3 Winners And 2 Losers Of The Buy-The-Dip High-Yield Portfolio In H1 2014

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 |  Includes: BDCS, GBAB, HTGC, PSEC, SDR, VER
by: Stanford Chemist

Summary

The Buy-The-Dip High-Yield portfolio gained 13.91% (27.83% annualized) in H1 2014 net of fees and taxes, competitive with most underlying indexes.

The portfolio was relatively active and made around 75 trades this half-year.

3 winners and 2 losers of the portfolio in H1 2014 are highlighted.

Introduction

The "Buy-The-Dip High-Yield" (BTDHY) portfolio is designed to be relatively active, buying the dips on high-yield securities such as REITs, mREITs, BDCs, MLPs, high-yield bonds and CEFs in order to enhance total return. The BTDHY portfolio turned in a strong 1H 2014 performance thanks to market optimism and falling interest rates boosting the performance of both equity and income assets. On an absolute basis, the portfolio gained 13.91% (27.83% annualized) net of fees and taxes, competitive with most underlying indexes. After accounting for leverage, the portfolio gained 11.81% (annualized 23.63%). Moreover, the portfolio yielded 8.97% annualized on a 6-month trailing basis, or 7.62% if leverage is accounted for.

Buying the dips in high-yield stocks or funds is a potential strategy to lock in higher yields and achieve potential capital appreciation. Hence, the portfolio was relatively active and made around 75 trades this half-year. This article presents 3 winners and 2 losers of the BTDHY portfolio in H1 2014.

Three winners

1. Hercules Technology Growth Capital (NYSE:HTGC)

HTGC is a BDC that provides debt and equity growth capital to technology-related companies. The salient points regarding this BDC are nicely presented in Dividend Sleuth's recent article entitled "7.7% Yielding Hercules Added To Portfolio" (paraphrased):

  • HTGC is the largest BDC that focuses on venture capital companies. Since the company's founding in 2003, it has deployed over $4.4 billion in financing for 290 companies. HTGC reports $900 million invested in 107 companies and it has $225 million in cash. The company states that in the course of its history, it has lost only 0.9% on its investments.
  • HTGC invests $500 million to $700 million annually in new deals. Loans are short term, typically 36 months, with interest rates ranging from 10% to 14%, plus an "equity kicker."
  • HTGC is internally managed, which means management's interests are aligned with shareholders. The CEO and the management team are investors in HTGC and their focus is driving income higher, not focusing on "assets under management."

HTGC was purchased at $13.59 on 4/1/2014. The RSI of the stock had fallen to about 30, indicating an oversold condition, while the yield of the stock was above 9%. The decline in HTGC could be possibly linked to the general malaise of BDC stocks during that time as a result of their imminent removal from the Russell indexes, though HTGC appeared to sell-off harder than most as revealed by a comparison of its stock price relative to the BDC index (NYSEARCA:BDCS).

HTGC Total Return Price Chart

HTGC Total Return Price data by YCharts

The stock hovered at the $13-$14 range for the next month, then took off. The total return at the end of H1 2014 was 20.85%. I still have a position in this BDC.

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Key takeaway: Sector-specific events may cause individual components of the sector to fall harder than others. Use this opportunity to go shopping for quality names on your watchlist.

2. Sandridge Mississippian Trust II (NYSE:SDR)

SDR owns royalty interest in oil and natural gas properties leased by Sandridge Energy wells in the Mississippian formation in northern Oklahoma and southern Kansas. The trust is set to terminate in 2031.

At the time of writing, SDR sports a massive yield of nearly 30%. However, given that the distributions of the trust are linked to well performance, the payouts have been uneven. The last 5 distributions per share have been $0.683, $0.536, $0.568, $0.559, $0.486. This unevenness, coupled with the massive yield of the trust, is one possible reason why the trust experiences regular swings of 10%+, as concerns over well underperformance compete with yield-hunters who might step in to provide a floor to the share price. However, what should not be ignored is the company's overly optimistic projections on the amount of oil and gas that could be extracted, which inevitably leads to disappointment (and sell-off) when the true performance of the trust is revealed. As presented in Daniel R Moore's recent article entitled "SandRidge Mississippian Trust II- Nightmare Turning Into Reality", the last five distributions have all fallen below the targeted distribution for that quarter.

