Income Investing: Back In 2014?

Includes: PGX, PML, REM
by: Nicholas Vardy, CFA

2013 was a tough year if you were an income investor.

After all, the Fed's zero interest rate policy ("ZIRP") has been punishing savers with its low interest rates since 2009. Many retirees depending on their accumulated savings had grown increasingly frustrated trying to eke out income from their hard-earned investments. So, it's no surprise that many had piled into income investments that promised regular high single-digit, or even double-digit, percentage income.

But with the Fed announcing the onset of tapering back in May - and then actually launching it in December - the bottom dropped out from virtually all "safe" income investments.

Income investors suddenly found that even if a diversified portfolio of, say, U.S. Real Estate Income Trusts (REITs) boasted headlines about double-digit yields, that mattered little if the principal dropped by 20%, thanks to the threat of rising interest rates.

Meanwhile, these same investors stood by as stock market investors enjoyed their biggest gains since 1997.

Is Income Investing Back in 2014?

But with the S&P 500 pulling back 2.53% so far in 2014, many investors are again turning their attention back to income investing.

After all, a handful of income-generating investments - through a combination of income and capital gains - have already generated big gains barely a month and a half into the New Year.

And the promise of steady income - hearing the cash register of regular returns ring every month or quarter - suddenly offers the security the volatile stock markets cannot.

I manage just such a program of diversified income-generating investments at my firm Global Guru Capital.

The "Double Your Dividends" program assembles a portfolio investment that generates income from the widest possible range of sources. It includes sources of income from Master Limited Partnerships (MLPS), up 26.46% last year, to Business Development Companies (BDCS), up 15.34% in 2013.

Six weeks into 2014, most of these income investments are solidly in the plus column. All but one income investment is outperforming the S&P 500 year to date. One is even on the verge of double-digit percentage gains.

With that, here are the "Double Your Dividends" Program's top-performing income investments, so far in 2014:

1. PIMCO Municipal Income II (NYSE:PML) - 9.66% Gain

PIMCO Municipal Income II is an actively managed, highly leveraged municipal fund. The fund typically generates its large distribution by venturing down the credit spectrum into non-rated and junk-rated muni debt, focusing on the intermediate and long portions of the yield curve, and then leveraging its holdings.

The fund has maintained a level income-only monthly distribution of $0.065 per share since 2007. This translates to an above-average 7.2% yield. It has logged peer group-topping returns since the 2008 market meltdown, returning an annualized 8.7%. The fund's advisor is paid 0.65% of the average daily net assets, plus the proceeds from preferred shares.

PML has generated a gain of 9.66% so far this year.

2. iShares Mortgage Real Estate Capped ETF (NYSEARCA:REM) - 7.64% Gain

iShares Mortgage Real Estate Capped ETF tracks the FTSE NAREIT All Mortgage Capped Index. The index is weighted by market cap and screens constituents for size and liquidity. Most of REM's holdings are in medium- and small-cap mortgage real estate investment trusts. REM has large allocations to two giant mortgage REITs, Annaly Capital Management (17%) and American Capital Agency (14%).

Unlike equity REITs, which generate income by managing properties and collecting rent, mortgage REITs are financial firms that engage in arbitrage on the spread between the short-term interest rate and income from mortgage-backed securities.

Mortgage REITs are very susceptible to rising rate risk. Even small upticks in the short-term rate can have a significant impact on these firms' profitability. Several Mortgage REITs have cut their distributions and have performed poorly during past rising rate environments.

REM yields an impressive 15.25%, pays dividends quarterly and charges a fee of 0.48% annually.

REM has generated a total return of 7.64% year to date.

3. PowerShares Preferred (NYSEARCA:PGX) - 3.98% Gain

The PowerShares Preferred tracks the BofA Merrill Lynch Core Plus Fixed Rate Preferred Stock Index. The index includes preferred stocks that have a market cap of at least $100 million.

Preferred stocks are hybrid securities that have bond- and stock-like qualities. They are usually issued by highly leveraged companies like financial institutions, telecoms and utilities. Almost all of PGX's holdings are issued by financial companies, which include banks, real estate firms and insurance companies. Preferred stock pays income on a regular basis and does not benefit from earnings growth of the issuing company.

PGX yields 6.68% and pays out dividends monthly. It charges an annual fee of 0.50%.

PGX has generated a total return of 3.98% year to date.

Disclosure: I have long positions in these ideas on behalf of my clients at Global Guru Capital. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.