there is even some bloom on the shares due to the fact that the current threat of North Korea looks somewhat subdued … if war drums start beating on the peninsula again, all bets are off.

Korea itself is a very interesting investment environment, in my opinion — an extremely high tech economy, generally a developed country that’s still considered to be an “emerging market” by some, a huge amount of heavy industry and a very unionized and active workforce, but still quite low costs for most companies that operate there. Oh, and most of the companies have the kind of incestuous ties through various chaebol (conglomerates) that make Japan such a confusing place to invest — the Hyundai and Samsung names are attached to half the companies in the country, it seems, and they are all intertwined.

So … why would you want a fund with a management fee of just under 1% when you could have a cheaper ETF that has much of the same holdings?

Well, if you do want income to be distributed to you and you don’t want to have to sell shares to get it, a closed end fund is probably easier. It doesn’t make a difference in your wealth-building, particularly, since the closed end fund price will go down by exactly the amount of the dividend, and you’ll be taxed on the dividend income, but you do get distributed cash, which some people like.

If that’s your thing, buy before November 28 to get the distribution — but keep in mind that all you’re doing in most cases like this is getting a portion of your purchase money back AND paying taxes on the gains that you didn’t actually get. You buy a share for $49, get $15 back and your share is then worth $34, and you have to pay some kind of taxes on the $15. If you had bought the shares back when they were around $34 anyway, that’s a nice way of realizing your capital gains … but if you bought at $49, it’s just a way to give something back to the taxman unless you believe that the shares are going to be worth more in the future. I haven’t studied how the shares have reacted to disbursements like this in the past, but personally I’d probably buy after the distribution if I wanted shares.

I have nothing against the Korea Fund, though I did personally decide to move my Korean investments to the EWY ETF instead because I really wanted just to ride the Korean economy, not try to beat it or risk trailing it by taking on “manager risk.” I’ve since sold my EWY, too, because I bought Korea largely due to the fact that it was so incredibly cheap and I don’t think it’s cheap anymore. Reasonable maybe, depending on your perspective, but (arguably) no longer cheap.

And finally, just to give you some idea of what you’re getting with this Fund, here are their top ten holdings, in order:

Samsung Electronic
Posco
Hyundai Heavy
Samsung Fire and Mar.
Daeweeo Shipbuilding and Marine
GS Engineering
Kookmin Bank
Shinhua Financial
Samsung Heavy
Shinsegae

And here are the top ten holdings of the Korea ETF (the top ten largest companies in the Korean exchange, more or less):

Samsung Electronics
Posco
Kookmin Bank
Shinhan Financial
Hyundai Heavy
Korea Electric Power
Hyundai Motor
Samsung Corp.
Shinsegai
Samsung Heavy

You can’t tell from that, but KF is actually somewhat less concentrated on the biggest names — it owns a bit less of Samsung Electronics, which is 14 or 15% of the entire Korean market, and of Posco, and it seems to be generally slightly more weighted on the heavy construction and marine business (Korea is a world center of shipbuilding these days). But overall, one would expect that the heavy focus of both of these funds on the few largest companies in Korea means they’re probably going to continue to move more or less in line with each other over time. KF might be helped by their smaller helping of Samsung Electronics at the moment, since the chipmaker (among other things) has been a bit mired in the mud in recent years.

The other benefit, if you want to call it that, of a closed end fund is that they usually trade at a discount — so the Korea Fund trades at about a 7% discount to the underlying net asset value of the shares they own. There isn’t a way to harvest that discount unless the fund gets popular and suddenly trades at a surplus in the future, but many people like the perceived “cushion” that a discount might provide. My personal theory is that the discount or premium just amplifies what the returns would have already been, so when the fund is falling people sell in panic and the discount gets larger, meaning that your shares fall faster than the index. When the fund is climbing, people want to buy and the discount shrinks, meaning your return might outpace the index. I haven’t proven this theory, it’s just my personal view.

So … certainly it has been a high income security, though not necessarily the best one to buy for immediate income, depending on your circumstances. And if you believe that Korea is on the cusp of great things this is one way to get a piece of that in a tradeable security (you can also buy several of the individual companies, including Kookmin, Posco, and a few others, as ADRs on the NYSE).

