The other big default

As you read this, the U.S. stock market is selling off because Greece is teetering closer to default. But life is not good in the municipal bond market today, either. The reason: The governor of Puerto Rico has announced that the U.S. commonwealth cannot pay its debts.

How bad could that be? Pretty bad, actually. The island has about eight times as much municipal debt as Detroit does. Puerto Rico’s muni bonds were wildly popular with investors because their income was free from state and local taxes for residents of every state in the Union. And, because states and commonwealths can’t go bankrupt, investors figured they were safe.

Whoops. “The debt is not payable,” Mr. García Padilla, the island’s governor, told The New York Times. “There is no other option. I would love to have an easier option. This is not politics, this is math.”

puerto ricoYou might be thinking, “But I don’t own any Puerto Rico muni bonds!” But if you own a muni bond fund, it’s fairly likely you do. One of the largest muni bond funds is Oppenheimer Rochester Fund Municipals, a $6 billion fund. It has 27% of its portfolio in Puerto Rico bonds. Franklin Templeton Double Tax-Free fund, a $223 million fund, has 49% of its portfolio in Puerto Rico bonds.

But the biggest shock might come to holders of Oppenheimer Rochester Maryland Municipal fund, which is aimed at Maryland residents. The $60 million fund has Puerto Rico bonds stuffed into it like crabmeat in the Saturday night special on the Eastern shore. To be exact: The fund has 48% of its portfolio in Puerto Rico bonds, according to Morningstar.

The state-specific Oppenheimer Rochester funds seem to have a fondness for Puerto Rico. The Virginia muni fund has 39% of its portfolio in Puerto Rico; the Pennsylvania fund has 35%.

As of Friday, most of the Oppenheimer muni funds were showing modest positive total returns. Because Puerto Rico can’t go bankrupt, it’s likely it will try to negotiate longer payout periods or even partial debt forgiveness from its bondholders. And that, in turn, will push keep its bond prices down for some time to come.

Betting the bank

Sometimes, as a personal finance writer, you run into situations where awful companies are actually kind of good investments. Which brings us to bank stocks.

Jamie Dimon, CEO, JPMorganChase
Jamie Dimon, CEO, JPMorganChase

If you care about people’s personal finances, you know that one of the worst things a person can do is get deeply into credit-card debt. It’s a long, painful and expensive workout that, for many people, only ends in bankruptcy.

And what makes credit-card debt particularly difficult is the interest rate, currently an average 15.91%, according to For those with poor credit — typically those who are in the most trouble — the rate climbs to 30% or more.

On the other hand, if you are interested in investments, you have to love the interest rate spread on credit cards. The highest-yielding one-year bank CD in the land yields 1.2%, Bankrate says. And, according to the Federal Reserve, the default rate on credit cards has fallen to 2.10% in the first quarter from 6.81% in the second quarter of 2009.

And, in fact, it’s a swell time for lenders generally, at least in terms of defaults:

  • Residential real estate default rate was 6.14% in the first quarter, down from a high of 11.26% in the second quarter of 2010.
  • Commercial real estate default rate: 1.41%, down from 8.77% in the second quarter of 2010.
  • Commerical and industrial loans: 0.74%, down from 4.36% in the third quarter of 2009.

Agricultural loans had a slight uptick in the first quarter, but remain well below their recession highs.

What would make things even better? An increase in interest rates. Banks typically hike loan rates much more quickly than they do deposit rates.

The one fly in the ointment is large banks’ criminal tendencies, for which they have been paying breathtaking fines. Now, it may well be that they are even now engaging in making bad loans or doing illegal things. But the glory of investing in banks is that it takes years for investors to discover these things — and in the meantime, banks blithely report increasing earnings.

Probably the best way to invest in banks is through a diversified fund. One good index fund: SPDR S&P Bank ETF (KBE), up 4.35% this year. But pay off your credit cards first.

Nothing lasts

And in the mutual fund world, top performance is the main thing that doesn’t last. There are very few Triple Crown winners in the fund world.

"Seabiscuit workout with GW up" by Seabiscuit Heritage Foundation - Seabiscuit Heritage Foundation. Licensed under Public Domain via Wikimedia Commons -
“Seabiscuit workout with GW up” by Seabiscuit Heritage Foundation – Seabiscuit Heritage Foundation. Licensed under Public Domain via Wikimedia Commons –

Standard and Poor’s released its annual Persistence Scorecard and, predictably, it showed that few managers who are at the top stay there for long. In particular:

Out of 682 domestic equity funds that were in the top quartile as of March 2013, only 5.28% managed to stay in the top quartile at the end of March 2015. Just 3.95% of the large-cap funds, 5.26% of the mid-cap funds and 4.67% of the small-cap funds remained in the top quartile.

Over the longer term, the results are even worse. How many funds remained in the top 20% over five years? That would be none. Zip. Zero.

For fund investors, this means that your odds of picking a long-term winner are thinner than your odds of getting a new cell phone in less than three hours. And this strengthens the case for index funds: You won’t get a fund that’s in the top 20%, but you won’t get one that’s in the bottom 20%, either.

And speaking of the bottom 20%: The research shows that it’s more likely for a fund in the top 20% to be in the bottom 20% over time than it is for the reverse. Bad funds tend to stay bad, typically because of expenses, and there’s no real reason to try to bargain-hunt among mutual funds.

Why Greece matters

Greece, cradle of democracy and creator of souvlaki, has a gross domestic product of about $242.2 billion, or roughly half the assets of the Vanguard Total Stock Market Index fund. Why, then, does Greece wreak such havoc on the stock market?

