One Investor's Very Brief Dalliance With American Capital And Annaly

Includes: AGNC, NLY
by: Mike Nadel

After great consideration, more than a little consternation and considerable procrastination, I finally took the leap last week: I was going to buy American Capital Agency (NASDAQ:AGNC) and Annaly Capital Management (NYSE:NLY), the two most-discussed mREITs here on Seeking Alpha.

Before going to bed Thursday, I placed limit orders for both companies. By Friday morning, my gut was telling me AGNC, NLY and other mREITs didn't belong in the Dividend Growth portfolio I was painstakingly building. So I went to my brokerage Web site and canceled the orders.

It was a 180-degree flip-flop that would do any politician proud. What the heck happened?

AGNC and NLY seem to have almost cult-like followings on Seeking Alpha. I fully understand the attraction, with American Capital yielding about 15 percent and Annaly 13 percent.

Fed chairman Ben Bernanke has pledged to keep interest rates at record lows for two more years, and mortgage REITs thrive in low-rate environments. Having adopted the DG strategy less than a year ago, I am still in the accumulation phase and about 25 percent of my portfolio is in cash. As I patiently research potential long-term holdings, why not put more money to work in popular mREITs such as AGNC and NLY?

Yes, combined with the many SA authors who champion mREITs, I was doing a pretty good job of talking myself into buying them.

Then I started thinking about why I adopted Dividend Growth as an investing strategy. I want stable, proven, high-quality companies that have raised dividends for years and figure to keep doing so for decades. On top of a current portfolio yield of about 4 percent, I want dividends that will beat inflation. When my wife and I are retired, I want that reliable, growing, inflation-beating dividend stream to complement monthly Social Security and pension checks, giving us predictable, dependable retirement income.

The 22 companies I've chosen so far -- most of which I discussed in this article -- might not be idiot-proof, but they're pretty close.

I don't have to keep very close tabs on Procter & Gamble (NYSE:PG), 3M (NYSE:MMM) and Coca-Cola (NYSE:KO), iconic companies that have raised dividends for 56, 54 and 50 years, respectively. Even my higher yielders, such as ConocoPhillips (NYSE:COP), Linn Energy (LINE) and National Retail Properties (NYSE:NNN), seem significantly more solid and "buy-and-holdish" than AGNC and NLY.

What am I giving up by not buying American Capital, Annaly and other mREITs? While it's true that I wouldn't lose much money in a worst-case scenario, it's equally true that I wouldn't gain much in dividends.

Let's say I have a $1 million portfolio -- sadly, I don't -- and I invest $10,000 each in AGNC and NLY. The most I would lose if both collapsed tomorrow would be $20,000, or 2 percent of my portfolio. (And it's far more likely that I would bail well before I'd lose anything close to that.) Big deal, right?

OK, now let's say both companies stay healthy and their yields remain at present levels. Over two years, I'd earn about $6,000 before selling the stocks in anticipation of a Fed rate hike. Although six grand is nothing to sneeze at, it seems pretty insubstantial as part of a million-dollar portfolio.

It's the whole risk-reward thing ... and I decided that for me (even without the million-dollar portfolio), the reward wasn't worth the risk.

Maybe I'll change my mind someday, but I decided I don't need ultra-high-yielders to meet my goals. I decided my interest in mREITs felt too much like I was following the herd. I decided it's no sin to be cash-heavy while waiting for opportunities to buy proven companies at attractive prices. I decided mREIT transactions felt too much like trades and not enough like investments, and I don't want to be a trader.

While I wish nothing but good fortune to American Capital and Annaly loyalists, I will sleep better at night by keeping my portfolio mREIT-free.

Disclosure: I am long PG, MMM, KO, COP, NNN, LINE.

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