Friday, January 31, 2014

Willow Fund’s Hedging, Investing and Speculating in Distressed Debt With Credit Default Swaps

By Geng Deng, PhD, CFA, FRM and Craig McCann, PhD, CFA

In a recent post we demonstrated how the Willow Fund’s purchase of credit default swaps evolved from hedging a portion of its distressed debt to swamping the portfolio with enormous short positions in distressed debt. In this post, we explain why the Willow Fund’s use of credit default swaps was inconsistent with its repeated disclosures that:
… The Fund may use a variety of special investment techniques to hedge a portion of its investment portfolio against various risks or other factors that generally affect the values of securities and for non-hedging purposes to pursue the Fund's investment objective. These techniques may involve the use of derivative transactions, including credit default swaps.*
A Credit Default Swap (“CDS”) is a contract that transfers the risk of a credit default on a given bond or portfolio of bonds. The company that issues the bond is called a reference entity. A CDS contract involves two parties, a party that wishes to buy insurance and a party that wishes to sell insurance. The buyer of insurance agrees to pay fixed periodic payments to the seller of insurance. The fixed payments are called CDS premiums. In exchange for the CDS premiums, if the bond issued by the reference entity defaults, the seller of insurance must purchase it from the buyer of insurance at face value or make a cash settlement payment equal to the difference between the defaulted bond’s face value and its market value.

Figure 1 Credit Default Swap Cash Flows

If perceived credit risk increases, CDS premiums which are the price of insurance against default losses will increase. Once a CDS contract is entered into and the CDS premium for that contract is fixed, if CDS premiums increase the credit protection buyer (seller) will have a mark-to-market gain (loss). Conversely, if at-market CDS premiums decrease because the credit risk decreases, the credit protection buyer (seller) will have a mark-to-market loss (gain).

Like other swap contracts, credit default swaps do not normally require an upfront exchange of the contract’s underlying exposure or “notional value.” CDS contracts are thus inherently leveraged investments. For example, an investor with $100 in cash could theoretically buy or sell a CDS contract with an arbitrarily large notional amount, e.g., $100,000. Although the investor doesn’t need to have the notional value to buy or sell the contract, he does have to deposit sufficient cash to cover any daily declines in the contract’s market value.

Using CDS to Hedge

Now, back to what the Willow Fund said it was doing with credit default swaps. First, the Fund said it might use CDS to “hedge a portion of its investment portfolio”. The Fund could hedge some of the credit risk out of its portfolio of distressed debt by buying CDS. Prior to 2007, the Willow Fund bought CDS contracts with total notional values that varied but were less than its portfolio of distressed securities. Since the CDS contracts the Fund owned would likely have gains if its portfolio of distressed securities suffered losses, the Fund’s pre-2007 use of CDS hedged a portion of its investment portfolio.

The September 30, 2007 N-Q (downloadable by clicking here) provides a good example of the Willow Fund’s use of CDS to hedge. Table 1 is an excerpt from the September 30, 2007 N-Q. The Fund had $465 million of Net Assets and purchased credit default swaps with $125 million in notional value. By doing so, it hedged or cancelled the credit risk in $125 million of its distressed debt portfolio.

Figure 2 Willow Fund September 30, 2007 Credit Default Swaps

The CDX HY8 entry warrants a little more discussion. CDX HY is a series of indexes of credit default swaps on high yield corporate debt much as the ABX is a series of indexes of credit default swaps on subprime mortgage backed securities. CDX HY 8 was the eighth in the series which has now grown to over 20 rolling high yield CDS indices. The “November 2008 Markit Credit Indices, A Primer” can be downloaded by clicking here. CDX HY 8 first calculated and reported by Markit in March 2007. A Markit fact sheet (download factsheet by clicking here) lists the 100 equally weighted high yield reference obligations underlying CDX HY 8. Being long the CDX HY contracts, allowed the Fund to hedge out market-wide changes in distressed debt credit risk and isolate the credit risk idiosyncratic to its holdings.

Using CDS to Invest

The Willow Fund also said that it could use credit default swaps “… for non-hedging purposes to pursue the Fund's investment objective.” By selling credit default swaps and purchasing low risk collateral equal to the notional value of the credit default swaps on distressed sold, the Willow Fund would have created a synthetic long position in the distressed debt referenced in the credit default swap. According to its SEC filings, the Willow Fund was always a buyer, not a seller, of credit default swaps and so didn’t use credit default swaps to implement its investment strategy.

Using CDS to Speculate and to Leverage

As a buyer of CDS contracts, the Willow Fund was shorting credit risk. Initially it was shorting less credit risk than it had in its portfolio of distressed securities and so could be said to be hedging. Starting in 2007 though the Willow Fund was short much more credit risk through its CDS portfolio than it was exposed to in its securities holdings. From 2007 onward the Willow Fund was using the CDS contracts not to hedge or to implement its investment strategy but to speculatively short distressed debt.

The Willow Fund chose a lousy time to deviate so dramatically from its disclosed investment strategy and massively short distressed debt. The blue bars in Figure 3 illustrate the Willow Fund’s CDS notional values. The red line is the at-market CDS rate on high yield debt. The Willow Fund had started speculating with CDS by late 2007 and dramatically increased its distressed debt short exposure from $500 million to $2.4 billion when the generic 5‑year HY CDS rates were between 800 and 1500 basis points. The Fund kept most of this exposure as HY CDS rates fell back below 500 basis points. The Fund was short $2 billion of distressed debt as credit risk declined and distressed debt prices recovered. These losses and the Fund’s 15-to-1 or greater leverage taken on through the CDS bets caused investors to lose nearly $300 million.

Figure 3 Willow Fund Bets Against Distressed Debt With Enormous Leverage as CDS Rates Fall

The temporary increases in CDS rates in early 2010 and in late 2011 explains the profits the Willow Fund had in the first half of 2010 and the second half of 2011, only temporarily interrupting the calamitous losses it suffered from June 2007 to December 2012.

The Willow Fund did not disclose this change in its use of CDS contracts until after it had suffered over $210 million in losses while speculating with CDS. In the 2010 N-CSR filed with the Securities and Exchange Commission on March 11, 2011 the Fund stated “... the Fund entered into credit default swaps for speculative purposes as a "protection buyer".” The fifteen previous annual and semi-annual reports said only stated “... the Fund entered into credit default swaps as a "protection buyer".” That is, 65% of the losses resulting from the Willow Fund’s explosive use of CDS contracts occurred before it even hinted in its SEC filings that it was no longer hedging or investing but was speculating with CDS.

