To date, we have selected three short candidates based upon having 50 percent or more of their constituent holdings in office and retail real estate stocks and our ability to short the stock at a reasonable cost. After reviewing the entire universe of ETFs and closed-end funds, we selected the Nuveen Real Estate Fund (AMEX: JRS, Figures 2-3), the iShares Dow Jones US Real Estate iShares (NYSEArca: IYR) and the iShares FTSE NAREIT Retail Capped Index Fund (NYSEArca: RTL). We have been short JRS since Aug. 27 (4 percent of exposures). We will opportunistically add IYR and RTL.
Strategic & Tactical Asset Positioning
On Sept. 29, 2009, we sold the rest of our iShares iBoxx High Yield Corporate Bond Fund (NYSEArca: HYG) and our iShares iBoxx $ Investment Grade Corporate Bond (NYSEArca: LQD). They were purchased in late 2008 and in early 2009 as equity substitutes at a time when a depression might have loomed. Our returns were near 38 percent on HYG and 18 percent on LQD. Our strategy was to sell these equity alternatives when they hit our expected price and return targets, which were harvested sooner than we expected.
Short-term gains from these trades will also offset the many short-term losses that we have realized to date in 2009.This trade enables us to show attractive tax efficiencies, which high-net-worth investors love.
Over the past few weeks, corporate bonds seem to be topping. They have experienced violent sell-offs with a couple of 2-3 percent daily declines on rising volume. Although HYG steadied last week, LQD did not. LQD ended last week at a new low for the month and it is testing its 50-day average. Last week's downturn shows that we were correct to raise a caution flag on corporate bonds.
We will be employing about 60 percent of proceeds from the sale of HYG and LQD (18 percent of gross exposure in the AI 75/50 Portfolio) into The Arbitrage Fund (ARBFX) and The Merger Fund (MERFX) soon. On Oct. 6, 2009, we allocated close to 70 percent of the sale proceeds from corporate bonds sales to the above two merger arbitrage (M&A) mutual funds. Additionally, 3.75 percent of portfolio assets were allocated to ARBFX with 3.75 percent allocated to MERFX. We will soon add 3.5 percent more (divided equally) to these funds to round out our target allocation.
On the date that we bought these funds, Charles Schwab provided the following market commentary about the day’s climate: “Stocks are solidly higher for the second-straight session on more M&A activity and carryover of economic enthusiasm from yesterday’s surprisingly strong reading in the ISM Non-Manufacturing Index.”
We are bullish on M&A because this strategy style seems to have bottomed. Year-over-year M&A deal volume collapsed. It is very unloved. However, weak domestic bank activity, combined with a hoard of domestic and foreign cash on the sidelines and deep value in direct company assets, attracts us. The strong are buying the weak with sound enterprise values but limited access to financing. A weak U.S. dollar also is a factor because enterprise assets are a hedge against inflation and an alternative to Treasury allocations, where much money is sitting that is normally targeted to M&A. M&A cash is hiding (but not for long).