Our roller-coaster first quarter was such a sobering start to the year that I am inclined to take our quite positive six-month results with more than a grain of salt. In other words, our 11% total return (5.5% of it in cash dividends) for the first half of the year (15% for the year to date, as we go to press later in July) is great and I'm happy to have it, but I prefer not to get too comfortable with all the uncertainty - political and economic - facing us in the months ahead.
As many readers know, I am retired, live largely off my investment income, and write about the investment decisions I make. So this is very much a case of "eating my own cooking," and doing it in public to boot.
Here are the main ideas that currently inform my portfolio decisions:
1. I seek a long-term "equity return" and define that as somewhere in the plus or minus 10% range
2. An "equity return" doesn't mean you have to actually own equity. In fact I am quite happy to make an equity return through other non-equity investments if it appears the risk/reward trade-off is more attractive in those other asset classes
3. Right now, I think corporate credit - bonds, loans and other credit-related investments - offers better risk-adjusted "equity" returns than most "real" equity. (The term "credit-related investments" does NOT include government or highly rated corporate bonds. These are interest rate bets, not credit investments, and you get paid almost nothing for taking considerable long-term risk.)
This third point is important. Investors should understand that all equity investments include the credit risk of the company issuing the equity. Equity owners get the upside reward in terms of earnings and stock appreciation, but they only get it if the company fully meets all its debt obligations - principal and interest.
I compare equity and credit investing to horse race gambling. If you buy equity you are betting on the horse to excel: win, place or at least show. If you buy the debt you are merely betting on the horse to finish the race. So if I can make 8%, 10% or more investing in credit, where all the company has to do is stay in business and pay its debts when they come due (i.e. "finish the race"), then how much more would I have to make to justify buying the company's stock, which only gives me a higher return than the company's debt if it grows its earnings, increases its dividend and performs well enough to increase the value of the stock? How much of a hoped for equity return - 12%, 14%, 16% - is enough to make me take that extra risk and pass up the relatively "sure thing" return that I'll get as a creditor if the company merely survives?
4. Readers of my "Income Growth versus Dividend Growth" articles (here and here), where I confess to being a "lapsed" or "fallen away" dividend growth investor, know that I have come around heavily to a "show me the money" strategy that favors high dividends that I can reinvest myself to create my future income growth through compounding. Using this approach I have constructed over the years a portfolio almost exclusively made up of closed end funds that are either fixed income or close to it. The "close to it" includes utility funds (I consider dividends of most utilities to be almost "fixed" in that they are supported by highly predictable cash flows often set by regulatory agencies) and a few equity funds that use options to protect their cash flows by trading away some of the upside.
5. Closed end funds are a particularly good vehicle for exercising such a strategy, because:
o The market is inefficient enough that you can almost always find funds in your asset class of choice (loans, high yield bonds, utilities, preferreds, convertibles, equities, etc.) that are selling at a discount to the funds' underlying net asset value. For an income investor, this means you are getting the current income from more assets than you are actually paying for. (For example if you buy a fund whose underlying assets are yielding 8%, but your price represents a 10% discount so you pay only 90 cents on the dollar, the cash distribution on your investment is actually 8.9%, i.e. 8/90 = 8.9%. Over time, compounding your portfolio at that extra rate makes a big difference to your long-term return.
o Closed end funds also allow funds to engage in a limited amount of leverage (which other open-end mutual funds can not do). This is a huge advantage for retail investors who have been able to get the advantage of cheap institutional funding rates (the kind banks and other institutions have access to but most investors do not) for the past few years. Some funds have borrowed at 1 to 2% and re-invested in their core assets at yields of 5-8%. The difference on those additional assets accrues to us fund investors. Again, this has been and continues to be a big advantage to small investors, many of whom have been hurt in general by the Fed's low interest rate policies. This has been a chance to get some of the benefit of those policies, by making the yield curve work FOR us rather than AGAINST us (i.e. like the big banks and other institutions do.)
o Finally, the closed end fund structure is a great vehicle for holding high-yielding but potentially illiquid or volatile assets. There are no "runs on the bank" with a closed end fund, like there can be with a traditional open-end mutual fund. Investors who want their money back have to sell in the market place, but can't demand that the fund manager liquidate the fund to pay them out. This allows long-term investors to hunker down and wait out the storm, which is what many of us did during the great crash of 2008, or during the mini-crash of this past winter. (By the way, a closed end fund manager can squander some of this advantage if they leverage themselves up to the CEF leverage limits set by the 1940 Investment Act, at which point drops in the market value of their underlying assets can require them to liquidate assets, perhaps at a fire-sale price. This happened earlier this year to Oxford Lane Capital (NASDAQ:OXLC), disappointing many of its investors.)
6. The times are right now for an "all-weather," non-heroic, hunker-down-and-collect-the-cash sort of portfolio, as we anticipate a continuing "muddle through" sort of economy.
o The globalization of labor markets will continue to level wages throughout the world, reducing inflation pressures, especially on wages, and stifling consumer confidence in the alleged "recovery." This will happen regardless of who gets elected president, and our CEO pay system, which encourages CEOs to merge or otherwise transform their companies and eliminate the jobs of their own colleagues, merely accelerates the trend. I wrote a book on this, for anyone interested in delving further into the subject.
o This also contributes to the increasing gap between the 1% at the top and everyone else. While morally wrong, this helps to ensure global liquidity and a demand for investments of all kinds, since the 1% cannot spend it all on material goods and have to invest it somewhere.
o Putting this together, I believe low inflation, low interest rates and anemic growth will likely continue, especially with all the uncertainty about the ongoing rollout of BREXIT and its impact on other EU countries, unknowns associated with the US presidential election, and the lingering concerns about terrorism.
o Faced with this sort of a world, I want a portfolio that just churns out the cash through thick and thin. That means:
§ Debt or fixed income obligations, not equity (I just want the companies I'm investing in to keep their heads down, survive and pay their debts)
§ Broad diversification (even if some horses don't finish the race, I'm betting that most of the field will)
§ I want lots of people on my side, with their own "skin in the game." If I own a diversified set of closed end funds and other vehicles, and each of them is diversified and owns the debt or other issues of hundreds of different companies, then I know I have lots of portfolio managers and lots of individual corporate CEOs and other executives, all with a vested interest in taking their little piece of my portfolio and sailing it successfully through whatever storms may lie ahead.