Figure 4 Willow Fund Partially Discloses Speculation After Three Years and $200 million in Losses


*This language is repeated verbatim in all the Fund’s Annual and Semi-Annual Reports. See, for example, the 2009 N-CSR here.

SEC Litigation Releases: Week in Review

Court Enters Final Judgment Against Broker in Settlement of Claims Arising from Fraudulent Misrepresentations and the Misappropriation of Funds, January 30, 2014, (Litigation Release No. 22914)

A final judgment was entered this week against David L. Rothman based on charges that "Rothman,...who was the Vice President and minority owner of Rothman Securities, Inc....creat[ed] and issu[ed] false account statements to certain elderly and unsophisticated investor/clients that materially overstated the value of their investment accounts." Furthermore, Rothman allegedly misappropriated investor funds, using a substantial portion of them "for his personal benefit." The final judgment permanently enjoins him from future violations of the Securities Act and Exchange Act and orders him to pay over $500,000 in disgorgement.

SEC Charges Chicago-Based Accountant with Insider Trading in Wife's Account, January 29, 2014, (Litigation Release No. 22913)

According to the complaint (PDF), Steven M. Dombrowski, a C.P.A. and former Director of Corporate Audit at Allscripts Healthcare Solutions, Inc., used insider information to trade in Allscripts securities through his wife's account. His alleged illicit trading resulted in over $285,000 in profit. The SEC has charged Dombrowski with violating sections of the Exchange Act and Securities Act and seeks permanent enjoinment from future violations, disgorgement, prejudgment interest, and civil penalties. The SEC's complaint names Lisa Fox, Dombrowski's wife, as a relief defendant, and seeks disgorgement plus prejudgment interest from her. In a parallel action, criminal charges were announced against Dombrowski.

Court Enters Judgment Against Three Wall Street Brokers for Defrauding Customers, January 28, 2014, (Litigation Release No. 22912)

Judgments were entered against Marek Leszczynski, Benjamin Chouchane, and Henry Condron in the SEC’s fraud case, SEC v. Leszczynski, at al. The judgment permanently enjoins the defendants from future violations of the securities laws and orders them to pay over $4.1 million in disgorgement and prejudgment interest. The SEC previously charged these brokers "with illegally overcharging customers $18.7 million by using hidden markups and markdowns and secretly keeping portions of profitable customer trades."

SEC, Joined by Deloitte China, Files a Motion to Dismiss Without Prejudice the Subpoena Enforcement Action, January 27, 2014, (Litigation Release No. 22911)

The SEC filed "a joint motion with Deloitte Touche Tohmatsu CPA Ltd. to dismiss without prejudice" the September 2011 subpoena enforcement action that the SEC filed against DTTC. The subpoena was issued "in connection with the SEC’s investigation into possible fraud by DTTC’s former audit client, China-based Longtop Financial Technologies Limited." DTTC "had argued that it was prohibited under Chinese law from producing the requested documents, which are located in China, to the SEC." The SEC recently received many of the documents it had called for and has received the cooperation of the China Securities Regulatory Commission. In light of the documents produced and the CSRC's cooperation, "the SEC, at present, does not believe that there is a need for judicial relief with respect to the subpoena."

Former Executive of Massachusetts-Based Company Sentenced in Insider Trading Case, January 27, 2014, (Litigation Release No. 22910)

Last week, Joseph M. Tocci was sentenced to one year probation, as well as a $100 fine, and ordered to pay disgorgement, prejudgment interest, and civil penalties for his "insider trading in the securities of...American Superconductor Corporation." Previously, a final judgment was entered against him permanently enjoining him from future violations of the securities laws and ordering him to pay over $170,000 in disgorgement, prejudgment interest, and civil penalties.

Massachusetts Resident Steven Palladino Sentenced to 10-12 Years in Prison for Role in Multi-Million Dollar Ponzi Scheme, January 24, 2014, (Litigation Release No. 22909)

Last week, Steven Palladino was sentenced in a criminal action to serve 10-12 years in prison, "followed by a probationary period of five years, and to pay restitution to victims, for crimes that he committed in connection with a Ponzi scheme perpetrated through" his company,Viking Financial Group, Inc. Palladino pled guilty to "criminal charges that included conspiracy, being an open and notorious thief, larceny, and larceny from elderly person(s)" and Viking "pled guilty to related charges and was sentenced to a probationary period of five years and ordered to pay restitution to victims." A further hearing has been set for March to determine the amount of restitution to be paid. These charges stem from an SEC action filed in April 2013.

Tuesday, January 28, 2014

Credit Default Swaps on Steroids: UBS’s Willow Fund

By Geng Deng, PhD, CFA, FRM and Craig McCann, PhD, CFA

We previously published a working paper on how investors in Oppenheimer’s Champion Income Fund lost 80% in 2008 when peer group funds lost about 25%. Our Champion Income Fund paper is available by clicking here (PDF). Oppenheimer had increased Champion Income Fund’s exposure to CMBS through credit default swaps and total return swaps in 2007 and 2008. Figure 1 reproduces a figure from our 2010 paper which demonstrates that the leverage Oppenheimer took on through the swaps fully explained the extraordinary losses suffered by investors in this fund.*

Figure 1 Oppenheimer’s Champion Income Fund Extraordinary Losses Were Due to Leverage Taken on with Credit Default Swaps and Total Return Swaps. 
UBS’s Willow Fund took what the Champion Income Fund did wrong and scaled it up ten-fold. The Willow Fund was sold as a distressed debt fund with an investment objective to maximize total return. Each annual report from 2000 to 2013 began with substantially this description of the fund although from 2008 onward, the third sentence was modified to read “The Fund's investment objective is to maximize total return with low volatility.”
UBS Willow Fund, L.L.C. (the "Fund") was organized as a limited liability company under the laws of Delaware on February 1, 2000. The Fund is registered under the Investment Company Act of 1940, as amended (the "1940 Act") as a closed-end, non-diversified management investment company. The Fund's investment objective is to maximize total return. The Fund pursues its investment objective by investing primarily in debt securities and other obligations and to a lesser extent equity securities of U.S. companies that are experiencing significant financial or business difficulties (collectively, "Distressed Obligations"). The Fund also may invest in Distressed Obligations of foreign issuers and other privately held obligations. The Fund may use a variety of special investment techniques to hedge a portion of its investment portfolio against various risks or other factors that generally affect the values of securities and for non-hedging purposes to pursue the Fund's investment objective. These techniques may involve the use of derivative transactions, including credit swaps. The Fund commenced operations on May 8, 2000.
The fund’s annual and semi-annual reports can be downloaded off the SEC website here. While the fund managers claimed to be investing in distressed debt, in late 2007 and early 2008 they were aggressively shorting high yield debt. The Fund increased its short position in 2008 and 2009 betting that credit spreads would widen further.

