At an amusement park you know that the roller coaster will always bring you right back to its original starting point. In the investment world you can never be sure where it will let you off.
Fortunately, this first quarter's ride, while it was a doozy, managed to bring me back to where it started. In fact, it was even better than that, with a quarterly total return of 3.6% , of which 2.8% was cash yield. So except for the hair-raising quality of the ride (down by over 10% at one point in February) it was a pretty good quarter and exceeded my goal of an annualized return of 10% in cash yield. (Readers of my articles on "income growth vs. dividend growth," available here and here know that I prefer the cash flow from what I call my "income growth" portfolio, (or "income factory"), from which I can create my own equivalent "dividend growth" portfolio by reinvesting and compounding some or all of the 10 or 11% yield that I target.
Since mathematically both approaches get you to the same place (i.e. 5% dividends to reinvest plus another 5% organic growth) or 10% dividends compounded and no organic growth), the choice comes down to a personal one about which approach allows a particular investor to sleep better at night, especially during turbulent market periods. This past quarter, while unnerving, convinced me of the soundness of my choice - for me, at least. Having dividends at an annual rate of 11% coming in regularly throughout the period that I could reinvest at bargain prices was an emotional safety net as well as a financial one.
More than clipping coupons
Of course, since all my holdings didn't go down as far as some of them, there was opportunity to shift holdings a bit to (1) try to take advantage of some that presented bigger bargains than others, and (2) move out of some that - frankly - made me more nervous than others as the market was being so volatile.
One group that I thought presented more of a bargain than it turned out it actually did was the MLP segment. As energy prices were crashing they brought the energy infrastructure companies (pipelines, etc.) down with them. I saw a lot of end-of-year "happy talk" research and commentary from the various MLP fund groups that emphasized that, while energy prices were way down, the pipelines and other infrastructure the funds invested in were largely immune to that and their cash flows were unlikely to be very affected. I - like a dummy - believed a lot of that and shifted into some of the MLP funds, like ones run by Tortoise (NYSE:NTG), Cohen & Steers (NYSE:MIE), Neuberger & Berman (NYSEMKT:NML), and Kayne Anderson (NYSE:KYN). As it turned out, some of them did end up cutting their dividends after all, with NML actually cutting theirs by about 50% (ouch!). So much for being smart.
But even with the occasional hiccup like that, my strategy continues to churn out lots of cash, most of which I plow back into additional income earning assets (virtually all closed end funds) currently yielding on average about 11%.
Pulling that average up are a couple high-yielders that I watch like a hawk, especially the funds that invest in collateralized loan obligations (CLOs). As a former banker and credit professional I know a fair bit about leveraged loans and the securitized vehicles (mostly CLOs) that hold them. As an asset class they are solid and even came through the great crash of 2007/2008 very well, providing stellar returns to investors that held them and didn't panic when their prices (along with everything else) dropped through the floor, only to come roaring back in 2009 and afterwards.
The key to owning CLOs (and syndicated loans and high yield bonds generally) is to hold them in vehicles that are NOT subject to liquidity calls or daily redemptions. Third Avenue Focused Credit Fund (MUTF:TFCIX and MUTF:TFCVX), a highly illiquid "vulture" high-yield bond fund proved this when it collapsed due to a "run on the bank" last year because its management foolishly, in hindsight, failed to realize how exposed it was as a traditional "open end" mutual fund.
Had Third Avenue, which I luckily sold out of (and reported it here!) when I saw the handwriting on the wall last fall, been set up as a closed end fund, it would most likely still be among the living. It is precisely this ability to be safe from "runs on the bank" that first attracted me to Oxford Lane Capital (NASDAQ:OXLC) and then later on to Eagle Point Credit (NYSE:ECC), two closed-end funds that buy CLO equity. Since I knew from experience what lucrative long-term investments CLOs had been for hedge funds and other institutional players, my first thought was "Oh boy, a chance for retail investors to get in on this action too."
While closed end funds are immune from having to worry about investors forcing them to sell out in order to get their money back, a closed end fund's management can squander this advantage if it leverages itself so much that an adverse swing in the market price of its assets causes its leverage ratio to fall below the minimum set by the Investment Company Act of 1940. Unfortunately, OXLC's management did just that, so instead of being able to enjoy themselves over the last few months using their strong cash flow to purchase more high-yielding CLO equity at bargain prices, they have apparently had to either forgo re-investment or even sell some of their own portfolio at fire-sale prices in order to redeem their preferred stock to stay within the 1940 Act leverage limits. How much of a damper (if any) that will put on OXLC's own distributions in the future we are still not sure, but I didn't want to sit on the stock waiting to find out and sold all my OXLC during the quarter.
Fortunately I was able to reinvest the proceeds back into the same high-yielding CLO asset class, which I am still quite bullish about, and increased my position substantially in Eagle Point. ECC's management is first class and their cash flow appears to be growing at a rate that will most likely not only sustain the present dividend level but pay some special ones every so often as well. They also have very modest leverage levels, so they don't have to worry about breaching limits or liquidating assets when they don't want to.
Let me fend off in advance the inevitable question about what appears to be a huge premium over NAV on ECC's market price. Since ECC holds highly illiquid CLO equity tranches, the so-called NAV reflects a theoretical fire-sale price that the company might have to settle for if it were forced (which it wouldn't be) to sell the asset. CLO assets were traditionally bought by institutional cash flow investors who never even paid attention to "market value." Forcing an artificially derived market value on the asset results in absurd values during volatile periods, but has little to do with the underlying economic value of the fund, which is the discounted present value of its future cash flows. That is a very different number than the reported NAV.
