EFTA00822153.pdf

From: "Ens, Amanda" •fl• To: "jeevacationtantail.com" <[email protected]> Cc: Richard Kahn Subject: Prefermds, thoughts on fixed income, mandatory converts Date: Thu, 04 Aug 2016 22:30:04 +0000 Attachments: GEVI_6.28.2016.pdf: AGN.PDF: TEVA.PDF: FTR.PDF Inline-Images: image005.jpg: imagc006.jpg: image007.jpg: image008.jpg: image009.jpg: intage010.gie imagc011.png: image003.jpg: imagc015.jpg: image016.jpg: image017.jpg Jeffrey, Rich mentioned you're interested in potentially buying preferreds. While they still pay a decent yield. I wanted to share some thoughts about why I would look at the more equity-Ilke mandatory convertible preferred market Instead. I've outlined a few points about fixed Income, with some specific mandatory convert details further down. Would love to discuss in more detail at your convenience. Is fixed Income the next "accident" waiting to happen in markets? • Japanese buying of US corporate credit is slowing • Supply is increasing • Investors are trafficking as "tourists" in bond markets that they don't usually buy — unwind could be painful • Risk parity quant funds might need to rebalance if the correlation between bonds and equities tums higher • High yield keeps climbing despite falling oil prices • Poor liquidity in a crowded trade (Volcker rule and other structural changes) The Japanese had been huge Incremental buyers of US corporate credit this year but last week's data shows this fell buying has fallen towards zero. This is happening in a market where supply is Increasing. Owns below. I attended some buyside meetings this week with our cross-asset and credit strategy teams and what really stood out to me was the relative acceptance of the continued theme of "tourism" in various credit markets ranging from US corporates to EM to European subordinated bank bonds to preferreds. With the incessant hunt for yield, there was even the Joke that the yield craze has approached Pokdmon-like levels. While the music could play on for a while, it seems that the risk-reward Is more favorable at this point for US equities vs. fixed Income. Equities are under- owned: institutions have net sold equities this year if you exclude buybacks, cash levels are at 15 year highs, investors have been buying protection but not much upside. Bonds don't seem to be pricing in sufficient risk premium, especially at the long end. We've been closely following quant fund positioning, leverage levels and potential for forced selling in the future. With risk parity fund leverage high and bond-equity correlation moving from negative to —zero now, the potential for rebalancing is on our radar. Risk parity portfolios own more bonds than equities (due to the lower bond vol), so there is more notional size of bonds to sell to rebalance, making US equities potentially less dangerous than the bond market. A few more details about risk parity funds are in the attached report (pages 9-11: Morket lmpoct of quant funds: Seporoung Jett from fiction) and in the Risk Polity Risks in Fixed Income writeup further down. Japanese buying of foreign bonds FELL again toward zero as of July 29 (vs LQD in yellow). L.,[email protected] EFTA00822153  id:[email protected] id:image006.JP8(g01DIEE78.B98D33A0 Mandatory Convertibly PrPharreds As investors continue to search and stretch for yield, mandatory convertible preferreds stand out to me as an attractive yet often overlooked opportunity. In case you're not familiar with them, they are generally short-dated, pay a high dividend and mandatorily convert into common stock at maturity. Due to the mandatory conversion, they lack a bond floor and are equity-like with yield enhancement. You're "paid to wait" while the underlying company's fundamental story develops, so they are attractive for names where we like the company's longer term prospects but are only neutral to slightly bullish in the near term. The yield, along with the conversion ratio sliding scale, can result in an attractively skewed upside vs downside profile for holding the mandatory convert vs the common stock. Allergen, Teva and Frontier Communications are three names we have high conviction on and they have mandatory convert preferreds that I recommend buying. Allergen (AGN) - BAML reaffirming BUY on AGN after the FTC approval of generics sale to Teva. We like AGN due to its healthy product mix, solid pipeline and flexibility to deploy capital to drive shareholder return. Next catalyst will be 2Q earnings/V.116 Outlook on 8/8. AGN Is on our firm's US-1list of best investment Ideas. Teva Pharma (TWA) - BAML reiterating BUY on TEVA after the FTCs approval of AGN generics deal. We continue to like TEVA's positioning in generic pharma where scale and product diversity are increasingly important. TWA remains one of our top picks in Spec Pharma. Frontier Comm (FTR) - BAM reaffirming