The upper panel of Figure 2 plots the notional value of the Willow Fund’s credit default swaps as percent of the fund’s non-CDS assets each quarter and the lower panel of Figure 2 plots the Fund's semi-annual profits from 2003 to 2012. Consistent with the Willow Fund’s disclosures, in the early years it invested in securities of distressed companies and hedged out some of the credit risk in its portfolios by purchasing credit default swaps. From January 1, 2003 to June 30, 2007 the Willow Fund had $309,415,927 in profit. From June 30, 2007 to December 31, 2012 while the Willow Fund’s portfolio deviated substantially from the Fund’s SEC filings, the Fund suffered losses of $287,576,818.

Figure 2 Willow Fund’s CDS Notional Value as a Percent of non-CDS Assets, Quarterly.  Profit and Loss in Millions.

The Willow Fund’s 2012 collapse has received some media coverage which focuses on the Willow Fund’s bets against sovereign debt but the losses it suffered and its ultimate collapse would have occurred whether it was short only high yield corporate credit rather than short a mixture of corporate debt and sovereign debt.

As we will explain more fully in subsequent posts, the losses the Willow Fund suffered and its ultimate collapse occurred because beginning in 2007 the fund deviated substantially from the investment policy described in the fund’s annual reports and was no longer using credit default swaps to “hedge a portion of its investment portfolio against various risks or other factors that generally affect the values of securities and for non-hedging purposes to pursue the Fund's investment objective.”

More to follow shortly.
* Oppenheimer’s settlement with the Securities and Exchange Commission over this conduct can be downloaded by clicking here (PDF). Much of what is said in the SEC Complaint against Oppenheimer can be directly applied to UBS Willow Fund as well.

Monday, January 27, 2014

Another Example of Non-Traded REITs’ Wealth Destruction: Columbia Property Trust (Wells REIT II) Cost Investors $4.4 Billion

By Tim Husson, PhD, Craig McCann, PhD, CFA, and Carmen Taveras, PhD

Non-traded REITs are illiquid investments, not listed on public exchanges and with little to no secondary market trading. Their offering documents typically claim that after some period of time, perhaps 5-10 years, the REIT intends to list on an exchange, merge with another company, or in some other way allow investors to sell their shares but for many non-traded REITs, this “liquidity event” never occurs.

However, even if a non-traded REIT lists on a major exchange, that does not mean that its original investors have benefited from being sold such an illiquid investment. Investors in many subsequently listed non-traded REITs have sustained massive losses relative to low cost, liquid alternatives they should have been sold in the first place.

For example, Columbia Property Trust (CXP, formerly known as Wells Real Estate Investment Trust II) was first sold as a non-traded REIT in 2004 and subsequently listed on the New York Stock Exchange in October 2013. Before it was listed, it sold shares to new investors at $10 per share. After its first day trading on the NYSE, its per share value was $22.52.

Looks like a win for CXP’s investors but that was accomplished entirely by sleight of hand. Columbia Property Trust underwent a 4-for-1 reverse share split. Therefore the post-listing value of a $10 CXP share was approximately $5.63 or equivalently investors originally paid $40 for what was selling after the listing for $22.52 -- a capital loss of almost 44%. Many non-traded REITs do a reverse stock split before listing to give the appearance of capital appreciation.

The CXP losses are even greater if you consider what that $10 would have purchased in a low cost, diversified real estate fund such as Vanguard's REIT Index Fund. We can do this using the same methodology we applied to Behringer Harvard REIT I / TIER REIT last week. Columbia Property Trust (or Wells Real Estate Investment Trust II) raised approximately $6.1 billion from 2004 to 2013, as reflected in its 10-K and 424B3 filings:

Columbia Property Trust / Wells REIT II Gross Proceeds
(blue dots are from 424B3s, red dots are from 10-Ks)
It also paid approximately $1.1 billion in quarterly distributions:

Columbia Property Trust / Wells REIT II Distributions
Columbia Property Trust's value after its first day of trading was $22.52. Based on the 134,192,610 post-split shares outstanding, the aggregate value of the CXP REIT was approximately $3.0 billion. If we apply the proceeds raised by Columbia Property Trust from its offering of common shares to the Vanguard REIT Index Fund, the resulting October 2013 value is approximately $7.4 billion.

Investors’ Net Investments in Wells REIT II Applied to Vanguard’s Traded REIT Fund
By choosing Wells REIT II / Columbia Property Trust over a liquid alternative, investors lost $4.4 billion.  In addition, Columbia Property Trust's liquid market value was over $1 billion less than the sponsor's estimated value.

A casual observer might think that Columbia Property Trust was a success story: a successful listing at over twice its offering price. But the reality is that investors lost big as a result of being sold a high cost, illiquid non-traded REIT. If they had chosen a low cost, diversified, completely liquid real estate mutual fund, they would have had about $4.4 billion more than they ended up with.

Friday, January 24, 2014

SEC Litigation Releases: Week in Review

Final Judgments Entered Against Former Hedge Fund Manager and His Company, January 23, 2014, (Litigation Release No. 22908)

Final judgments were entered against Berton M. Hochfeld and his "wholly-owned entity, Hochfeld Capital Management, L.L.C.," for allegedly "misappropriating assets and making material misstatements to investors in the Heppelwhite Fund L.P., a now defunct hedge fund." Previously, the court had ordered injunctions and an asset freeze, and granted "the Commission's motion to create a Fair Fund to compensate defrauded investors." The final judgments entered against the defendants this week enjoin them from future violations of the securities laws and order them to pay "disgorgement of $1,785,332, which will be deemed satisfied by the criminal forfeiture order entered against Hochfeld in a parallel criminal case." In the criminal case, United States v. Hochfeld, Hochfeld pled guilty to securities fraud and wire fraud and was sentenced to "a two-year prison term, which he is now serving, and pay forfeiture and restitution totaling approximately $2.9 million."