Leonard G. - Own work. Licensed under Public Domain via Wikipedia
“AthensAcropolisDawnAdj06028” by User:Leonard G. – Own work. Licensed under Public Domain via

In a nutshell, here’s why. Greece owes about €323 billion ($361 billion) to various creditors, the largest and most important of whom is the International Monetary Fund. But Greece’s biggest worry at the moment isn’t the €323 billion it owes in total, but the €1.6 billion ($1.79 billion) it needs to pay by the end of the month.

In the worst-case scenario, Greece defaults on its debt, leading to an exit from the Eurozone, the 19 countries that use the euro as a common currency. This could lead to crushing economic consequences for ordinary Greeks, who are already suffering under austerity measures so strict that they have been labeled “sado-monetarism.”

It could also mean that European banks who have loaned money to Greece could suffer potentially crushing losses. More worrisome, a Greek exit also means that weaker Eurozone countries (we’re looking at you, Portugal, Spain and Italy) could follow, prompting a wave of defaults.

All of which would eventually affect the U.S., because debt defaults rarely remain contained. A severe recession in the Eurozone could mean that U.S. banks would get tripped up, spurring yet another financial crisis here.

There aren’t any great answers. Forgiving Greek debt runs the risk of moral hazard — that is, the notion that other debtors could easily decide that the consequences of default aren’t all that bad. Restructuring the debt makes creditors deeply, deeply unhappy. Asking for more austerity could unseat the current Greek government.

For the moment, at least, Greece seems close to accommodation with its creditors, and stocks have rallied on another tragedy narrowly averted. But that simply sets the stage for the next big Greek debt payment crisis next month.

What’s an investor to do? One solution would be to sell short shares of a Greek exchange-traded fund, such as Global X FTSE Greece 20 ETF (ticker: GREK). But that would lead to extremely painful periods like the past four days, which has seen the fund rise 14%.

For those who don’t want to wager on the fortunes of a single country — and who are optimistic about an eventual resolution between Greece and its creditors — a better bet would be a diversified European fund, such as T. Rowe Price European fund, up an average 14.3% a year the past five years, and 10.2% this year. Vanguard European Stock Index would be the choice for index fans,

ETF investors have an interesting choice in Wisdom Tree Europe Hedged Equity, which tries to limit the effects of the currency market, currently the bane of international investors. Eurozone countries are up 15.4% this year in euro terms, but 8.7% when converted to U.S. dollars. The fund has gained 14.4% this year, vs. 10.3% for the unhedged Vanguard FTSE Europe fund.

Slim Pickings

My friend George Scombulis at Kairos Opportunities used this for the title of one of his recent updates, and it seems to be the general consensus: There isn’t a lot to like out there. Stocks are expensive, and bonds are, too.

Slim Pickens in Dr. Strangelove
Slim Pickens in Dr. Strangelove

Standard and Poor’s chief market strategist, Sam Stovall, paints a fairly gloomy picture in his second-half outlook: “Economic growth is expected to be slower this year than last, S&P 500 EPS growth will have difficulty keeping its head above water, forward 12-month valuations are nearly 33% higher than a year ago, and the value of the U.S. dollar is 20% above where it was last year.”


What’s an investor to do? One solution is to hold more cash until the market seems more appealing to you. This means, of course, that you’ll be able to time the market, which is a wonderful thing on the few times it works.

Another solution is to invest in a fund that has allowed cash to build up because it, too, can’t find anything worth buying. Normally, these are value investors who won’t put money to work if they can’t find bargains. And this seems like a reasonable approach to holding cash. So let’s start by looking for diversified stock funds with 10% or more of their assets in cash.

The key, however, is that the fund must have a decent strategy for investing. Of those cash-laden funds, 25 have five-year records that put them in the top 10% of their category. In short, these funds all have excellent records and at least a 10% buying reserve.

A few glosses: Eventide Gilead is a social and religious fund that tends to favor health-care stocks, which have been hot this year. Hennessy Focus, as its name implies, is a best-ideas fund that typically keeps 20 to 30 stocks and expects to hold them at least five years. Upright Growth is a small fund — $10.5 million in assets — that apparently has no web site.

The Metro West fund invests the bulk of its money in bonds and cash, using stock futures to give it its equity kicker, so the 64% cash weighting is actually less defensive than it looks. The Undiscovered Managers Behavioral Value listed below is institutional — meaning you need a ton of money to buy it. Or you could buy the investor shares, which carry a maximum 5.25% sales charge but have a more reasonable minimum.

The two Artisan funds are closed to most new investors, but do tend to re-open when management thinks opportunities are ripe. It’s worth keeping an eye out for a re-opening.

Fund Ticker Category Total return 2015 Total return (annualized) 5 years Cash %
Eventide Gilead N ETGLX Mid-Cap Growth 13.8% 23.7% 18.2%
Hennessy Focus Investor HFCSX Mid-Cap Growth 6.9% 19.0% 12.5%
Upright Growth UPUPX Large Blend 14.9% 18.4% 10.6%
Metropolitan West AlphaTrak 500 MWATX Large Blend 3.1% 18.1% 64.0%
Undiscovered Mgrs Behavioral Value Inst UBVLX Small Value 8.3% 17.7% 10.1%
Monteagle Select Value MVEIX Large Value 3.9% 17.5% 10.7%
Johnson Enhanced Return JENHX Large Blend 3.5% 16.9% 30.5%
Artisan Global Value Investor ARTGX World Stock 3.4% 14.6% 12.5%
Artisan International Value Investor ARTKX Foreign Large Blend 6.3% 13.7% 15.0%
Tweedy, Browne Global Value TBGVX Foreign Large Value 2.8% 9.8% 23.4%