- With apologies to Herman's Hermits and their hit song 'I'm 'Enery the 8th I Am,' our 2nd qtr strategy and results were much like the 1st qtr.
- Total returns of about 20% annualized, and - more important - yields above 9%.
- As prices rose and yields fell, took profits in utility funds.
- Re-invested in credit funds with better risk/reward profile as equity prices reach record highs.
Those investors among us of a certain age will immediately recognize the memorable line from I'm 'Enery the Eighth I Am, the Herman's Hermits' 1965 hit song. "Second verse, same as the first" aptly describes the 2nd quarter performance of my "savvy senior" IRA portfolio. I didn't change much at all in the portfolio, other than to harvest a few equity funds that had provided stellar returns but whose yields had dropped below my target levels. I reinvested the proceeds from that, as well as accumulated dividends, in some higher-yielding credit-oriented funds that I believe are more likely to provide equity-type returns than "real" equity bought at current levels. Time will tell. If I'm wrong, I'll still be collecting and compounding 7-8% and higher cash returns.
Total returns for the 6 months through June 30 were 10.4% (20.8% annualized), of which 4.6% was cash dividends. That's an annual yield of 9.2%. Readers of my 1st quarter review (available here) learned that we started the year with a 4% total return (16% annualized), of which 2.4% represented actual cash, or a 9.6% annual yield. So while the annualized rate of total return improved slightly in the 2nd quarter, the yield actually dropped, which makes sense since the same basic portfolio was producing the same basic income stream, but the rise in market prices increased the value of the portfolio producing that income (i.e. the denominator in the fraction), so the yield dropped slightly.
This is the basic conundrum of long-term income investing. If you want your income stream to keep growing, you almost need to "root against yourself" in terms of capital appreciation, because the more your investments (and similar assets on your "approved" or target list) increase in value, the more it costs you to reinvest in them, and the lower the yield on your reinvested capital. So while capital appreciation boosts total return and gives you that warm, fuzzy feeling as you see your assets increase in value, it can be counter-productive to the goal of maximizing your total income stream over time through compounding your dividends.
Don't get me wrong. I'm not complaining about a 20% annualized total return, especially if I know that almost half of it is coming from cash dividends that are being plowed back into similar high-yielding assets.
I made very few changes to my core IRA portfolio, which is still basically the same as it was last quarter and can be seen in its entirety (as it was then) in the previously referenced article.
But I did do some tweaking:
I took profits in some equity funds that had done extremely well and whose yields had dropped to the low 6% level or below, specifically Reaves Utility Income Fund (NYSEMKT:UTG), Cohen & Steers Infrastructure Fund (NYSE:UTF), and Duff & Phelps Global Utility Fund (NYSE:DPG). I can hear the screams and foresee the comments already from some readers about this. These are all great funds that I have held for years and made a lot of money owning, both from their dividends and from the capital appreciation. But they became too expensive in terms of the yield they offered, compared to some other income alternatives that seem safer given the rise that utilities and other equities have experienced. (By the way, I still own all three funds in some other less aggressive portfolios that I manage for some family and friends.)
I also sold the small positions I had started in the MLP sector, the Neuberger Berman MLP fund (NYSEMKT:NML) and the Cohen & Steers MLP fund (NYSE:MIE). Here I had no particularly negative reasons for selling, only a general lack of conviction and enthusiasm, especially after the Boardwalk Pipeline Partners (NYSE:BWP) disaster, and more to the point, a feeling that there were better opportunities elsewhere. So it was a case of "selling what I liked least" out of a portfolio I was actually quite content with, in order to make some new investments that interested me more.
Here's what I bought.
I added to my portfolios of credit-oriented funds, specifically:
- Avenue Income Credit Strategy (NYSE:ACP) - senior secured loans, 7% discount, 8% yield.
- Ares Multi-Strategy Credit (NYSE:ARMF) - senior loans, high yield bonds, other credit instruments, 9% discount, over 8% yield.
- Eaton Vance Limited Duration Income (NYSEMKT:EVV) - senior loans, high yield bonds and mortgage backed securities, 7% discount, 8% yield; great all-weather, well-managed fund that I've owned off and on for years with great results.
- Apollo Tactical income (NYSE:AIF) - senior loans, high yield bonds, structured loan vehicles, 8% discount, 7.6% yield.
- BlackRock Multi-Sector Income (NYSE:BIT) - high yield bonds, preferreds, structured and asset backed securities, 9% discount, 7.6% yield.
- BlackRock Debt Strategies (NYSE:DSU) - senior loans and high yield bonds, 8.8% discount, 7.4% yield.
My rationale for all this has basically been that (1) equity markets have more downside risk all the time as they get higher and higher, and we're being compensated less for taking the greater risk as the higher prices drive yields down, (2) yields of 7-8% look pretty good by comparison, (3) the gradually improving economy means credit losses in the high yield sector will probably continue to be benign, while (4) the economic growth - on the other hand - is slow enough that interest rates will probably not rise very quickly and will be telegraphed pretty well in advance when they do.
This continues a theme I have emphasized lately of seeking "equity" returns from credit risk rather than actual equity risk. This means holding a lot of senior secured loan and high yield bond funds, assets I am personally familiar and quite comfortable with, as well as some higher yielding credit-oriented investments like business development companies (that tend to yield in the 9-10% range) and structured credit (collateralized loan obligation or CLO) investments, like Oxford Lane Capital (NASDAQ:OXLC), which yields about 14%.
Meanwhile I added some new "starter" positions:
- Cohen & Steers Total Return Realty (NYSE:RFI) - 9% discount, 7% yield, great long term record (Thanks to Seeking Alpha contributor Illuminati for pointing out this opportunity in his article)
- ETRACS Leveraged CEF ETN (NYSEARCA:CEFL) - leveraged index of closed end funds, paying a yield of 16-17%. This is a risky investment, due to the leverage both of the instrument and the underlying leveraged funds within the index. But I think the risk is contained and reasonable in view of the return. (i.e. a reasonable risk/reward profile). A big shout-out and thanks to Lance Brofman for taking this rather opaque investment and making it more transparent to the rest of us. Likewise to David Fabian and LeftBanker for their very helpful articles on CEFL.
So that's basically what I did this past quarter. If some of these ideas look familiar, it is because I got most of them from other Seeking Alpha contributors. I regard myself as essentially a "portfolio manager" rather than a stock, bond or fund "analyst," per se. Although I may write a few articles focusing on specific investments (Oxford Lane Capital, OXLC, for example) I mostly regard my fellow Seeking Alpha contributors as the analysts on whom I rely to do original research on the underlying securities or funds, from which I make my portfolio selections. This is the model most big investment firms use, where they have teams of analysts doing the fundamental research and then portfolio managers that rely on that research to make their picks. So I want to acknowledge and thank all of you fellow contributors who are - for me and for many others - our "analytical team." There are so many of you - Douglas Albo, LeftBanker, George Spritzer, Robert Mattei, Morgan Myrmo, Fibonacci Sequence - and many, many more. Please keep up your good work, because your ideas continue to help me (and others) make a lot of money.