Subject of SEC Investigation Held in Contempt of Court and Arrested for Failing to Comply with Subpoenas, January 23, 2014, (Litigation Release No. 22907)

Anthony Coronati, the founder of, "has been held in contempt of court and arrested for failing to comply with subpoenas requiring him to produce documents and give testimony." Last November, the SEC filed a subpoena action against the defendant, because it is "investigating, among other things, whether Coronati commingled investor funds with other money in an account he controlled and used it to pay personal expenses." Coronati failed to appear for testimony or produce any documents despite being served two subpoenas in 2013. Coronati was found in civil contempt and ordered to pay $4,812 to the SEC to reimburse the costs of serving him the subpoenas. Additionally, "the U.S. Marshals Service arrested Coronati." At a hearing "the court ordered Coronati released on $50,000 bond and restricted his travel to the Southern and Eastern Districts of New York." A further hearing has been scheduled for February 6, 2014.

Thursday, January 23, 2014

El Uso de Apalancamiento en Los Fondos Cerrados UBS Puerto Rico Magnifica Las Pérdidas

Por Edward O'Neal, PhD English Version

Durante el año 2013, los fondos de bonos de UBS Puerto Rico sufrieron grandes pérdidas. Estas pérdidas fueron agresivamente rápidas, especialmente considerando que los títulos de renta fija tienden a ser inversiones más seguras. En entradas anteriores a nuestro blog hemos argumentado algunas de las razones de las precipitosas pérdidas y hemos hablado de las sutilezas transaccionales de los bonos. Además, hemos discutido los conflictos de intereses entre los gestores de los fondos y los inversionistas que pudieron haber contribuido a la pérdida de valor de los fondos. En esta entrada, hablaremos de cómo el uso del apalancamiento (o “leverage”) hizo que los fondos se volvieran más riesgosos.

Una técnica para intentar aumentar el retorno de los fondos, es tomar un préstamo y comprar más títulos que los activos netos del fondo. Esto ocurre también en fondos cerrados domiciliados en los Estados Unidos. Este "efecto palanca" puede tomar muchas formas: créditos directos de instituciones financieras, la emisión de acciones preferenciales, acuerdos de recompra de valores, entre otras. Independientemente del tipo de deuda, el apalancamiento, sin lugar a dudas, aumenta el riesgo de los accionistas del fondo. La cantidad de apalancamiento de un fondo cerrado es a menudo definida por la cantidad del préstamo tomada dividida por el total de los activos del fondo (deuda/activos totales). Este "ratio de apalancamiento" es la porción de los activos del fondo adquirido con deuda en lugar de dinero de los inversionistas. Por lo general, en los Estados Unidos, el ratio de apalancamiento se limita a un máximo de 33% en deuda y un 50% en acciones preferentes de la emisión. Los fondos UBS PR pueden tener un ratio de apalancamiento del 50% en cualquier forma de endeudamiento. Por ejemplo, un fondo UBS PR con una cartera de $500 millones de dólares puede tomar prestado hasta $250 millones de dólares. En situaciones donde las condiciones del mercado son inestables, el Comisionado de Instituciones Financieras de Puerto Rico puede permitir que un fondo aumente su nivel de apalancamiento a un 55%.[1]

Nuestro análisis de los fondos UBS PR en el 2013 muestra que dichos fondos tenían un nivel de apalancamiento muy cercano al máximo permitido por los reglamentos de valores de Puerto Rico. En junio de 2013 los ratios de apalancamiento oscilaban entre 44.01 % y 50.74 %. Las pérdidas de valor sufridas por los bonos de Puerto Rico durante el año 2013 fueron magnificadas por el elevado uso de apalancamiento.

Anteriormente, en una entrada en nuestro blog, habíamos discutido la naturaleza de los fondos UBS PR no diversificados (o concentrados). La unión del apalancamiento y la concentración de estos fondos incrementó significativamente la exposición a riesgo de los inversionistas de estos fondos. Nuestro análisis de los fondos UBS PR demuestra que las mayores pérdidas registradas tenían una gran concentración de bonos de dos emisores puertorriqueños: El Sistema de Pensiones de los Empleados de Puerto Rico y la Corporación del Fondo de Interés Apremiante de Puerto Rico (COFINA). El uso de apalancamiento aumentó las pérdidas atribuibles a estos dos emisores. Por ejemplo, la cartera del fondo Puerto Rico Fixed Income Fund I tenía activos netos de $361 millones a junio de 2013. El apalancamiento permitió que el fondo tuviera inversiones de $748 millones. De estas inversiones, $338 millones estaban invertidos en estos dos emisores. Así que, aunque los dos emisores representaban el 45% del total de las inversiones hechas por el fondo, esta cantidad equivalía a un 93% de los activos netos del fondo. El riesgo al que los inversionistas están expuestos es en relación con el porcentaje de los activos netos. Si el valor de los títulos de estos dos emisores hubiese caído a cero, el fondo hubiese perdido casi todo su valor.

Los bonos de estos dos emisores perdieron 36% de su valor entre julio y septiembre del 2013. Estas pérdidas causaron una caída en los activos netos del fondo de un 34%. Dado que estas inversiones representaban cerca de la mitad del total de los activos en el fondo y que el ratio de apalancamiento era aproximadamente de un 50%, las pérdidas de estas dos emisiones tuvieron casi una relación 1 a 1 con las pérdidas del fondo.

En comparación, un fondo diversificado sin apalancamiento alguno, sólo tendría un 10% de sus activos totales invertidos en estos dos emisores. En esta situación, un descenso en el valor de los bonos de estos dos emisores, sólo representarían una pérdida para los inversionistas del fondo de un décimo de la pérdida actual de los bonos. En nuestro ejemplo, cuando los dos bonos presentaron pérdidas de un 36%, el fondo diversificado solamente hubiese perdido sólo un 3.6% de su valor.

Por último, algunos medios de prensa han señalado que los inversionistas fueron alentados a tomar dinero prestado para invertir en fondos UBS PR. Este apalancamiento por parte de los inversionistas y de manera externa a los fondos, hubiese aumentado las pérdidas de los inversionistas.

