Time To Batten Down The Hatches?

by: Bargain Hunter


Is it time to get a bit more defensive with income producing stocks?

Do bond portfolios need some adjustment?

Now is a very good time to think about protecting capital.

As income seeking investors, we're facing a challenging period ahead. The easy money in bonds has been made and, going forward, as interest rates rise it will be exceedingly difficult to maintain acceptable yields while avoiding capital losses. The stock market is no better, and sitting near all-time highs it's become harder and harder to find the kind of high-yield bargains we seek. Add in the possibility, or probability, of a correction and the situation is even more daunting.

If you're fully invested and the market corrects, you simply have little or no cash available to take advantage of what you perceive to be bargain prices. Even if you've kept some cash on the sidelines, will you have the guts to pull the trigger when most others are running for the exits? The fact is, each investor has a pain level he or she is willing and able to tolerate; after that level is reached, decisions are usually made with emotions rather than reason. It's easy to look at your $250,000 portfolio and proclaim all is well, that you'll be able to handle a market pullback, maybe even pick up a few bargains. But when that statement suddenly reads $200,000, will you still have such conviction or will panic start to set in?

Now, I'm not predicting a 20% correction. However, in my opinion, the next 10% move in the stock market is more likely to be down than up. Will the correction, if and when it happens, stop at 10%? Who knows? There's certainly no guarantee that stocks will keep going up and up every year. Similarly, interest rates have nowhere to go but up, so clearly we know higher rates are a certainty. It's just the timing that remains unclear.

So what's an income seeker looking for a little peace of mind supposed to do? I've been managing an income producing portfolio for my wife and I for a number of years, and here's what I've done in recent weeks. In early July, our rather eclectic income producing portfolio looked like this:

Cash: 19%

Bonds, Bond Mutual Funds, Bond CEFs: 42%, evenly spread between the following -- Blackrock Multi Sector Income (NYSE:BIT), Blackrock Income Trust (NYSE:BKT), DoubleLine Income Solutions (NYSE:DSL), Powershares CEF Income ETF (NYSEARCA:PCEF), Pimco Dynamic Credit Income Fund (NYSE:PCI), Federated High Yield Trust (MUTF:FHYTX), RiverNorth/Doubleline Strategic Income (MUTF:RNDLX), Brookfield High Income Fund (HHY), U.S. Steel 7.375% bond (maturity April 1, 2020), Clean Harbors 5.25% bond (maturity August 1, 2020), and Alpha Natural Resources 9.75% bond (maturity April 15, 2018).

Stocks: 39%, broken down like this:

Preferreds, 5.3% -- Ladenburg Thalman Preferred Series A (LTS-A), NorthStar Realty Finance Corp. Preferred Series C (NRF-C), Box Ships Inc. Preferred Series C (TEU-C), Arbor Realty Trust Senior Note (ABRN), Nuveen Preferred and Income Fund (NYSE:JPI), and Wells Fargo Preferred ETF (NYSEARCA:PSK).

BDCs, 6.3% -- Apollo Investment Corp. (NASDAQ:AINV), KCAP Financial (NASDAQ:KCAP), New Mountain Finance Corp. (NYSE:NMFC), PennantPark Investment Corp. (NASDAQ:PNNT), Prospect Capital Corp. (NASDAQ:PSEC), and THL Credit (NASDAQ:TCRD).

REITs, 9.5% -- American Realty Capital (ARCP), Campus Crest Communities (NYSE:CCG), Chambers Street Properties (NYSE:CSG), EPR Properties (NYSE:EPR), Gaming & Leisure Properties (NASDAQ:GLPI), Omega Healthcare Investors (NYSE:OHI), Senior Housing Properties (NYSE:SNH), UMH Properties (NYSEMKT:UMH), and Alpine Global Premier Properties (NYSE:AWP).

MREITs, 3.5% -- Hatteras Financial Corp. (NYSE:HTS), Western Asset Mortgage (NYSE:WMC), and iShares MReit ETF (NYSEARCA:REM).

MLPs, 5.2% -- Atlas Resource Partners (NYSE:ARP), Eagle Rock Energy Partners (NASDAQ:EROC), Kinder Morgan Energy Partners (NYSE:KMP), and Morgan Stanley Cushing MLP ETF (NYSEARCA:MLPY).

Energy Stocks: 1.9% -- Seadrill Ltd. (NYSE:SDRL).

International: 4.0% -- iShares Emerging Market Dividend ETF (NYSEARCA:DVYE), iShares Intl. Select Dividend ETF (NYSEARCA:IDV), and Global X SuperDividend ETF (NYSEARCA:SDIV).

Miscellaneous: 3.0% WisdomTree Dividend Ex-Finl ETF (NYSEARCA:DTN), Powershares High-Yield Financial ETF (NASDAQ:KBWD), and Utilities Select Sector Spdr ETF (NYSEARCA:XLU).

Since I generally shy away from the 2% and 3% yielders in favor of the higher-yielding securities, this portfolio yielded 6.3% -- even with the 19% cash cushion. And now? I've made some big changes on both the stock and bond side. Stocks have been trimmed back to 19%. I've sold all the BDCs, some REITs, and all the foreign holdings. I also picked up two positions, Ship Finance Intl. (NYSE:SFL) and Compressco Partners LP (GSJK). After all the trimming, we're now holding the following stocks and MLPs: ABRN, GSJK, JPI, KBWD, MLPY, PSK, REM, GLPI, KMP, LTS-A, NRF-C, SDRL, SFL, TEU-C, UMH, WMC.

On the bond side, I cut way back on high yield, selling HHY as well as DSL, BKT, and PCI. I've added a short duration CEF, Nuveen Short Duration Fund (NYSE:JSD), and a floating rate CEF, Nuveen Floating Rate Income (NYSE:JFR). I've kept the mutual funds (FYHTX, RNDLX) and the individual bond holdings, although the Alpha Natural Resources bond does makes me a bit nervous. Bonds now make up 35% of the portfolio, and cash is all the way up to 46%. Even with a huge cash position, our yield sits at 4.1%.

So what's the bottom line on all this? The bond portion of our portfolio is better able to handle the coming interest rate movements. The stock portion is now small enough that we can handle a significant correction without losing sleep, with plenty of cash available if and when it happens. It's true that we've given up about a third of our monthly income, and if I'm wrong and the stock market keeps charging we will have given up some yield every month -- at least temporarily -- as a result of my effort to achieve a good night's sleep. We can both live with that.

Disclosure: The author is long BIT, GLPI, JFR, KMP, PCEF, SDRL, SFL, UMH, WMC, GSJK, JPI, JSD, KBWD, MLPY, PSK, REM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.