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Home > Blog > Monthly Archives: December 2015

Monthly Archives: December 2015

Prospect Capital Corporation – a Major Player in the Business Development Company (BDC) Marketplace – Faces Increased Scrutiny and Questions

As noted in a December 24, 2015 article in The New York Times (“Obscure Corner of Wall St. Draws Skepticism from Investors”), one obscure sector of the stock market – Business Development Companies (“BDCs”) – has been the subject of increasing controversy over some of its results and fees.

BDCs are firms that were created by Congress in 1980 to encourage investment in small businesses whose growth may generate jobs. They sell stock to the public and then use some of the proceeds to make loans to emerging businesses for a variety of needs. The category has grown tenfold over the last decade, to $64 billion in assets. That is partly because business development companies offer higher yields in exchange for the high-risk nature of their assets, and partly because they cater to a market that big banks have retreated from since the financial crisis.

One of the most criticized business development companies, however, is Prospect Capital Corporation (NASDAQ: PSEC). With $6.6 billion in assets as of September 30, 2015, Prospect is a large player in the category. But in the last year and a half, its stock price and net-asset value per share have been steadily sinking. Even before the recent junk-bond market upheaval, Prospect has traded at a discount to net-asset-value of more than 30 percent this year, well below the average of less than 20 percent for such firms.

Some analysts have accused Prospect of charging what they say are conspicuously high fees, even as investor returns have faltered. And others have taken issue with the compensation paid its chief executive, John F. Barry III — more than $100 million annually in recent years, according to estimates by former employees and an outside analyst.

Prospect invests in high-yield, high-risk assets like stocks, loans and bonds of companies through private equity buyouts, finance companies, debt pools like collateralized loan obligations, real estate investment trusts, aircraft leasing and even online loans – a significant portion of which are leveraged. Prospect’s fees, however, like those of many business development companies, are similar to those of private equity funds. Its external manager charges a 2 percent annual management fee on all assets plus an incentive fee of 20 percent of certain income gains — and administrative expenses — at the high end of the sector. For its fiscal year that ended in June, the Barry-owned manager received fees and expenses totaling $240 million, or about 3.5 percent of its total assets, according to the company’s annual report.

Some analysts say Prospect has often paid out dividends above its earnings, and sold stock below its book value, both of which can hurt investors. Both moves have helped Prospect raise its assets tenfold since 2008, also increasing fees. With its shares down 34 percent in the last 17 months, Prospect has curtailed new stock sales. As a result, growth of its assets slowed to 5 percent in its latest fiscal year from an annual rate of 58 percent over the previous five years.

One reason for Prospect’s big discount to net-asset value, now 28 percent, is that some investors are skeptical of the value Prospect reports for some assets – commonly referred to as “Level 3” assets – which means that, rather than being priced based on actual trade prices, these investments are valued by management based on their own estimates and valuation models.

The combination of leverage, questionable Level 3 valuations and excessive fees are, more often than not, an indication of potential significant concern – especially in a rising interest rate environment.

If you are an individual or institutional investor who has any concerns about your investment in Prospect Capital Corporation or any other Business Development Company (“BDC”), please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Tom Buck Update

The latest on broker Tom Buck, is a settlement has been made costing $4.1 Million for Merrill Lynch. For the all the details visit

ArbitrationTask Force Attorney Mark Maddox Served on Final Report Issued

Our own attorney Mark Maddox served as one of the 13 members of the FINRA Dispute Resolution Task Force Members. FINRA released their recommendations this week in the  Final-DR-task-force-report. With 51 recommendations to enhance the arbitration and mediation forum, the next step is for FINRA’s Standing Board Advisory Committee to review them. The National Arbitration and Mediation Committee (NAMC) will meet to discuss the report and can make recommendations on items to implement immediately, items that will require further discussion and items that may not be feasible. Click here for a link to FINRA’s press release on Explained Decisions, Increased Arbitrator Honoraria, Creation of a Special Arbitrator Panel for Expungement Hearings Among Recommendations

High-Yield Bond Funds: A Growing Crisis of Concern

As reported by The Wall Street Journal on December 15, 2015 (“Investors Abandon Risky Funds”), the U.S. High-Yield bond rout has deepened this week, with the bonds of dozens of low-rated companies falling anew and the shares of some large fund-management firms tumbling as well.