[1] Aunque los folletos del fondo UBS PR describen apalancamiento en términos del ratio de apalancamiento, la Ley de Compañías de Inversión de 1940 menciona el apalancamiento de fondos cerrados en términos de "ratios de cobertura de activos." El ratio de cobertura de activos es simplemente la inversa del ratio de apalancamiento. Por lo tanto, el ratio de cobertura de activos para fondos puertorriqueños es 1/.50 = 2-a-1 o 200 por ciento. A mayor ratio de cobertura de activos, menor apalancamiento usado por el fondo.

The Use of Leverage in the UBS Puerto Rico Closed-End Funds Magnified Losses

By Edward S. O’Neal, PhD Versión en Español

The massive declines that hit investors in the UBS Puerto Rico closed-end bond funds in 2013 were especially quick and brutal for fixed income securities which are usually safer investments. In previous posts we have discussed some of the reasons for the precipitous fall in the values of the bond funds and some of the nuances of bond transactions that may have given rise to conflicts of interest between the fund managers and investors. In this post, we will discuss another culprit in the destruction of value for the funds’ investors: the fund managers’ use of leverage in the funds.

Closed-end funds, even those domiciled in the United States, often borrow and purchase more securities than the funds' net assets in an attempt to increase returns. This “leverage” can take many forms: direct borrowing from financial institutions, the issuance of preferred stock, and security repurchase agreements are some examples. Regardless of the specific form of borrowing, the leverage unequivocally increases risk to fund shareholders. The amount of leverage a closed-end fund utilizes is often measured by the amount of borrowing divided by the total assets of the fund (debt/total assets). This “leverage ratio” is the portion of the fund’s assets purchased with borrowed money rather than with fund investors’ contributions. Closed-end funds in the United States are generally limited to a maximum leverage ratio of 33% on borrowings and 50% on preferred stock issuance. The UBS PR funds can employ a leverage ratio of 50% on all forms of leverage. So, for example, a UBS PR fund with $500 million in portfolio securities may have total borrowings of up to $250 million. In unsettled market conditions, the Puerto Rico Commissioner of Financial Institutions may allow a fund to have a leverage ratio of 55%.[1]

Our analysis of the UBS PR funds in 2013 shows that the funds on average had leverage that was very close to the maximum amount allowed by Puerto Rican securities regulations. In June 2013 the leverage ratios ranged between 44.01% and 50.74%. Declines in the value of Puerto Rican bonds that occurred in 2013 were magnified in the funds by the high use of leverage.

Leverage in UBS PR funds
Fund 6/30/2013
Puerto Rico AAA Portfolio Bond Fund 50.74%
Puerto Rico AAA Portfolio Bond Fund II 48.84%
Puerto Rico AAA Portfolio Target Maturity Fund 49.20%
Puerto Rico Fixed Income Funds I 50.54%
Puerto Rico Fixed Income Funds II 50.34%
Puerto Rico Fixed Income Funds III 50.51%
Puerto Rico Fixed Income Funds IV 50.12%
Puerto Rico Fixed Income Funds V 50.61%
Puerto Rico Fixed Income Funds VI 46.71%
Puerto Rico GNMA & U.S. Government Target Maturity Fund 49.24%
Puerto Rico Investors Bond Fund I 49.54%
Puerto Rico Investors Tax-Free Fund 49.44%
Puerto Rico Investors Tax-Free Fund II 49.38%
Puerto Rico Investors Tax-Free Fund III 49.21%
Puerto Rico Investors Tax-Free Fund IV 49.54%
Puerto Rico Investors Tax-Free Fund V 49.47%
Puerto Rico Investors Tax-Free Fund VI 49.47%
Puerto Rico Mortgage-Backed & U.S. Government Securities Fund 49.58%
Puerto Rico Tax-Free Target Maturity Fund 45.91%
Puerto Rico Tax-Free Target Maturity Fund II 44.01%
Tax-Free Puerto Rico Fund 50.34%
Tax-Free Puerto Rico Fund II 50.20%
Tax-Free Puerto Rico Target Maturity Fund 49.56%
Average 49.24%

We have already discussed the non-diversified (or concentrated) nature of the UBS PR funds in a previous blog post, and the coupling of concentration and leverage served to dramatically increase the risks to which fund investors were exposed. Our analysis of the funds shows that the UBS PR funds that experienced the greatest losses were heavily concentrated in the bonds of two specific Puerto Rican issuers: the Puerto Rican Employees Retirement System and the Puerto Rican Sales Tax Financing Corp. The use of leverage magnified the losses attributable to these two issuers. For example, the Puerto Rico Fixed Income Fund I portfolio had net assets of $361M as of June 2013. The leverage allowed the fund to hold total investments of $748M. Of these, $338M was in the two issuers. So while the two issuers represented 45% of the total investments in the fund, they represented 93% of the net assets of the fund. The risk exposure of investors is related to the percentage of net assets the securities represent. If those two issuers’ securities declined to zero, it would have almost completely wiped out the fund.

In the three months ended September 2013, these issues lost 36% of their value. The losses in just these two issues caused a 34% decline in the net assets of the fund. Due to the fact that the holdings were close to half of the total assets in the fund and the leverage ratio was roughly 50%, declines in those two issuers together had close to a 1-to-1 impact on the fund.

As a comparison, a diversified fund with no leverage could have as a maximum only 10% of the total assets of the fund invested in two issuers. In such a situation, a decline in the bonds of the two issuers would only be felt by fund investors at 1/10th of the actual decline in the bonds. In our example where the two issuers fell by 36%, the diversified fund would have only declined by 3.6%.

Finally, some media reports have also pointed out that investors may have been encouraged to borrow money to invest in the UBS PR bond funds. This leverage, external to the funds, would further magnify investor losses. Our analysis above does not address this external component of leverage, but our proprietary research addresses the additional problems it causes.

[1] While the UBS PR Fund prospectuses express leverage in terms of a leverage ratio, the US Investment Company Act of 1940 discusses closed-end fund leverage in terms of “asset coverage ratios.” The asset coverage ratio is simply the inverse of the leverage ratio. So the asset coverage ratio for Puerto Rican funds is 1/.50 = 2-to-1 or 200 percent. The higher the asset coverage ratio, the less leverage a fund is using.

