While my previous long bias remains, the recent market weakness after a strong October has finally given me pause. I had been insanely long (using significant margin) up until today because there were continual buy signals (technicals, insider buying) which lined up with the businesses and valuations I liked (durable competitive advantage/roe at less than 25 ttm earnings).
The business thesis for most of these investments remain, but my portfolio has simply gotten too large and often leads to a fundamental issue of my approach. A stock that falls is cheaper and often a better buy (value), but persistent weakness is often a signal of worse things to come (momentum). My bread and butter approach is to find businesses which I would like to buy as they get cheaper, but wait under the trend turns (or at least stabilizes) to prevent a Bill Miller-like 2008.
The corollary to the above then, is to not hesitate to cut positions when the trend turns or weakens, even if an investment has not reached what I believe to be fair value. This has happened now with HLSS, VOYA, AIG, (some of the largest positions) and have I reduced. I had recently added to HLSS on weakness because 1) the weakness was not panic-driven and 2) there was a nearby catalyst that could reverse the trend (earnings). The earnings driven pop has now weakened, so I have reduced the position to more manageable level, especially given the lower returns which I now believe is reasonable for HLSS.
As for specific numbers, I use a variation of the kelly criterion, described by another well-known blogger and money-manager.
*My approach remains value + trend-following, for the
long-term. While minimizing activity is a goal, position-sizing and
risk-management is necessary to ensure the portfolio can take advantage
of long-term views.
Thursday, October 31, 2013
Monday, October 28, 2013
A broad market squeeze... upwards?
With the current relentless rally, I do wonder how this compares to the post-92 rally, when stocks would steadily reach new highs. Shorts (esp. valuation/tech) continue to get clobbered (save for pockets such as China tech in the last week), but of all the long positions I own (e.g. VOYA, AIG), I'm finding it hard to reduce because they all seem highly compelling as businesses and technically. I have reduced a percent here or there, but remain very long and have very few/often no shorts on.
Time will tell, but communities such as zerohedge do keep me more comfortable. If everyone has bought in, the rally is tough to sustain. If, however, there are many doomsday sales/shorts in the market...
Time will tell, but communities such as zerohedge do keep me more comfortable. If everyone has bought in, the rally is tough to sustain. If, however, there are many doomsday sales/shorts in the market...
Saturday, October 26, 2013
HLSS - A Follow Up
I've written about Home Loan Servicing Solutions, Ltd. since last year and added from 19$ all the way until $25. With the price at $23.90 as of today's close, I'm still in the money, but a bit from the highs.
Despite being different than a traditional mREIT, HLSS has fallen similarly from its highs. From fears about book value to lower dividends, HLSS has become a victim of the general shift away from (financially-driven) dividend stocks. An even more fundamental reason is that in a time of rising rates, the relative value of other fixed income-like investments are less (similar to duration risk for treasury bonds).
Bill Erbey (Chairman) did address this on the Q3 conference call, referring to the current valuation and weakness relative to equity market as a whole as due to 1) interest rate volatility and 2) an assumption of low-growth and relatively high valuation due to book (~1.4). The latter does seem the most interesting, as Erbey hints (but not does detail) that this assumption is not true. But where/how does growth come from?
There are plenty of articles about the market opportunity for mortgage servicing rights (MSRs) in general (see Nationstar's S-1 last year for one), but how does the selling reach HLSS? Ocwen can buy rights at about 3% of UPB or less and sub-sells a portion to HLSS. 3% is roughly 6 times the (max) 50 bps fee that Ocwen gets. MSRs are a wasting asset with principal (pre)payments, however, and 6 times is higher than the 4 or even 2 times paid for homeward. Granted, there are more details (quality of borrowers, delinquencies, etc.) which could make either one worth it or not, but the multiple is a bit worse than before. On the other hand, HLSS only needed to use 0.64% for ~0.20% annual revenue in cash to subservice the same asset from Ocwen by borrowing the rest. In other words, HLSS paid the full purchasing price that Ocwen paid, allowing Ocwen to gain revenue without paying for it (a nice business model). HLSS gains the ability to lever by keeping the less volatile part of the fee (variation is usually paid by Ocwen).
HLSS gets most of that cash from equity raises as 90% of net income is paid out as dividends, so that doesn't necessary increase (or even maintain) the dividend. What does? the 90-250% of net income that is cash available for reinvestment (from the Q3 investor presentation):
The non-cash amortization of the MSR portfolio (due to prepayments) means that HLSS has more cash to buy assets and the the dividends are only part of the story. It is true that the amortization means lower future revenue from the existing revenue, so it is up to HLSS to deploy that cash in an accretive manner.
