By David Sterman
The relationship between risk and reward never changes. If you're seeking great riches -- in the form of juicy dividends -- then you're likely pursuing very speculative investments. On the flip side, seeking "safe" dividend payers likely means you're going to get a paltry payout.
But sometimes it's OK to shoulder a good deal of risk, especially if it's only a small part of your portfolio. As long as you stay current on what's going on at the company in which you have invested, you may be able to get out of the stock before the risk part of the equation comes back to bite.
Out of curiosity, I went in search of micro-cap and small-cap investments (with a market value below $500 million), and was surprised to find dozens of choices that yield 10% or more. Logic would tell you that if these high payouts were sustainable, then more investors would pile into them, pushing up their price and pushing down their yield. Yet some of these high-dividend investments can keep the payouts coming -- if the chips keep falling their way.
Take the Cornerstone Progressive Return Fund as an example. The fund invests in a range of unusual securities such as high-yield municipal debt and arbitrage option plays on proposed acquisitions. The fund intentionally seeks out investments that few others would dare touch because of a higher-than-normal possibility the investment will go bust. Yet the strategy has worked fairly well in recent years. From 2008 through 2010, the fund paid out more than $36 million in dividend income to investors. Right now, the fund expects to pay out about $0.10 a share per month, or around $1.20 per year. That's good for a 16.6% yield.
Life Partners Holdings may be the poster child for risk and reward. The company, which re-sells life insurance policies (known as "life settlements") has failed to file its most recent 10-K and 10-Q. Ernst & Young decided to stop acting as the company's auditor in June, citing a revenue recognition policy that was far too aggressive. Those factors partially explain why shares have fallen 75% this year, pushing the dividend yield into the mid-teens.
The company's problems appear to revolve around accounting estimates for the projected life span of insurance policy holders. Undercutting projected dates leads to an inflated value for each policy. Management presumably has learned to throttle back its aggressive stance with its new auditors that joined about a month ago.
We'll soon find out. Life Partners plans to get up to date with its filings next week. This should enable Life Partners to regain compliance with Nasdaq. Results will likely be re-stated to reflect more conservative actuarial forecasts. Still, if those filings are otherwise clean, then shares may see a quick upturn, providing solid capital appreciation along with that juicy payout. But it pays to wait and see if the company needs to re-state past results -- and possibly cut that juicy payout.
The energy sector offers plenty of high-yield plays simply because output of oil and gas is very robust in certain areas relative the cost of the land that was initially acquired. For example, Whiting Petroleum (NYSE:WLL) paid around $400 an acre for more than 600,000 acres that are now producing a high output of oil and gas.
In a bid to raise money to tap its energy fields, Whiting formed a consortium with other financial backers and sold an interest in future cash flow streams. That entity, known as Whiting USA Trust 1 is a profit gusher in its own right, offering a 16% dividend yield. Over time, those energy fields will start to produce less oil and gas, and cash flow will start to drop. The key is for the drop to happen slowly, so this trust keeps paying out enough for investors to recoup their initial investment and also make a handsome profit.
Lastly, I'm intrigued by a high-yielding closed-end fund run by Germany-based Allianz Global, one of the world's largest asset management firms. The AGIC International & Premium Strategy Fund seeks out stocks outside the United States and then focuses on the best options strategy for producing income from those stocks through the premiums written by selling call options.
Quarterly payouts have been erratic. The fund paid out $0.23 a share each quarter in 2009, though that payout was cut in half in 2010 as the options strategy didn't do as well in a fast-rising market. Payouts have rebounded nicely in 2011, averaging $0.40 a share in each of the last two quarters. That $1.60 annualized payout equates to a 12% dividend yield. Shares, which have historically traded at a slight premium to Net Asset Value currently trade at a slight discount.
To capture such high yields, each of these investments has strayed from the beaten path, seeking out unusual investments that aren't being chased by other investors. They certainly entail ample risk, but their business models have proven themselves over time. If you're comfortable with the risks, then consider taking a flier on one of these names.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.