Friday, January 17, 2014

SEC Litigation Releases: Week in Review

SEC Charges Former Senior Executives of Public Company Subsidiary with Falsifying Financial Records and Circumventing Internal Controls, January 15, 2014, (Litigation Release No. 22906)

This week, the SEC announced charges against Christopher Hohol and Brian Poshak, "formerly the senior vice president for operations and the controller, respectively, of Veolia Special Services, a fourth-tier United States subsidiary of Veolia Environnement S.A." According to the SEC, the defendants falsified "books, records, and accounts and circumvent[ed] internal controls in order to overstate Special Services’ earnings before taxes over a period of at least three years." This illicit behavior caused Special Services to overstate its EBT by about $64 million. This then resulted in "Hohol and Poshak receiv[ing] $136,000 and $28,000, respectively, in ill-gotten bonus payments that were triggered by the inflated financial performance of Special Services."

The defendants have consented to a final judgment that permanently enjoins them from future violations of the Exchange Act and orders them to pay over $135,000 in disgorgement and prejudgment interest combined.

Former Stockbroker Ordered to Pay $5.6 Million for Insider Trader in Burger King Stock, January 14, 2014, (Litigation Release No. 22905)

A final judgment was entered this week against Waldyr Da Silva Prado Neto who "misappropriated material nonpublic information from his customer and used it to trade Burger King Holding, Inc.'s securities and tip others before the company's September 2, 2010 announcement that it was being acquired by a New York private equity firm." According to the SEC, Prado made $175,000 in illicit profits from his illegal trading. The final judgment permanently enjoins Prado from future violations of the Exchange Act and orders him to pay over $5.6 million in disgorgement, prejudgment interest, and penalties.

Court Enters Final Judgment Against Officer, Broker and Relief Defendant Broker-Dealer in Settlement of Insider Trading Charges, January 14, 2014, (Litigation Release No. 22904)

Final judgments were entered against Mack D. Murrell and Charles W. Adams, as well as relief defendant Raymond James Financial Services, Inc., for their involvement in an insider trading scheme involving The Dow Chemical Company's securities. The judgments permanently enjoin Murrell and Adams from violating the Exchange Act and order them to pay over $444,000 in disgorgement, prejudgment interest, and civil penalties. A director and officer bar was placed against Murrell. Relief defendant Raymond James was ordered to pay over $382,000 in disgorgement and prejudgment interest. David A. Teekell was also charged for his alleged involvement in the scheme and previously settled the SEC's charges.

District Court Enters Default Judgment Against Defendant Claudio Osorio, Judgment of Permanent Injunction Against Defendant Innovida Holdings LLC., Judgment of Permanent Injunction and Other Relief Against Defendant Craig Toll and Order Dismissing Case, January 13, 2014, (Litigation Release No. 22903)

Last November, a judgment was entered against Craig Toll that permanently enjoins him from future violations of the securities laws and places a director and officer bar against him. Additionally, the judge ordered Toll's "disgorgement, prejudgment interest and civil penalty be dismissed as Toll was convicted in a parallel criminal case, sentenced to four years in prison, and ordered to pay restitution."

Previously, a permanent injunction and officer/director bar were placed against Claudio Osorio for his alleged violations of the same securities laws. "On November 22, 2013, the Commission dismissed its civil penalty and disgorgement claims against Osorio because of his prison sentence and restitution order in the parallel criminal case."  Additionally, "the Court dismissed disgorgement and civil penalty claims against Defendant InnoVida Holdings because it is under the control of a bankruptcy trustee."

Monday, January 13, 2014

SEC Examiniation Priorities 2014

By Tim Dulaney, PhD, FRM and Tim Husson, PhD

The Securities and Exchange Commission (SEC) senior staff recently announced their 2014 examination priorities (PDF).   The national examination program will be focusing on fraud detection and prevention, corporate governance, and registrants that serve as both a broker-dealer and investment adviser.

SEC staff also plans to undertake initiatives that examine the rollover of retirement vehicles during employment transitions or near retirement.  In particular, the staff is concerned about misleading or improper sales practices that encourage retirement-age workers to rollover "employer-sponsored 401(k) plan into higher cost investments."  Investors near, or in, retirement have much to lose and are often the most vulnerable investors in the market. We've done a lot of work on high cost investments aimed at retirees, and we think the SEC staff is on track with these initiatives.*

In addition, SEC staff intends to "examine governance and supervision of information technology systems." This priority is consistent with the priorities announced by FINRA earlier this month and shows that regulators are increasingly focusing on technological issues plaguing the financial markets.  They are also investigating investment advisers who rely on quantitative trading models to ensure proper compliance and to prevent market manipulation.

The SEC will also look into 'alternative' funds, a broad category of investments that includes many of the products we discuss frequently on this blog such as leveraged and inverse ETFs, non-traded REITs, volatility derivatives, and others.  Broker-dealers continue to sell large amounts of these risky products, and new products appear every year.

Given the types of issues we see on a daily basis, we think the SEC's staff is on the right track.  Stay tuned to our blog throughout the year for more updates and analysis about these and other current issues.
*See, for example, our paper (PDF) on a new kind of variable annuities that was recently accepted to the Journal of Retirement. 

Friday, January 10, 2014

SEC Litigation Releases: Week in Review

Securities and Exchange Commission v. Diamond Foods, Inc., January 9, 2014, (Litigation Release No. 22902)

According to the complaint (PDF), Diamond Foods, Inc. manipulated walnut costs to report "higher net income and inflated earnings to exceed analysts' estimates for fiscal quarters in 2010 and 2011." According to the complaint (PDF) against Diamond's former CFO, Steven Neil, Neil "directed the effort to fraudulently underreport money paid to walnut growers." Diamond's former CEO, Michael Mendes, has also been charged because he allegedly should have "known that Diamond's reported walnut cost was incorrect at the time he certified the company's financial statements."

Diamond was charged with violating various provisions of the securities laws and agreed to pay a $5 million penalty and permanent injunctions to settle the charges. Mendes and Neil were also charged with violating various provisions of the securities laws. Mendes agreed to pay a $125,000 penalty and has already "returned or forfeited more than $4 million in bonuses and other benefits he received during the time of the company's fraudulent financial reporting." The complaint against Neil seeks "a permanent injunction, civil penalties, an officer and director bar, disgorgement plus prejudgment interest, and relief pursuant to the Sarbanes-Oxley Act of 2002."