Oh, and I just checked the details — the default for this distribution is additional shares of KF. So unless you’re a shareholder of record by the 19th (Monday — which means you had to buy it last week) and specifically tell them that you want cash, your dividend will be in the form of additional shares. And the dividend is almost entirely a taxable long term capital gain in this case. You get the dividend as long as you buy shares by November 28, and it will be distributed on the 29th, on which day the share price of the fund will also drop by roughly the amount of the dividend.

Happy Investing, everyone.

Apologies for those who were unable to get in to the site this morning — some technical problems with my host really messed things up. I hope to be able to fix it soon so that doesn’t happen again.

Anyway, on with the work at hand:

This teaser has been circulating for a few months, but I’m still seeing it pretty frequently so I thought I’d take a little stab at it here. As we’ll see in a moment, this is actually probably a more interesting time to look at most of these companies than a couple months ago, though that doesn’t necessarily mean there’s anything worth buying here (that’s up to you, of course, the Gumshoe just digs — he can’t tell you what to do with your own money … and if he could, you probably shouldn’t listen).

But anyway, this is all about the secret “Phipps Stock Market” — yet another one in a long line of invented titles by newsletter publishers that obscure the names of relatively common investments. And I appreciate that, it gives a little flair to the emails and gives us something to talk about — and of course, it gives the Gumshoe something to uncover.

This one’s from The Oxford Club, a newsletter I haven’t done much snooping into in the past, though I know several folks aver at the forum have been generally complimentary of the service (if you disagree, please let us know — knowledge is power!). I believe it’s currently on sale (as are almost all newsletters, almost all the time) for $79 a year.

And along with the subscription, they’re hawking their special report: “America’s Private Stock Market: How to Make 2,441% this Year from the Coming Private Equity Boom.”

That is, clearly, what the Phipps Stock Market is — the private equity market. Steelmaker Henry Phipps, a contemporary of Andrew Carnegie, is the Phipps discussed in the letter (and the Phipps fortune is still around, for whatever that’s worth). His “private equity” fund, the Bessemer Trust funded by J.P. Morgan’s buyout of their company, U.S. Steel, for a then-unimaginable amount of money, acted not unlike the buyout firms of today (though maybe a little more like Berkshire Hathaway than the LBO flippers of the 1980s, I suppose). That’s mostly in the ad letter, so no big secret there.

The crux of the argument in favor of private equity, according to the Oxford Club in this ad, is that these companies can proceed without regard for public market pressures, can keep all their capital gains or distribute them as they see fit, can issue large dividends to owners if they want to, etc. … all the same arguments that I’m sure the private equity guys still use when trying to convince a public company to accept a private buyout today. Certainly, being a private company is easier in most respects.

The Oxford Club’s promise is that, “while these private funds generally require investment minimums well into the millions, you could soon sidestep all the red tape and grab 2,441% in combined gains over the next 12 months… not including dividends … starting with just a few hundred dollars.”

And they’ve got four investments to allow you to participate in the private equity market. As we’ll see in a moment, if you’re someone who bought into these even last month you’re probably a little grumpy about it, but who knows, maybe we’ve got some bargains here. Just to warn you, this is a little bit of an atypical Gumshoe writeup — the clues are very sparse, so I’m only really sure about two of these, the first and last ones may be worth discussing but I don’t know if we can pin them down exactly (or at least, not without lots more work by the already beleaguered Gumshoe).

Of course, I can already hear your complaints — “private equity is dead!” … “Hedge funds are ripoffs” … “moribund debt markets mean an inexorable decline for highly leveraged private market transactions”

That last one was an accountant sneaking in … sorry. I don’t necessarily disagree that this isn’t the right time to buy private equity firms or targets, though I think those who “know” that timing is perfectly wrong are, themselves, often perfectly wrong. I will note that James Stewart has a good article on the Ivy League endowments in the latest SmartMoney (sorry, I don’t think the article is available for free online yet), and those big guys continue to emphasize alternative investments, including real estate, timber, energy etc, but they also still put a lot of money into market neutral investments (hedge funds) and private equity, especially compared to their holdings in the more prosaic stocks and bonds that the rest of us typically favor. So, maybe in the long term a little private equity could be good for us even at these prices … I dunno.