By the way, hats off to Sean Dougherty who has been following both OXLC and ECC closely over the last few quarters and has written some in-depth articles about both funds, available here and here. While I may understand these asset classes from 10,000 feet, Sean, with his strong background in analyzing, structuring and rating these securities, can really get down deep into the accounting and other issues. He has helped many of us understand the risks and opportunities in both of these funds far better than we previously did.
In summary, it was a volatile and challenging quarter that happened to turn out well, but a lot can happen over the next nine months. If you examine my portfolio (below) you will see a lot of "batten down the hatches" sorts of investments, at least by my standards. Diversified funds made up of a wide range of companies that only have to stay in business and continue to service their debts and pay their dividends for me to continue to have a nice 10%-plus income, regardless of how the market prices the "dividend factory" churning out the cash.
As I have said before, I prefer to bet on mere survival, rather than heroic performance, on the part of the companies that make up the portfolios of the funds I buy. Funds like Cohen & Steers Closed End Opportunity Fund (NYSE:FOF), Eaton Vance Limited Duration Fund (NYSEMKT:EVV), LMP Capital & Income (NYSE:SCD) and my utility funds - Cohen & Steers Infrastructure (NYSE:UTF) and Duff & Phelps (NYSE:DPG) - all with generous yields and big discounts, may not be exciting but fit the bill nicely.
Thanks again to the many Seeking Alpha contributors and commenters, whose insights and ideas I freely borrow, utilize and, especially, are entertained by.
|Savvy Senior Portfolio 4/7/2016||Symbol||Current Yield||CEF Premium/ Discount||This Holding As % of Portfolio Income||This Holding % of Portfolio Income 3 Months Ago||Increase/Decrease as % of Portfolio income|
|Eagle Point Credit Co.||ECC||14.4%||37.0%||13.55%||7.24%||6.32%|
|Eaton Vance Limited Duration||EVV||9.3%||-9.6%||9.53%||11.68%||-2.16%|
|Cohen & Steers CEF Oppty Fund||FOF||9.6%||-11.9%||7.74%||7.83%||-0.08%|
|First Trust Specialty Financial Oppty Fund||FGB||11.7%||-4.6%||6.50%||4.69%||1.81%|
|Duff & Phelps Global Utility Fund||DPG||9.2%||-13.5%||6.41%||7.11%||-0.70%|
|Calamos Global Dynamic Income Fund||CHW||12.2%||-14.9%||6.12%||4.55%||1.57%|
|Pimco Dynamic Credit Income Fund||PCI||11.2%||-10.6%||5.69%||5.92%||-0.22%|
|LMP Capital & Income||SCD||10.2%||-16.2%||4.84%||4.84%|
|Pimco Income Strategy Fund||PFL||11.2%||-3.5%||3.92%||3.92%|
|Cohen & Steers Infrastructure Fund||UTF||8.3%||-16.5%||3.81%||3.39%||0.42%|
|Allianz Convertible & Income||NCZ||14.2%||-7.5%||3.22%||3.22%|
|Blackstone GSO Strategic Credit Fund||BGB||9.3%||-10.8%||3.19%||1.24%||1.95%|
|Voya Risk Managed Natural Resources||IRR||15.0%||-13.9%||2.76%||2.76%|
|Pimco Income Strategy Fund II||PFN||11.0%||-3.0%||2.62%||2.69%||-0.07%|
|Eaton Vance Tax Mgd Global Div Inc Fund||EXG||11.3%||-6.8%||2.47%||2.29%||0.18%|
|Nuveen Energy MLP||JMF||14.0%||-3.9%||2.37%||3.42%||-1.05%|
|Allianz Convertible & income II||NCV||14.2%||-7.0%||2.18%||2.18%|
|UBS ETRACS Leveraged REIT||MORL||27.0%||NA||2.01%||2.67%||-0.66%|
|Cohen & Steers MLP Fund||MIE||11.8%||-12.1%||1.96%||7.16%||-5.19%|
|Pimco Income Opportunity Fund||PKO||11.1%||-5.3%||1.46%||1.49%||-0.04%|
|Kayne Anderson Midstream Energy Fund||KMF||17.7%||-4.3%||1.23%||1.23%|
|Kayne Anderson MLP Inv Co||KYN||16.9%||1.8%||1.13%||0.52%||0.62%|
|Eaton Vance Tax Mgd Global Buy Write Fd||ETW||11.2%||-5.18%||1.08%||1.06%||0.02%|
|Tortoise MLP Fund||NTG||10.6%||-4.87%||1.06%||2.09%||-1.02%|
|Blackstone Lg/Sht Credit income Fund||BGX||8.6%||-11.67%||0.88%||1.74%||-0.85%|
|John Hancock Investors Trust||JHI||8.8%||-7.91%||0.86%||1.76%||-0.90%|
|Ares Dynamic Credit Allocation Fund||ARDC||9.9%||-13.23||0.76%||2.31%||-1.55%|
|Voya Global Equity Dividend||IGD||13.5%||-12.44%||0.63%||0.63%|
|Positions Eliminated||Previous % of portfolio income|
|Babson Capital Partners||MPV||0.8%|
|First Trust Inter. Duration Pfd & Inc||FPF||2.6%|
|Neuberger Berman MLP Income Fund||NML||0.6%|
|Nuveen Real Asset Income & Growth||JRI||0.9%|
|Oxford Lane Capital Corp.||OXLC||7.9%|
|Reaves Utility Income Fund||UTG||2.7%|
Disclosure: I am/we are long DPG, UTF, SCD, FOF, EVV, ECC, NTG, KYN, MIE.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.