Investors retreated from the U.S. junk-bond market for the third straight trading day and stocks of large asset managers were hit by heavy selling, a sign that the deepest turmoil in financial markets since summer is intensifying. Some investors reported difficulties selling lower-rated bonds quickly or at listed prices, though others said the market appeared to stabilize somewhat after the record plunge in prices on Friday.

While the market for the highest-quality bonds remains intact, there are signs across Wall Street that investors are losing confidence in lower-quality bonds and the firms that most actively deal in them.

Waddell & Reed Financial Inc., which manages the $6.2 billion Ivy High Income Fund, has suffered the largest outflows this year of any junk-bond fund. According to Morningstar, investors withdrew $1.8 billion from the fund this year through November, the highest level of any high-yield bond fund during that period. The Ivy High Income Fund is among the worst high-yield performers this year, according to Morningstar. The fund is down 6.4% this year through last Friday.

AllianceBernstein Holding LP, which runs the $5.8 billion AB High Income Advisor fund, dropped 7% and Affiliated Managers Group Inc., a major investor in Third Avenue Management LLC, which last week suspended withdrawals at its junk-bond fund, dropped 5.7%.

If you are an individual or institutional investor who has any concerns about your investment in high-yield bond funds, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

High-Yield Bond Funds: Increasing Blood in the Water

As reported by Bloomberg on December 13, 2015 (“Investors See Third Avenue Fueling More Bond Market Carnage”), “top bond managers are predicting more carnage for high-yield investors amid a market rout that forced at least three credit funds in the past week to wind down.”

The three bond funds that suffered losses within the past week include the Third Avenue Focused Credit Fund (which has announced the suspension of investor redemptions from its $788.5 million mutual fund), Stone Lion Capital Partners (which has announced the similar suspension of investor redemptions from its $400 million fund) and Lucidus Capital Partners (which has announced the liquidation of its $900 million portfolio).

Some Wall Street experts, including Jeffrey Gundlach, Carl Icahn, Bill Gross and Wilbur Ross, are predicting that an increasing percentage of high-yield funds may face a high level of withdrawal requests as more and more investors become concerned about the ability to get their funds back.

The root of the problem facing many high-yield funds appears to be the valuations of the securities that are held in their portfolios – securities that are valued based on the estimates of their portfolio managers that have no basis in fact or reality when those securities are later attempted to be sold. This forces a fire-sale of the securities at prices that are significantly below what they are being carried on the books of the funds at which then leads to the inability of those funds to meet investor redemption requests.

If you are an individual or institutional investor who has any concerns about your investment in the high-yield bond funds, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Third Avenue Focused Credit Fund Sinks – Not Enough Lifeboats as Investor Withdrawals are Suspended

A firm originally founded by investor Martin Whitman has announced that it is barring investor withdrawals while it attempts to liquidate its high-yield bond fund, an unusual move that highlights the severity of the months-long junk-bond plunge that has swept Wall Street.

The decision by Third Avenue Management LLC means investors in the $789 million Third Avenue Focused Credit Fund may not receive their money back for months, if not more.

Third Avenue Management, in a letter to investors dated December 9, 2015, said that investor redemption requests, coupled with the general reduction of liquidity in the fixed income markets, have made it “impracticable” for the Third Avenue Focused Credit Fund to honor requests for those investors who want their money back.

The move at Third Avenue Focused Credit Fund is intended to facilitate an orderly liquidation of the fund, which recently had $789 million in assets, down from more than $2.4 billion earlier this year.

If you are an individual or institutional investor who has any concerns about your investment in the Third Avenue Focused Credit Fund, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Regulators & Investors Anxiety towards ETF’s Grows

Recently, Exchange-Traded Funds are being perceived as scary to many in the investment world. Some financial advisers say they are now guarded about recommending the products to clients. Lots of questions arose about the products’ trading and marketing in the days following the Aug. 24 “flash crash,” when prices of several ETFs appeared to come unbalanced from their primary value.