So what are the four investments?

“PHIPPS STOCK #1 - The ‘Fund of Funds’”

They call this a conservative fund that invests in 27 “Phipps Market” investments. From the description, it has to be either a closed end fund or an ETF. Priced at “less than $50.”

This one is, unfortunately, a little tough — the most likely candidate here, the relatively new (less than a year old) Powershares Listed Private Equity ETF (PSP), doesn’t quite fit the clues — it’s priced around $25, so the $50 clue doesn’t make much sense, and it actually holds 30 stocks (as does the index it is designed to track, the Listed Private Equity index by Red Rock Capital Management).

So that’s out there, for folks who believe that private equity is the wave of future profits … and it’s quite a bit cheaper than it was last month, down roughly 15% at the moment.

So I suppose that’s a possibility — I don’t think the fund had exactly 27 investments in it at any earlier point in its existence, either, though that’s possible, so I suppose we may be dealing instead with some kind of Closed End Fund. Unfortunately, there are at least dozens of these thanks to the popularity of hedge funds in recent years — there are 30 or 40 in London alone. There are also quite a few mutual funds that offer hedge fund like strategies or that buy hedge funds as part of their portfolio, and some Rydex ETF products that attempt to mimic hedge fund strategies without buying hedge funds (their Sphinx ETF, which was more of a hedge fund of funds product if I remember correctly, got smoked by the Refco scandal and I believe no longer exists).

So, I hate to say it, but if you want to track down all the various fund of funds CEFs, you’re on your own on this one — that’s far too boring for the Gumshoe. If that’s what you want, probably the Powershares ETF is more liquid and offers the kind of diversification that’s being teased here, whether or not it’s the investment they had in mind. I expect the expense ratio is likely much smaller, too. The ETF holds the big guys like Fortress Investment, as well as the non-Hedge fund private equity companies like Leucadia and American Capital, and some other interesting investments — including Affiliated Managers Group, which owns Third Avenue and a bunch of other small, well respected money managers, including some who advise or run private equity and hedge funds. I expect they probably hold Blackstone by now, too.

“PHIPPS STOCK #2 - Invest Like a Barbarian”

This is a fund that’s a child of a “specialty financing firm”a behemoth of the private equity world.

The parent “put modern private equity on the map with its buyout of RJR Nabisco on the “Phipps Stock Market” for $36 billion back in 1989.”

This is a spin-off of that well known parent.

“Toys R Us, Sealy Mattress and Neilsen Ratings are churning out profits for investors in this fund”

8.10% dividends.

They call this a perfect pure investment in the private equity market … so what is it?

Well, clearly the parent is Kohlberg Kravis Roberts, of “Barbarians at the Gate” fame. And the spinoff publicly traded fund must be …

KKR Financial (KFN).

That counts as an “oops” as far as July recommendations go, since KKR Financial is pretty heavily into residential mortgages and also has a REIT subsidiary (or something like that), and therefore fell just like all its compatriots pretty dramatically in recent weeks. The shares plummeted to about $10 (from $25) very briefly, and are now trading around $15. The dividend last year was just over a dollar, so the indicated dividend of 8.1% makes sense.

So, what else have we got?

“PHIPPS STOCK #3 - Make 1,118% on the IPO of the Decade”

This is a private equity company that went public “not long ago.” They’ve at least updated the teaser, since when I first saw this one they were saying it was “about to go” public.

“We love the fundamentals here, and this offering is unique: It gives you a cut from the enormous dividends this fund collects from its holdings every year.”

They say that they’ve “discovered a simple, safe way to play it for swift capital gains of 1,118%. plus dividends.”

I have no idea what kind of time frame they’re talking about, or whether their “simple, safe way” includes options, but 1,118% is a pretty stiff promise to make to investors.

