Staying Cautious With My Income Producing Portfolio

by: Bargain Hunter


Capital preservation is key right now.

Stocks at all-time highs and interest rates poised to rise equals dangerous times for investors.

Giving up a little yield for a lot of safety might be a prudent move for conservative investors.

The income producing portfolio I manage for my wife and I has seen significant changes in the last month as I've switched into "extreme caution" mode. The first wave of changes are documented here. Essentially, I trimmed our stock holdings from 39 to 19 percent, trimmed our bond holdings from 42 to 35 percent, and increased our cash position from 19 to 39 percent. I also took steps to shorten the duration of our bond CEFs, and added a floating rate bond CEF. Any bond CEFs that exhibited a good deal of volatility during 2013's bond sell-off are gone. Our overall yield has dropped from 6.3% to 4.1%.

Before I get to the recent changes, let me discuss my reasoning for all this caution. First off, across the globe, havoc is the rule in three areas -- Ukraine/Russia, ISIS/Syria-Iraq, and Israel/Hamas. The odds have increased that we will see a terrorist attack at home (or in Great Britain). On Aug. 29, 2014, Great Britain raised its terror alert level to "severe." On the same day, news stories broke regarding an increased risk of a terrorist attack near the U.S. southern border, citing numerous high level intelligence sources.

Many economies across the globe are limping along in slow growth or no growth mode. U.S. companies, for the most part, sell products worldwide and, as a result, need growing economies all over the globe to excel. Without getting too political, the inflation numbers our government keeps throwing at us are a joke. Anyone who's walked into a supermarket in the last three to five years knows that prices have been steadily climbing. Gas is not far from an all-time high. Cheap and easy money is the only thing keeping auto and housing sales moving. The question is: Why does the government keep this inflation charade going?

1. No or low inflation means extremely small "COLAs," or cost of living adjustments. To be blunt, they are sticking it to those of us who are on social security.

2. The U.S. government is carrying an outrageous amount of debt. An increase in interest rates would be devastating to an already out of control U.S. budget. Thus, fabricating these low inflation numbers allows our government to save two ways (interest paid out and COLAs paid out), while also keeping the economy propped up with cheap money.

So where is all this heading? My opinion is that it won't be good. But I could be wrong. All least half the market observers I hear expect the stock market to keep charging upward. But one thing that I've learned from 20 years of stock trading (in another account) is that wearing the hat of "risk manager" is of the utmost importance in becoming a successful trader. I see no reason why a manager of an income producing portfolio shouldn't also wear that hat. In other words, an income portfolio doesn't necessarily have to be a buy and hold proposition. You don't have to sit back and watch your capital disappear, while the gurus on CNBC tell you all is well. If you're not comfortable with the direction things are heading, you can take proactive steps to decrease your risk, while still keeping a decent yield coming in every month.

It's true that bonds recovered nicely from last summer's sell-off. But if and when interest rates start rising, it's quite possible, probable even, that bond funds and CEFs will get hit for an extended period of time. In my opinion, it's our job as managers of our own portfolios to get positioned so as to minimize that risk. Same goes for the stock portions of our holdings. Here are the recent changes I've made along with some of the reasoning behind them.

I sold Compressco Partners LP (GSJK). This was an example of taking advantage of a pullback after a company issues shares and selling after the rebound, a strategy advocated by a few Seeking Alpha contributors. I've found that it works well, but I only use it with dividend payers in case the snap back doesn't occur.

I also sold Kinder Morgan Energy Partners (NYSE:KMP). This sale was particularly profitable, as I was able to sell at $103.25 in the pre-market the Monday after the company announced it was reconfiguring the whole Kinder Morgan empire. A 27% profit on our shares (after collecting the dividend for about two years) was too good to pass up.

The recent strength also allowed me to take profits in Ship Finance International (NYSE:SFL) and UMH Properties (NYSEMKT:UMH) and Western Asset Management (NYSE:WMC). The WMC strategy is another winner I picked up from a Seeking Alpha contributor.

"Extreme caution" mode means I only add positions on pretty serious pullbacks. The thinking being that, during a market sell-off, a stock that's already been hammered may suffer less than the general market.

That said, I've added two positions on recent pullbacks, Transocean Ltd. (NYSE:RIG) at $38.50 and Prospect Capital Corp. (NASDAQ:PSEC) at $10.30. I hesitated to buy the RIG since we already have a double position in Seadrill Ltd. (NYSE:SDRL), and I know about half of you would give me an argument here, but my position is oil prices will not stay depressed for long, oil demand will continue to climb, and the 8% dividend is nice to collect along the way. PSEC, which I've owned twice before with good results, is a BDC that recently got hammered due to weaker-than-expected earnings, and pays a 12.9% dividend based on my cost. If it falls to the $9.75 area I might consider adding more.

I also have an unfilled buy order for Dominion Resources Junior Note (NYSE:DRU) at $25.50, which will yield 8.2% if and when I get filled. I've got my eyes on refiner MLPs Calumet Specialty Products (NASDAQ:CLMT) and CVR Refining (NYSE:CVRR) for any big pullbacks. And I'm considering positions in Sabra Healthcare REIT Preferred Series A (SBRAP) with a yield of about 7%, and Fifth Street Senior Floating Rate (NASDAQ:FSFR) with a yield of about 8.2%. Brookfield High Income is a high-yield bond CEF that I sold at $10.30 in late July. I might look to retake a small position if it falls to the mid-$9s.

The bottom line? Our portfolio yields 3.6% now, and I seek to get that yield up to 4.0%. So while I'm being cautious, I'm looking for beaten down high yielders to add in the mix. Here's the current makeup of our portfolio:

Cash: 50.0%

Bonds, Bond Mutual Funds, and Bond CEFs: 35.3%. Positions: Blackrock Multi-Sector (NYSE:BIT), Nuveen Floating Rate (NYSE:JFR), Powershares ETF Trust (NYSEARCA:PCEF), Federated High Yield Mutual Fund (MUTF:FHYTX), Rivernorth/Doubleline Strategic Income fund (MUTF:RNDLX), Nuveen Short Duration (NYSE:JSD), US Steel 7.375% Bond-Maturity 4/1/2020, Clean Harbors 5.25% Bond-Maturity 8/1/2020, Alpha Natural Resources 9.75% Bond-Maturity 4/15/2018.

Stocks: 14.7%. Positions: Gaming and Leisure Properties REIT (NASDAQ:GLPI), Ladenburg Thalman Financial Services Preferred (LTS-A), Northstar Realty Finance Corp Preferred (NRF-C), Prospect Capital BDC, Seadrill, Box Ships Preferred (TEU-C), Arbor Realty Trust Senior Note (ABRN), Nuveen Preferred & Income CEF (NYSE:JPI), Powershares ETF High Yield Financial (NASDAQ:KBWD), Morgan Stanley Cushing MLP ETF (NYSEARCA:MLPY), SPDR Wells Fargo Preferred ETF (NYSEARCA:PSK), IShares MREIT ETF (NYSEARCA:REM), Transocean Ltd.

What would it take to get me more bullish? I can't answer that, but I don't see it happening anytime soon. In the meantime, preserving capital and garnering a decent yield is my goal.

Disclosure: The author is long JPI, JSD, KBWD, MLPY, PSK, REM, RIG, BIT, GLPI, JFR, PCEF, PSEC, SDRL.

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.