According to the Wall Street Journal, for those looking to practice “safe ETF,” here are five questions to consider:

  1. Do ETF investors have enough safeguards?

There are plenty of consumer-protection regulations surrounding ETFs, but that doesn’t mean the rules are airtight.

Initially created to track indexes, ETFs are similar to mutual funds in that they mostly consist of baskets of stocks and bonds, but they are different in that they trade on exchanges all day like stocks.

Because of ETFs’ hybrid nature—and because there is no separate “ETF law”—they are governed partly by the Investment Company Act of 1940, which sets rules for mutual funds, and partly by the Securities Exchange Act of 1934, which sets rules for brokers and exchange oversight.

The problem is, neither law was designed to account for a product that relies on second-by-second pricing of both itself and a collection of other securities. As Aug. 24 showed, ETFs in rough markets can fall harder than the prices of their underlying assets. In normal markets, ETF traders who profit from zooming in and out of the ETFs and their underlying holdings keep the values in line, but investors have been startled to see that balance can be disrupted at times.

ETFs are a “digital-age technology” governed by “Depression-era legislation,” analysts at fund-tracker Morningstar have said.

Exchanges, as well as some fund providers, are examining how to prevent these rare trading anomalies. Meanwhile, the risk that ETFs may not always trade or price as expected is one that investors need to consider.

  1. Everyone is doing it. Do I need to be invested in ETFs?

You don’t need ETFs any more than you need to buy the latest iPhone. One reason investors have poured money into ETFs is their tax efficiency and typically low fees (which is possible because 93% of the products track indexes with low turnover, according to researcher XTF Inc., which is what keeps down transaction costs and realized capital gains).

However, ETFs aren’t the only game in town when it comes to low-cost investing. In certain asset classes, index-tracking mutual funds can be just as cheap as comparable ETFs. What’s more, while ETFs are known for their tax efficiency, that may not be of great importance to everyone, especially those who don’t plan to hold the funds in taxable accounts.

What matters most—and what investors should focus on—is whether a fund’s underlying portfolio fits with their goals, says Rick Ferri, the founder of Portfolio Solutions and long a proponent of index investing. “Look under the hood,” he advises, because many funds that seem similar really aren’t and will produce very different results. From there, investors can assess the product’s structure and whether the costs involved in holding or trading it are a good fit for them.

For some people, ETFs’ intraday tradability is a strong selling point. Unlike mutual funds, which can be bought or sold only at each day’s closing net asset value (NAV), ETFs can be traded all day on exchanges, which usually makes it easier for investors to get into or out of positions at a market price quickly (except, of course, on days like Aug. 24). “How important is that to you?” Mr. Ferri asks.

Others like ETFs because they offer a way to get low-cost exposure to corners of the market that used to be inaccessible to most individual investors.

“ETFs have democratized access to a broad array of asset classes,” says Onur Erzan, director of McKinsey & Co.’s North American asset-management practice. “This has improved the ability of investors and advisers to construct more granular and efficient portfolios,” he says. These include specific segments of the government and corporate debt markets, including high-yield securities (junk bonds) and bank loans, as well as hard-to-reach economies such as China, India and other developing markets, domestic and international sectors and industries, and socially responsible themes. On top of these, some asset managers offer currency hedging within the ETF and leveraged or short daily exposure geared more toward professional traders.

  1. What happened in August and could it happen again?

Critics say stock-market swings on Aug. 24 exposed the flaws in ETFs they have been warning about for years. Proponents say ETFs mostly were caught in the crossfire of marketwide trading issues that had little to do with them. One thing is for sure: It wasn’t the first time ETFs have surprised investors.

ETFs were in focus during the flash crash of 2010, in which bids on dozens of ETFs (and other stocks) fell as low as a penny a share, and again in 2013, when municipal-bond ETFs traded at a discount to their net asset values during the “taper tantrum,” when bond yields jumped.