The result? HLSS has an insurance like-free float available to invest in more MSRs - if prices remain low and there is more selling from banks such as Citi (banks currently 50% of $10 trillion market).
Based on the next $50B to be acquired (after 2 quarters and given that amortization decreases per the conference call, then 5% quarterly UPB increase after):
With a 7.66% yield, that means in one year, HLSS could be trading >$30. My previous write-up underestimated the sizes of the equity raises necessary, so this is closer to the mark.
*Disclosure: still long HLSS
Despite being different than a traditional mREIT, HLSS has fallen similarly from its highs. From fears about book value to lower dividends, HLSS has become a victim of the general shift away from (financially-driven) dividend stocks. An even more fundamental reason is that in a time of rising rates, the relative value of other fixed income-like investments are less (similar to duration risk for treasury bonds).
Bill Erbey (Chairman) did address this on the Q3 conference call, referring to the current valuation and weakness relative to equity market as a whole as due to 1) interest rate volatility and 2) an assumption of low-growth and relatively high valuation due to book (~1.4). The latter does seem the most interesting, as Erbey hints (but not does detail) that this assumption is not true. But where/how does growth come from?
There are plenty of articles about the market opportunity for mortgage servicing rights (MSRs) in general (see Nationstar's S-1 last year for one), but how does the selling reach HLSS? Ocwen can buy rights at about 3% of UPB or less and sub-sells a portion to HLSS. 3% is roughly 6 times the (max) 50 bps fee that Ocwen gets. MSRs are a wasting asset with principal (pre)payments, however, and 6 times is higher than the 4 or even 2 times paid for homeward. Granted, there are more details (quality of borrowers, delinquencies, etc.) which could make either one worth it or not, but the multiple is a bit worse than before. On the other hand, HLSS only needed to use 0.64% for ~0.20% annual revenue in cash to subservice the same asset from Ocwen by borrowing the rest. In other words, HLSS paid the full purchasing price that Ocwen paid, allowing Ocwen to gain revenue without paying for it (a nice business model). HLSS gains the ability to lever by keeping the less volatile part of the fee (variation is usually paid by Ocwen).
HLSS gets most of that cash from equity raises as 90% of net income is paid out as dividends, so that doesn't necessary increase (or even maintain) the dividend. What does? the 90-250% of net income that is cash available for reinvestment (from the Q3 investor presentation):
The non-cash amortization of the MSR portfolio (due to prepayments) means that HLSS has more cash to buy assets and the the dividends are only part of the story. It is true that the amortization means lower future revenue from the existing revenue, so it is up to HLSS to deploy that cash in an accretive manner.
The result? HLSS has an insurance like-free float available to invest in more MSRs - if prices remain low and there is more selling from banks such as Citi (banks currently 50% of $10 trillion market).
Based on the next $50B to be acquired (after 2 quarters and given that amortization decreases per the conference call, then 5% quarterly UPB increase after):
With a 7.66% yield, that means in one year, HLSS could be trading >$30. My previous write-up underestimated the sizes of the equity raises necessary, so this is closer to the mark.
*Disclosure: still long HLSS
Thursday, October 3, 2013
Macro as an opportunity - HLSS, IBTX
Many have lamented the dominance of macro-events in markets. From 2008's soul-crushing housing-driven swings in the market to 2011's euro-crisis dips, financial journalists and some money managers bring up the difficulty of investing when all stocks move up/down together. This, however, assumes that daily market moves are the main risk to investing, i.e. seeing the market drop 5% in a week is painful. This may indeed be true emotionally when most judge performance on a daily/monthly/quarterly basis.
What if we instead see the stock market as simply a marketplace for buying companies? Indeed, what if macro drawdowns are just Mr. Market instituting a fire-sale of all items? A heat-wave inside Target may make the dairy products go bad, but how about the clothes?
Few would believe that all companies are equally affected by the government shutdown, so given any (fear-driven) corrections in the market as a whole, I'd actually welcome them as opportunities to buy unjustly affected companies.
--
Actions speak louder than words, though, so I am therefore taking this opportunity to buy more of HLSS, IBTX and UHAL, the first two of which I plan to write more of.
What if we instead see the stock market as simply a marketplace for buying companies? Indeed, what if macro drawdowns are just Mr. Market instituting a fire-sale of all items? A heat-wave inside Target may make the dairy products go bad, but how about the clothes?
Few would believe that all companies are equally affected by the government shutdown, so given any (fear-driven) corrections in the market as a whole, I'd actually welcome them as opportunities to buy unjustly affected companies.
--
Actions speak louder than words, though, so I am therefore taking this opportunity to buy more of HLSS, IBTX and UHAL, the first two of which I plan to write more of.
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