District Court Finds Eric Aronson Liable for Operating a Ponzi Scheme, Issues Permanent Injunctions Against Remaining Individual Defendants and Grants Other Relief, January 6, 2014, (Litigation Release No. 22901)

According to the SEC, "from 2006 to 2010, PermaPave Industries and its affiliates raised more than $26 million from the sale of promissory notes and 'use of funds' agreements to over 140 investors." Defendants Eric Aronson and Vincent Buonauro, as well as others, "told investors that there was a tremendous demand for the product...permeable paving stones" when in fact "there was little demand for the product." Defendants then "used investors' money to make 'interest' and 'profit' payments to earlier investors and to fund management's lavish lifestyles." Additionally, "shortly after an affiliate of PermaPave Industries acquired a majority stake in Interlink-US-Network, Ltd., Eric Aronson, Fredric Aaron - who was the attorney for Eric Aronson...- and others issued a press release stating that a company that had never heard of Interlink intended to invest $6 million in Interlink."

The SEC has charged the defendants with violating various provisions of the securities laws. Aaron has consented to a judgment that enjoins him from future violations and imposes a five-year officer-director bar as well as a penny stock bar against him. Buonauro consented to a judgment that enjoins him from future violations of the securities laws. Monetary relief against both defendants will be determined at a later date. Relief for Aronson's violations will also be determined at a later date. The SEC's civil action continues against relief defendant, Deborah Buonauro.

Wednesday, January 8, 2014

Behringer Harvard / TIER REIT Illustrates How Non-Traded REIT Sponsors and Brokers Have Siphoned $10 Billion to $20 Billion (and Counting) From Investors

By Tim Husson, PhD, Craig McCann, PhD, CFA, and Carmen Taveras, PhD

Sponsors have issued, and brokers had sold, over $85 billion of non-traded real estate investment trusts (REITs) by the end of 2012. These investments are illiquid, high-commissioned, poorly diversified real estate investments. Despite their glaring defects another $20 billion of non-traded REITs were sold to investors in 2013.

Sponsors and brokers have siphoned off at least $20 billion from investors through their sales of non-traded REITs up through 2012. We illustrate the calculation of these sponsor and broker transfers from investors using investors experience in the Behringer Harvard REIT I.

With the help of highly compensated brokers, Behringer Harvard sold $2.9 billion of its BH REIT I shares to investors between 2003 and 2010.* Figure 1 plots the gross proceeds raised by BH REIT I, now known as TIER REIT, from its first effective date through its most recent 10-K:

Figure 1: Behringer Harvard REIT I Gross Proceeds
(blue dots are from 424B3s, red dots are from 10-Ks)

BH REIT 1 also paid monthly distributions (reported quarterly) plotted in Figure 2.

Figure 2 Behringer Harvard REIT I Distributions

BH REIT 1’s most recent reported value was $4.01, although secondary market trades have been below $2.50. Thus investors in this non-traded REIT suffered principal losses of $1.4 billion ($1.1 billion after offsetting with $300 million in distributions). These losses are not the result of general losses in the underlying commercial real estate market. The value of US commercial real estate as a whole has been increasing rapidly since a low point in early 2009 and now exceeds its prior peak.

Figure 3: Split and Dividend Adjusted Vanguard REIT Index Fund [VGSIX]

What if all that investor money that brokers directed into the BH REIT 1 had been invested in a portfolio of traded REITs like the Vanguard fund instead? The value of that investment over time is shown below:

Figure 4: Investors’ Net Investments in BH REIT 1 Applied to Vanguard’s Traded REIT Fund

Had the funds put into BH REIT I been instead invested in the Vanguard REIT Index Fund, they would be worth approximately $3.8 billion. If we apply Behringer Harvard's last reported value of $4.01 BH REIT I’s current value is only $1.2 billion -- a shortfall of $2.6 billion. This relative loss of value reflects a combination of high fees and poor returns relative to real estate as a whole.

However, the last reported value of a non-traded REIT is merely the sponsor’s claimed estimate. This REIT has traded in the limited secondary market for approximately $2.19 per share. Therefore the current value could as low as $0.7 billion, for a shortfall of $3.1 billion.

The losses investors suffered in BH REIT 1 relative to liquid, diversified real estate investments were in part due to the high commissions brokers receive for selling these products and large fees taken by non-traded REIT sponsors. Investors paid about $300 million in unnecessary upfront fees in BH REIT 1. Had those fees been invested in traded REITs they would be worth over $500 million today. We estimate that as much as $20 billion in current real estate investment values have been transferred from retail investors to sponsors, brokerage firms and brokers through the sale of non-traded REITs.

No investors should buy these illiquid, high-commissioned, poorly diversified non-traded REITs and no un-conflicted broker would recommend them.
* We estimate this from BH REIT I’s 424B3 and 10-Ks filings with the SEC.

Monday, January 6, 2014

Did UBS Charge its Proprietary Puerto Rico Bond Funds Excessive Markups? Part II

By Craig McCann, PhD, CFA Versión en Español

We have previously posted several blog posts about UBS Puerto Rico's collapsing closed-end municipal bond funds including: Trouble in Paradise: UBS Puerto Rico Bond Fund Investors Hit Hard, Diversification and UBS Puerto Rico Bond Fund Losses, Did UBS Charge its Proprietary Puerto Rico Bond Funds Excessive Markups? and Merry Christmas from UBS Asset Managers of Puerto Rico.

UBS has argued that since we couldn’t identify which trades in the EMMA data were the UBS bond fund trades and UBS wasn’t providing the data, we shouldn’t speculate about whether UBS charged excessive markups or not. It turns out that we can identify at least some of UBS’s purchases of Puerto Rican municipal bonds for the funds it managed and those purchases tell an interesting story.

Table 1 shows UBS PR funds’ $86.95 million holdings face value of the 6.45% coupon, long term Puerto Rican municipal bond (CUSIP: 29216MAN0) issued in January 2008 by the Employees Retirement System.

Table 2 lists the trading activity in this bond and shows that these UBS funds were the only purchasers of this $87 million bond issue and that the funds paid the $100 offering price.

There are many other examples in which the UBS funds buy all, or virtually all, of a UBS underwritten bond from an issuer whose bonds the mainland funds wouldn’t touch. This raises a number of issues which we address in later posts. For today, we will just address the markup issue.

Our example bond was part of a larger Employees Retirement System deal. The Official Statement can be found here. The underwriters paid $98.95 on average for the bonds. UBS resold these bonds, which it paid the Employee Retirement System approximately $86,033,050 in the when-issued market, to its proprietary mutual funds for $86,950,000. UBS charged its mutual fund investors a $916,950 markup over the price UBS paid the issuer in what was, economically at least, a riskless principal trade. This as a 1.05% markup on an $86 million institutional purchase.

