I have been thinking about how to create a portfolio structure that would be relatively low risk, but provide a high yield as well as a reasonable return over the next two years. I will list some of the assumptions I am making and then lay out the case for using this strategy.
- One assumption is that the equity market in general will not do well over the next two years. You only have to look at the realistic earnings projections to come to that conclusion or take a look at the condition of the world economy. In either case, it appears pretty grim.
- The next assumption is that most fixed income instruments provide more safety than their respective equity counterparts.
- Lastly, I would guess that most individuals might choose a chance for a reasonable return over the next couple of years that, although not guaranteed, does possess a sense of certainty.
With those assumptions in mind, I have decided that a strategy that avoids the volatility and risk in the equity market can be accomplished using both preferred stocks and corporate bonds to provide a return is more than you might expect. I have done a fair amount of research trying to find fixed income instruments that I believe will weather the storm that is occurring at the moment. One website where you can do the same research is www.quantumonline.com which is basically devoted to research of income oriented securities.
In any event, I have pored over this site and identified what I believe to be very strong credits that might provide a yield in the 9% plus range over the next two years. I am only considering the current income of these securities, although I expect that there could be considerable capital gains at some point. All of them are investment grade and in some cases qualify for the 15% percent tax on dividends. Here is the list and my reasoning.
A. Credit Suisse Tier 1 notes. Symbol CRP rated AA. The current yield on this security is 10% . Credit Suisse has one of the highest tier 1 ratios of any bank in the world. At present it is 13.7% which is almost twice as much as most of the major banks in Europe or the U.S. It is a very strong institution and should weather any crisis.
B. HSBC Holdings preferred. Symbol HCS rated AA. This preferred yields about 8.8% and HSBC is one of the largest banks in the world and is known as a conservatively run bank.
C. Wells Fargo preferred. Symbol WCO rated AA. Probably the best bank in the U.S with Warren Buffet being a major shareholder. It has avoided most of the problems experienced by the large banks in the U.S and it has a very large deposit base. The current yield is 8.625%
D. Met Life preferred. Symbol MET-A . Baa rated. This is one of the more unique preferred out there. It is a floating rate preferred that floats 75 basis points above 3 month labor with a minimum rate of 4% and no cap on the upside rate. What is unique is that this preferred trades at a dollar price of $11 which produce a minimum possible yield of 9.09%. The interesting aspect is that if we get back to a normal interest rate environment, then you could easily see labor trading in the 5-6% area. In that case this preferred would yield between 13% and 16% this preferred also qualifies for the 15% rate on dividends. Met Life is the largest life insurance company in the U.S and unlike AIG, has a conservative portfolio. If I was the CFO of Met Life, I would attempt to either tender for the shares or buy them in the open market. This was originally a 600 million dollar issue. At today's price they could buy the whole issue back at 264 million dollars.
E. Constellation Energy notes. Symbol CEG-A rated Baa. These notes have one feature that is very appealing. Berkshire Hathaway's subsidiary Mid American Energy has proposed a buyout of Constellation and it is awaiting approval from the utility regulators. That is expected, and Mid American has given Constellation 1 billion dollars in the form of a preferred stock until the buyout is completed. I think that it is a safe bet that Warren will keep his word. The issue trades with a 9.6% yield and it will be upgraded once the merger is completed.
If you bought equal amounts of each issue mentioned above the overall yield would be 9.20% percent. Of course there are risks in every investment's, but I would use this strategy than try to manage an equity portfolio in this market. I am not suggesting that you throw your whole net worth at this strategy, but you could you it to pick up incremental return. Considering the outlook for interest rates over the next few years, it is going to be tough to get a decent return. Remember to do your own research on these issues, but I think you will find I covered most of the bases.
Stock position: Long.