And then came Aug. 24. The debacle was a test for the labyrinth of new regulations put in place after the 2010 flash crash, and it wasn’t pretty. As the Dow Jones Industrial Average plunged 1,000 points, triggers went off for mandated halts in many stocks held by ETFs, as well as the ETFs themselves. Then, a number of ETFs stunned investors by trading at prices far below their NAV, highlighting concerns that ETFs might not be as easy to move in and out of at “fair” prices when markets are in disarray.

In response to the Aug. 24 debacle, the three U.S. listing exchanges—the New York Stock Exchange, ICE -0.85 % Nasdaq Stock Market NDAQ -0.58 % and BATS Global Markets Inc.—indicated they will no longer accept stop-loss orders on any traded securities. Such orders seem to protect investors by triggering a sale when a target price is met, but at a certain point in a falling market they become “market orders” that are completed at any price. The NYSE is considering a way to flag “aberrant” ETF trades.

Meanwhile, it may be more advisable than ever for investors to use limit orders—orders to buy or sell a security at a specific price or better, literally putting a limit on how low the price can go.

“Have good trading hygiene,” says Dave Nadig, director of ETFs for FactSet. “The vast majority of ETFs deliver on their core promise to investors. But if you trade them poorly, that’s probably on you.”

  1. What parts of the ETF market should I be most wary of?

Investors should be wary of “any area where there’s a lot of product development,” Mr. Nadig says.

Regulatory issues aside, the “safety” of any financial product largely depends on how well an investor understands it, and in this regard, the ETF ecosystem has grown more complicated in recent years.

The idea behind the earliest index-tracking ETFs was pretty simple: provide investors with market-cap-weighted exposure to entire markets or giant chunks of markets at the lowest possible cost.

Since then, ETF offerings have proliferated. Anyone with a brokerage account can now choose from among more than 1,800 different exchange-traded products, covering almost every conceivable market sector, niche and trading strategy. While some advisers love that—it gives them an easy, low-cost way to provide clients with exposure to certain market segments—the concern is that some less-sophisticated investors may be buying complex, heavily marketed funds without fully understanding what they are getting.

“ ‘Smart beta,’ in particular, creates real due-diligence problems,” Mr. Nadig says, referring to the growth in index products that shun traditional market-cap weightings and instead weight holdings according to an investment factor such as volatility, value, quality or momentum.

“With some new factor-based ETFs, it can be very hard to really understand what you are getting and why,” says Mr. Nadig. It requires understanding how the fund is segmenting securities based on a factor such as value, how it is weighting stocks in the portfolio, how often its index is rebalanced, and whether there are stock or sector limitations or weights.

If you don’t have the knowledge or time to build and manage a complex portfolio, it may be best to stick with broad-based index ETFs with significant assets and trading volume, experts say, and leave the niches to the pros.

  1. Where do ETFs go from here?

Even as ETFs continue to surge in popularity, gobbling up $200 billion in investors’ dollars so far this year, their emerging dominance in the passive-investing world is already being challenged.

Online broker Motif Investing, for example, offers low-cost direct investing in baskets of up to 30 stocks tied to investment themes, industries and sectors. It charges only $9.95 per “motif” trade or rebalance order.

Among “robo advisers,” which are automated investing services, Wealthfront now offers direct indexing for clients with more than $100,000. Instead of using an ETF, Wealthfront will buy anywhere from 100 to 1,000 individual stocks, proportional to their share in Standard & Poor’s market-cap-weighted U.S. indexes, and harvest tax losses at the individual security level. The company charges 0.25% of assets annually manages the first $10,000 free.

Traditional mutual-fund managers, meanwhile, are looking to ride a new investment vehicle developed by a unit of Eaton Vance EV -2.88 % —an exchange-traded managed fund that will trade all day like a stock but won’t have to fully disclose its portfolio like other actively managed ETFs—to sustain interest in their investment strategies. Similarly, other issuers of index ETFs, including BlackRock, State Street Corp. STT -2.08 % ’s State Street Global Advisors and Vanguard Group, are looking at ways to reintroduce ETF-inclined investors to active strategies.

“Investors will ultimately embrace them only if they are convinced of the incremental value versus some of the technicalities,” says McKinsey’s Mr. Erzan.

So far, it has all been a tough sell.

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