BUY after rontier reported its first post-Verizon assets merger results. FTR's ea nings miss was due to a decline in the legacy business but FTR is targeting ncreased deal synergies that should offset the decli e In legacy business. We like FTR with Its 8.6% dividend yield and estimated 56% dividend payout ratio in 2017. We continue to think the market is mispricing FTR. BAML BA L to tot p to wn Stock Pfd Low High Current Advantage Ranking Price Tgt Upside to 25%: PM 25%: Pfd Notional Name Ref Level Sulke Strike Yield over Stock (Stock) (Stock) Price Tgt Return Return Outstanding AGN(AGNprA)5 3/1/18 252.95 893.45 288.00 3$280 6.2% 6.2% 1 - Buy $ 294.00 16.2% 22.7% -153% $5.0800 I TEVA (TEWF) 7% 12/15/2018 53.50 886.08 62.50 75.00 7.9% 5.4% 1- Buy $ 72.00 34.6% 32.6% -7.8% $3.7125bn FIR (rrapreL SL !Lj - 6/29/IS w 4.85 93.85 5.00 5.87 11.9% 3.2% 1 - Buy $ 7.50 54.6% 33.6% 1.2% $1.925bn urce: Boamoerg, S4Mt. Up/down return vs underlying stock price./- 25% assumes preferredIS held to maturity From Aug 2: Risk Parity Risks in US Fixed Income Psid:38917479 Today's simultaneous weakness in the US bond long end and weakness in US equities is unusual of late and tells us there is implications for risk parity portfolios. EFTA00822154 We expect a 165k change in Non-Farm Payrolls on Friday but a strong number sets up for some left hand tail risk in US Axed Income. Risk parity portfolios own more bonds than equities (due to the lower bond vol), so there is more notional size of bonds to sell to rebalance making US equities less dangerous than the bond market. Mardi 2017 ATM LQD vol is around 7.5% so a 100% Put costs —12% which given the long term chart below and all time high in shares outstanding looks cheap. Chart One shows hourly data of IEF (7.10y US Treasury ETF) and SPY (S&P500 ETF). Using 60 hourly data points, correlation has moved from around -80% a month ago to zero now. This means the volatility/leverage of risk parity portfolios is increasing and rebalancing is more likely to be required. This is happening while the US yield curve is steepening with Investment Grade Supply increasing. Yesterday, $23.4b of new investment grade credit priced, the highest daily volume in close to 3 months. As supply of duration has been increasing a few other topical IG issues are: On July 28 Apple issued — $7 billion On August 1, Microsoft issued —$20 billion Today, Alphabet — $ 2 billion Chart Two shows Investment Grade ETF, LQD, is at the top of a long term range with shares outstanding around an all time high. Hans Mikkelsen noted on Friday in "Credit Market Strategist" with Japanese inflows into IG market already at max strength there are mostly downside risks to US credit spreads associated with developments in Japan. Chart three is from "Global Equity Volatility Insights" from June 28 and suggests risk parity fund leverage is high and we do not think the relationships have changed significantly. Chart One shows hourly data of IEF (7-10y US Treasury ETF) and SPY (S&P500 ETF). Using 60 hourly data points, correlation has moved from around 40% a month ago to zero now. This means the volatility of risk parity portfolios are increasing and rebalancing is required. [slit i-d:98338928 Chart Two: Investment Grade ETF, LQD, is at the top of a long term channel with shares outstanding around an all time high. [,„:,tidarnage003.jpg@•OIDIEC9E.754418C0 Chart three is from "LiJahillImaty VelattIrCY_LLUglita" from June 28 and suggests risk parity fund leverage is high and we do not think the relationships have changed significantly. EFTA00822155  c bjdd:1994904455 Today on Bloomberg: Junk Debt Keeps Climbing Despite Plunging Oil Prices After moving in lockstep with oil markets for much of the last two years, high-yield bonds have gone their own way and posted modest gains while crude entered a bear market In early June. The Bloomberg USD High Yield Corporate Bond Index has advanced more than 2 percent with help from energy debt that comprises about 16 percent of its value. The question now Is whether turmoil In oil markets will drag down bonds of drillers and producers, taking the broader Junk Index with them, as defaults and bankruptcies pile up. Source. Bloomberg 8/4/2016 I his mer.sage. std any attaemems, is for the otended reopient(s)only, may contao informatuo that is gelvlieged.ccethdenbal and/or PlOPfletiq and subsect to important terms and corn:Event available at If you are not the molded rocosent. please delete this message. Amanda Ens Director The power of global connections" 6,,y_klimage031.png@OlD184D 2.3462f410 This message, and any attachments, is for the intended reel lent s onl . ma contain information that is privileged, confidential and/or proprietary and subject to important terms and conditions available at If you arc not the intended recipient, please delete this message. EFTA00822156