Today's Opportunities - July 1, 2008

This quarter we’re removing nine funds from our recommended list and adding six.. In our opinion the best opportunities are likely to be found in the U.S. small and mid-cap growth sectors, natural resources/energy, Africa/Middle East region of the emerging markets – each of which has shown resiliency in the market turbulence to date.  We suggest remaining overweight “growth” funds relative to “value” at this juncture as well.

For those who believe the bear market has further to run, we continue to recommend modest positions in the Grizzly Short and Prudent Bear funds - maybe 15-30% stakes in aggregate. Even without “alpha”, or risk-adjusted excess return, the reduced day-to-day portfolio volatility afforded by these funds make them prudent investments.   We continue to advise against owning real estate investment trusts (REITs), high yield bonds, and other instruments heavily dependent on issuing securities to fund their operations – typically financial service companies.

Opportunities are developing in the preferred stock and fixed income arenas as credit conditions continue to deteriorate.  Municipal bonds look extremely timely from a strategic perspective, especially for investors nearing retirement in higher-tax states such as California. Though it wouldn’t surprise us to see spreads widen out further (relative to treasuries) over coming months, the combination of historically wide tax-adjusted yield spreads and the high probability of tax rate increases after the election really shift the decision from “if” to “when” investors should make purchases.

Over the next quarter we will also be looking at opportunities in the convertible preferred, trust preferred, exchange-traded debt, convertible debt and closed-end fund spaces.  While often illiquid, these securities trade on the major stock exchanges and can be purchased through most brokers for commissions similar to those paid for common stock.  As is often the case when markets collapse, these less liquid sectors have been abandoned by underwriters, market-makers and investors alike, leaving solid long-term potential for those willing to conduct the research, step in to buy and hold for years to come. 

For those interested in researching indenture provisions and company capital structures themselves, we recommend a great free resource – QuantumOnline.com.

Changes in Fund Recommendations

We’re not going to elaborate on every change we made this quarter but will provide a bit of color for what we consider to be the more interesting edits to the list.

Hennessy Focus 30 (HFTFX): this is a “swing for the fences type fund”; it’ll likely leave you either jumping for joy (homerun), or crying in yourself to sleep (strike out).  The fund’s extremely concentrated with investments in just 30 companies and a handful of industries so it’s likely to see some drastic moves from time-to-time.  Yet the long-term performance is pretty impressive, assets haven’t ballooned to levels that hinder manager Neil Hennessy’s ability to be nimble, the expense ratio is fair and it’s available as a no-transaction fee fund through Fidelity, Schwab and TD Waterhouse.  Only buy in small amounts (maybe 5-10% of your portfolio value) with a plan to hold it for years to come and you’ll likely be well rewarded.

Loomis Sayles Mid Cap Growth (LAGRX):  Momentum investments have been working since late last year and this fund has capitalized.  With investments like MasterCard and First Solar it’s easy to see that the main risk to performance is a change in investor bias from growth, back to value.  Like Hennessy, this is a reasonably priced offering in sector being favored by the market presently but vulnerable – don’t load up too heavily on it.

PIMCO Commodity Real Return (PCRAX) - A: Returns have been stellar in 2008 after a trying first four years in which the fund trailed the natural resource sector by nearly 60% cumulatively.  Unlike most natural resource funds, the PIMCO offering uses a derivative-based strategy for implementing its views.  Specifically it buys and sells contracts tied to commodity prices which could expose fund shareholders to counter-party credit risk that we would vet prior to investing.

Janus Contrarian (JSVAX):  Fund’s value-oriented style is now out of favor – time to move on.