They also say that “some investors will likely get clobbered by playing it the wrong way.” Whatever that means.

So, they may have some kind of mysterious trading strategy around this investment, but it’s pretty clear that, given the time frame for when it went public, that they’re talking about …

Blackstone (BX).

I have no idea what they mean by “playing it” the right way. It is certainly much cheaper than it was back when they went public to much fanfare, thanks to the fact that private equity firms can’t sell their debt so easily these days, but it may well recover. The sentiment seems to be that Blackstone managed to sell out at the top, further burnishing the reputation of Stephen Schwarzman, but of course I have no idea if that’s true or not. They did just manage to finish funding a massive new investment pool of over $20 billion, so they’ll have plenty of fees coming their way, and they did beat earnings expectations in their first public quarter.

The expectation is that Blackstone will indeed have the potential to pay some pretty significant dividends — but keep in mind that, as a partnership, I think it’s also possible [warning: this is not tax advice and I probably don't know what I'm talking about] for you to be taxed on earnings that you haven’t received. They can keep earnings for investment, I think, but you still have to pay your taxes on them. Might be something to investigate, as well as your tolerance for handling a whole different kind of tax form if you do your own taxes and haven’t dealt with partnership income before, but as a partner you do also certainly have some rights to ongoing earnings — which is what I expect they mean by that “gives you a cut from the enormous dividends this fund collects from its holdings every year” bit.

Time to close this out … what else is in this “Phipps Market?”

“PHIPPS STOCK #4 - The Coming 1,223% ‘Takeover Target’ Windfall”

This is a company that they expect to be taken over by private equity (though they’ve been saying that they expect this “over the next few weeks” for well over a month now).

“This takeover announcement could hand investors in the target company 10-bagger gains.” (That’s got to mean options — unless they’re insanely optimistic).

So, what’s this company that’s due to be taken over, according to the Oxford Club?

It’s a software firm that’s flooded with cash and helping Fortune 500 companies solve an extremely challenging problem: getting their “in house” software programs to talk to each other.
So, discounting for the moment the fact that many rumored buyouts — and even agreed upon buyouts — are off the table now that the market has gotten so much worse for these deals, is it possible to determine which company this is?

Maybe not precisely, since they don’t give any specifics. It could have been Affiliated Computer Services if I was writing this in 2006, since last year they agreed to a buyout by Cerberus, but folks are so pessimistic about that that the shares are trading well under the buyout price.

I’m going to have to stick to guessing on this one, I think — there are plenty of private equity rumor mills, so if someone has a better idea for us, please let us know, but I think it’s pretty likely that they’re talking about either Computer Sciences Corp (CSC) or EDS (EDS). Both are IT outsourcing companies that do pretty much what the teaser says they do, both have been rumored private equity targets in the past (for years, in the case of CSC) and are pretty richly valued already as a result, and both have quite a lot of cash (though not that much net cash, in either case).

I could easily be wrong on this, so I’d be happy to hear your thoughts on this potential takeout target … though I think the days of profitably speculating on takeout targets may have receded into the rearview mirror for at least a little while.

I don’t know if the huge backlog of investable cash that the private equity firms have on their books will be good or bad for the market, or for the firms themselves. Certainly buyouts have been expensive in the last year as the big firms have competed for the choicest companies, but even as things turned south this Summer the firms were completing massive investment funds — there remain untold billions that are held by the big private equity firms and that are not yet invested, so that’s clearly going to have some kind of impact somewhere, whether good or ill I don’t know. It’s true that the buyout firms are having trouble getting financing lately, but if that clears up there’s no telling what they might buy (and if they get desperate, I suppose they could always pay cash…).

So … I thought I should look into this one, since I’ve been seeing it flash across my screen for months now, but I’m finding this conclusion terribly dissatisfying — it’s not so fun to sleuth out companies that have fallen on hard times in between a teaser’s first occurrence and my efforts, but who knows, maybe those of you who still have a yen for private equity and hedge funds will find a bargain in this muck.

Want to keep up with the Gumshoe? Subscribe now by entering your email at the top right of this page.