Therefore, SDR should not be considered for long-term investment. However, one might consider swing trading these names for short-term profits, as they do suffer severe sell-offs from time totime. SDR was purchased at $7.30 on 3/28/2014. The RSI of the stock had fallen to below 30, indicating an oversold condition. I was lucky enough to have caught the bottom and sold one month later at $8.05 for a total return of 10.27%.

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Key takeaway: Fixed-date royalty trusts may not be suitable for long-term holding, but their regular bouts of euphoria and pessimism may allow for the nimble investor to reap profits.

3. Guggenheim Build America Bonds Managed Duration Trust (NYSE:GBAB)

Recall that towards the end of 2013, the consensus view was that interest rates were going to begin their inevitable and inexorable rise upwards in 2014. This caused many interest rate-sensitive investments, such as bonds, to decline in value.

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GBAB is a municipal bond CEF that invests in a portfolio of taxable municipal securities known as Build America Bonds. It currently pays a monthly yield of 7.6%. It uses 22.84% leverage and its total expense ratio is 1.30%. Its holdings are concentrated in "AA" and "A"-rated bonds.

I purchased GBAB on the last day of 2013 at $19.77. The discount at that time was -8.84%, which was greater than its 3-year discount average of about -5%. Fast forward six months later, and it was clear that the consensus view that interest rates were bound to increase was wrong. I sold the CEF on 6/23/2014 for a total return of 14.34%. Notably, nearly 4% of that came from the narrowing of the discount alone, which had narrowed to -4.90% at the time of sale. Taking advantage of the mean-reverting nature of CEFs is a powerful way to juice up one's returns.

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Key takeaway: Grasp the opportunity to buy CEFs that are not only at a discount, but whose discounts are wider than their historical averages. Moreover, don't be afraid to challenge the consensus view.

Two losers

1. American Realty Capital Properties (ARCP)

I bought ARCP five times in H1 2014 as it continued to slump, ending up with a cost basis of $13.31. Clearly, uncertainty with the Red Lobster transaction had spooked many investors, not to mention the unexpected equity issuance at seemingly-low prices. However, I had confidence in the management and in the safety of the dividend, and so I bought more as the yield rose on each dip. Total return = -4.86%. Thank you to Brad Thomas for his excellent coverage on this name.

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2. Prospect Capital (NASDAQ:PSEC)

PSEC was another stock that had a dog of a half in 2014. I had a medium-sized position at the start of H1 2014, but ended up adding to it four times as the SEC inquiry unfolded and flushed out anxious sellers. I recall PSEC's management stating that the result of the SEC inquiry should have no material effect on the dividend, therefore I was confident in adding to the position. Remember that markets hate uncertainty, and a savvy investor might hope to take advantage of volatility (as long as the buy thesis remains intact) in order to boost portfolio returns. My PSEC position ended up with a total return of 3.72% in H1 2014 - so while technically this stock wasn't a loser, it certainly felt like it for most of the half!

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Concluding remarks

Does "buy-the-dip" always work? Obviously, the answer is no. Buying-the-dip works great in bull markets like the one we are now, and definitely amplified the returns of the BTDHY portfolio in H1 2014. In a pronounced correction, however, oversold names can get more oversold, and one might end up catching the proverbial falling knife. In those situations, an investor must ask himself whether or not his conviction in the name is strong enough to add more to the position if the stock dips further.

But the beauty of the BTDHY lies in the concept that you are being paid a high yield to wait for the share price to recover. One caveat: in a financial liquidity crisis like 2008, many of the asset classes in the BTDHY portfolio (e.g., high-yield bonds, REITs, mREITs) may crater, and dividends may be cut. Therefore, one needs to be able to either stomach this possibility, or have an exit plan in place.

Disclosure: The author is long PSEC, ARCP, HTGC, SDR. 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.