Breen, Hollifield, and Schurhoff (2006) find the average underwriting spread on municipal bonds is 0.8% and that more than half of this spread is provided to the brokerage firm as a sales credit or gross commission to motivate the sales force.*

They also find that a significant fraction of large trades are done below the reoffering price at the time of the offering.

So, if a $300,000 underwriter spread on this CUSIP would have been roughly the average non-sales credit component of the spread, why did UBS charge its mutual fund investors an additional $616,950? There were no retail brokers to motivate.

UBS paid the Puerto Rican Employee Retirement System hundreds of thousands of dollars less than it should have or UBS caused its mutual fund investors to pay hundreds of thousands of dollars too much – or both.

Ultimately others will judge UBS’s conduct but, to my eyes at least, the answer to the question posed in the title of this post is Yes.
*Breen, Hollifield, and Schurhoff (2006) "Dealer Intermediation and Price Behavior in the Aftermarket for New Bond Issues."

¿Acaso UBS Cobró Márgenes Excesivos a Sus Propios Fondos de Bonos de Puerto Rico? Segunda Parte

Por Craig McCann, PhD, CFA English Version

Anteriormente habíamos publicado varias entradas en nuestro blog acerca del colapso de los bonos municipales de UBS Puerto Rico: Peligro en la Isla del Encanto: Inversionistas de UBS Puerto Rico Sufren Cuantiosas Pérdidas, Diversificación y Pérdidas en los Fondos de Bonos de UBS Puerto Rico, ¿Acaso UBS cobró márgenes excesivos a sus propios Fondos de Bonos de Puerto Rico? y Feliz Navidad de parte de UBS Asset Managers de Puerto Rico.

UBS ha argumentado que no debemos especular si UBS cobró o no márgenes excesivos, dado que no hemos podido identificar las transacciones en la base de datos EMMA donde los fondos de bonos de UBS son negociados, ni UBS nos ha entregado dicha data. Resulta por lo menos que podemos identificar algunas de las compras de bonos municipales de Puerto Rico por UBS para los fondos que administran y esas compras cuentan una historia muy interesante.

La Tabla 1 muestra los $86.95 millones en valor nominal con cupón de 6.45 % en los Fondos de Puerto Rico de UBS, este es el bono municipal Puertorriqueño a largo plazo (CUSIP: 29216MAN0) emitido en enero de 2008 por el Sistema de Pensiones de Empleados.

La Tabla 2 incluye la actividad comercial en este bono y enseña que los fondos de UBS fueron los únicos compradores de la emisión de bonos por $87 millones y que estos fondos pagaron el precio de oferta de $100.

Hay muchos otros ejemplos demostrando que los fondos de UBS compraron todos, o casi todos, los bonos suscritos por UBS de un emisor de bonos que serían despreciados en los Estados Unidos. Esto plantea una serie de dilemas que abordarnos en futuras entradas de nuestro blog. Por ahora, sólo traeremos a colación el tema de sobreprecio.

Nuestro ejemplo del bono fue parte de un acuerdo con el Sistema de Pensiones de Empleados. La declaración oficial se puede encontrar aquí. Los suscriptores pagaron en promedio $98,95 por los bonos. UBS revendió estos bonos a sus propios fondos mutuos por $86,950,000, pagando al Sistema de Pensiones de Empleados aproximadamente $86.033.050. UBS cobró una comisión a sus inversionistas de $916,950 sobre el precio que UBS pagó al emisor, lo que parecería desde un punto de vista económico un negocio sin riesgo alguno. Esta comisión equivale a un 1,05 % sobre el valor de la compra institucional de $86 millones.

En un estudio por Breen, Hollifield, y Schurhoff (2006) encontraron que en promedio, la comisión de los suscriptores de bonos municipales tiende a ser alrededor de un 0.8 % y que más de la mitad de estos dineros son proporcionados a la casa de corretaje como un crédito de ventas o comisión para motivar las ventas. *

También llegan a la conclusión de que una fracción significativa de transacciones mayores son hechas por debajo del precio de re-oferta al momento de la oferta inicial.

Por lo tanto, si una comisión al suscriptor de este CUSIP de $300,000 hubiese sido más o menos equivalente al promedio de los créditos de no ventas ¿por qué UBS cobró a sus inversionistas de fondos mutuos una suma adicional de $616,950? En este caso, no había necesidad alguna de motivar a los corredores.

O UBS pagó cientos de miles de dólares menos de lo que hubiese debido pagar al Sistema de Retiro de Empleados o UBS hizo que sus inversionistas del fondo mutuo pagaran cientos de miles de dólares de más, o ambas opciones presentadas.

En definitiva, muchos juzgarán la conducta de UBS, pero por lo menos desde mi punto de vista, la respuesta a la pregunta de nuestro titular es un "Sí".

* Breen, Hollifield, Schurhoff (2006) "Dealer Intermediación y comportamiento de los precios en el mercado secundario para las nuevas emisiones de bonos".

FINRA Regulatory Priorities 2014

By Tim Dulaney, PhD, FRM and Tim Husson, PhD

Early this month, the Financial Industry Regulatory Authority (FINRA) released their 2014 regulatory and examination proirities (PDF).  FINRA is continuing to focus on the suitability of recommendations made to retail investors.  FINRA specifically mentions complex structured products (including leveraged ETFs), non-traded REITs, frontier funds, and interest rate sensitive instruments such as mortgage-backed securities and municipal bonds.  At a recent conference, a FINRA representative added that the regulator will also be looking at custom or user-defined structured product platforms, as well as sales practices to the elderly or those with diminished capacity, as reported by

FINRA also plans to broaden the "High Risk Broker" program that uses expedited examinations to target brokers who have a pattern of complaints.  In particular, the practice of 'cockroaching', when brokers with a large number of complaints switch brokerage firms, will come under intense scrutiny.

FINRA specifically mentions that algorithmic trading and high frequency trading (HFT) will be in their crosshairs in 2014.  In particular, FINRA wants to ensure that firms are meeting their supervisory obligations and preventing the use of HFT to manipulate markets.  HFT was a hot topic in 2013, especially related to the early release of economic data to fee-paying HFT firms, and remains highly controversial.

We've been seeing a large volume of cases come across our desks that touch on each of these topics.  Whether it is an ultra high net worth investor with a portfolio full of investments the broker doesn't even understand or a recent retiree bilked out of their life-savings, we think these priorities are hitting the nail squarely on the head.