Here's An Ideal Way To Earn High Yields And Prepare Your Portfolio For Rising Rates

Aug.29.14 | About: Fifth Street (FSFR)

Summary

It appears to be just a matter of time before interest rates rise.

A recent Wall Street Journal article suggests the Fed could raise rates in mid-2015.

Investors should consider preparing their portfolios now by seeking investments that can outperform in a rising rate environment.

Higher-yielding, floating rate securities appear to be a very attractive investment for income investors to consider now.

The stock market is trading near all-time highs and the real estate market is looking speculative in many regions once again. The Federal Reserve has certainly accomplished the goal of re-inflating asset values and that means it is time for the Fed to start pulling back, hopefully before things get too frothy. There are a number of ways in which the Fed can "pull back" and one way would be to raise interest rates. According to a recent Wall Street Journal article, the Fed could be poised to raise interest rates around mid-2015. This especially seems likely if the job market were to improve in the next couple of quarters.

After several years of a near-zero interest rate policy or "ZIRP", it appears that it is just a matter of time before rates rise, and this could cause bonds and even stocks to decline. When investors and savers are unable to earn anything of substance in a certificate of deposit or a savings account, they often seek other ways to earn decent yields either with bonds or dividend stocks. This has pushed a lot of money into risk assets, but as rates rise, the demand for some assets could be impacted. Furthermore, bonds typically drop in price when rates rise, which is a potential risk factor investors should start considering very seriously. An ideal way to avoid the risk of principal loss due to a potential rise in interest rates would be to invest in floating rate securities. The demand for floating rate securities seems to be growing and could become even more popular when rates really do start to rise. The US Treasury appears to be anticipating this future potential demand as it recently issued floating rate securities (starting in January 2014). Rates on these floating rate notes or "FRNs" remain very low. For example, a two-year note yields less than 1% annually. But the people buying these notes are probably less interested in yield than they are in preservation of capital. Many investors know that when rates rise, floating rate securities will protect them from losing capital. While the recently offered floating rate notes from the US Treasury might make sense for some investors in terms of preservation of capital, these notes don't offer much in terms of yield. There are a number of floating rate securities that can provide much better yields than what the US Treasury notes offer. One option that investors should consider is detailed below:

Fifth Street Floating Rate Corp. (NASDAQ:FSFR) appears to be an ideal way to pick up an undervalued stock that not only has rebound potential, but also a generous dividend yield of over 8% that could rise along with interest rates in the future. This company provides small and mid-sized firms with senior secured loans that primarily pay interest at rates that are determined on the basis of a floating rate lending rate. Under normal market conditions, about 80% of its portfolio will be invested in floating rate senior loans. The fact that this company primarily invests in senior securities lowers risks for investors because senior loans are first to get paid in the event of a corporate default. Furthermore, the risk of rising rates is greatly diminished since this company is primarily invested in floating rate securities that will also rise along with interest rates.

Fifth Street Floating Rate Corp. shares were recently trading for more than $14, but a recent secondary stock offering at $12.91 per share caused the stock to take a significant hit. It now trades even below that level, but I expect the stock to rebound as it is currently oversold and it also appears undervalued. Furthermore, it offers a very generous yield, which is over 8% and it is about to pay a 30-cent per share dividend in September. On September 11, 2014, this stock will trade ex-dividend, and shareholders on record as of September 15, will be paid the 30-cent per share dividend on October 15.

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As the chart above shows, this stock is oversold with the shares trading at just about $12.44. The relative strength index or "RSI" is at about 30, which indicates this stock is oversold and therefore due for a rebound. Furthermore, the secondary offering was done at $12.91 per share and before the offering, the net asset value was reported to be just over $15 per share. That means that this stock is cheap and now trading below both the secondary offering price and below the net asset value. As the selling pressure eases from disappointed shareholders, this stock should see trading volumes normalize and the share price could be due to rebound.

Prices
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Date Open High Low Close Volume Adj Close*
Aug 27, 2014 12.53 12.55 12.36 12.39 583,200 12.39
Aug 26, 2014 12.41 12.55 12.41 12.47 516,500 12.47
Aug 25, 2014 12.44 12.57 12.35 12.45 717,300 12.45
Aug 22, 2014 12.44 12.45 12.27 12.38 409,300 12.38
Aug 21, 2014 12.45 12.46 12.32 12.40 520,300 12.40
Aug 20, 2014 12.39 12.44 12.26 12.39 627,500 12.39
Aug 19, 2014 12.35 12.46 12.30 12.32 578,600 12.32
Aug 18, 2014 12.35 12.49 12.35 12.41 809,000 12.41
Aug 15, 2014 12.21 12.47 12.15 12.37 2,252,900 12.37
Aug 14, 2014 12.24 12.35 12.11 12.11 15,173,100 12.11
Aug 13, 2014 13.49 13.65 13.20 13.31 267,300 13.31
Aug 12, 2014 13.56 13.56 13.38 13.42 29,300 13.42
Aug 11, 2014 13.60 13.63 13.35 13.41 58,000 13.41
Aug 8, 2014 13.41 13.70 13.17 13.62 51,800 13.62
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By taking a look at the historical price and volume data provided above by Yahoo Finance, it is easy to see that the sell-off in the stock hit capitulation-like levels on August 14. On that day, trading volumes went over 15 million shares, which was when the secondary was announced. Just days before, trading volumes were as little as 29,300 shares. Since the massive volume of more than 15 million shares was reached on August 14, trading volumes have dropped significantly and begun to "normalize" to around 500,000 shares in recent days. This is a sign that the selling pressure is also starting to fade, which means a rebound in the share price could be coming next. One other positive is that insiders might be starting to take advantage of the recent pullback. On August 25, 2014, the CFO, Richard Petrocelli, purchased 1,000 shares at $12.44 each. While this is not a large purchase, it is still a positive sign and there could be more insider buys coming (or yet to be reported), as the stock appears undervalued and a very attractive yield play.

Here are some key points for Fifth Street Floating Rate Corp.:

Current share price: $12.44
The 52-week range is: $12.11 to $15.10
Quarterly dividend: 30 cents per share, which yields about 8.2%

Data is sourced from Yahoo Finance. No guarantees or representations
are made. Hawkinvest is not a registered investment advisor and does
not provide specific investment advice. The information is for
informational purposes only. You should always consult a financial
advisor.

Disclosure: The author is long FSFR.

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.