So, if you're still reading by now, that's my "macro orientation," and we can turn to the portfolio (Se table below.) Since my basic outlook hasn't changed dramatically from three months ago, the portfolio hasn't either, with a net turnover of about 7%. Most of my moves during the month involved "tweaking" rather than any fundamental change in direction. Here are the portfolio highlights:
· Eagle Point Credit (NYSE:ECC) continues to be my biggest holding. This fund holds equity positions in collateralized loan obligations ("CLOs") which are virtual banks (portfolios of senior secured corporate loans leveraged about 10 to 1). There is a "complexity risk" that drives up the yield, but for people who actually understand what is going on and can analyze it, the risk is no greater than actually owning a fund that holds a diversified portfolio of commercial bank equity, except in this case it is equity in "banks without walls." Fortunately here on Seeking Alpha we have a former S&P analyst, Sean Dougherty, who analyzed and rated these vehicles in a former life and now shares his expertise as a Seeking Alpha contributor. His articles have been helpful to me in bringing my own understanding of CLOs, which is at the "10,000 feet" theoretical level, down to a much closer level, especially in regard to the detailed accounting for income and distributions. I had "discovered" and written about another closed end fund that holds CLO equity, OXLC, a couple years ago. ECC operates in the same basic space as OXLC, but appears to be more conservative and transparent, which is why I have shifted, at least for the moment, all of my allocation to the CLO asset class to ECC. OXLC, which yields 26% to ECC's 14%, is still a very reasonable speculation for those so inclined, but I would treat it as a speculation and not bet the farm on it. ECC, by contrast, I regard as a core holding, for the reasons - conservatism and transparency - mentioned above, plus a very high personal regard for management. CLOs, by the way, although they dropped in market value like other debt and equity, came through the 2008 crash with flying colors for investors who hung on tight and didn't panic.
· Eaton Vance Limited Duration Fund (NYSEMKT:EVV) is my second largest holding. It pays a dividend of just under 9%, holds a diversified portfolio of senior secured corporate loans, high yield bonds and mortgage-backed securities, and is run by a highly-respected team of Eaton Vance portfolio managers, some of whom I have known for decades. Besides the dividend, I have a small capital gain on my original investment, the best evidence of all that the dividend has not been in any way "destructive."
· Cohen & Steers CEF Opportunity Fund (NYSE: FOF) is my third largest holding, paying me a solid 8.8% yield with no diminution in market value over the life of my holding. (With all closed end funds, you need to be opportunistic in timing your purchases, to take advantage of discounts and market lows.) What I really like about FOF is that you get double discounts (like "double coupon" days at the grocery store) since you buy FOF at a discount from its own NAV, while that NAV is actually calculated at the aggregate market price of its investments, which themselves are at a discount (most of them) from their own NAVs. So you have discounts on discounts. Two years ago I did an article on this and calculated that the total discount for FOF's underlying holdings was about 18% at that time.(https://seekingalpha.com/article/2562315-18-percent-off-sale-on-closed-end-funds-with-cohen-and-steers-closed-end-opportunity-fund)
· Duff & Phelps Global Utility Fund (NYSE:DPG) has been another "all weather" income fund, where I've collected a nice 8% yield while watching the market price appreciate by 12% over the past year as utilities have attracted a lot of investor interest.
· Cohen & Steers Infrastructure Fund (NYSE:UTF), a similar fund, has done equally well, paying a dividend of 7.5% while also running up a 12% capital gain. I took some profits in UTF because it had done so well the yield was beginning to look less attractive compared to other alternatives, like LMP Capital & Income Fund (NYSE:SCD), which while not strictly a utility fund, has some overlap and is a highly regarded fund that pays 9.1% and sells at a whopping 15% discount to net asset value. I have added a substantial position in SCD over the past six months.
· First Trust Specialty Finance & Financial Opportunities Fund (NYSE:FGB) is my fifth largest and one of my favorite funds. A fund that holds a diversified portfolio of business development companies (i.e. companies that lend to small and medium size businesses), it pays a yield of 10.8% and has held its market value. Its discount has shrunk from 11% to just under 5% currently. A solid portfolio performer.
· · A few recent newcomers in the list:
o I bought Voya Global Equity Dividend Fund (NYSE:IGD) because I was looking to increase my equity/option fund exposure and this looked like an undervalued fund with a decent portfolio that paid an attractive dividend (13%) at a nice 9.8% discount. So far performance has been positive but I will have to watch it to see whether it merits becoming a long-term holding.
o Allianz Diversified Income and Convertibles Fund (NYSE:ACV) is run by the same solid team that manages the Allianz Convertible and Income Fund (NYSE:NCZ) and the Allianz Convertible and Income II Fund (NYSE:NCV), both of which I have had very good results with over the past six months, running up considerably since I bought them, to where they sell at a premium or a very small discount. So I bought their "cousin" ACV, which still sells at a discount of 12.6%, while yielding just a hair under 11%.
o My newest addition, the Miller/Howard High Income Fund (NYSE:HIE), focuses on stocks with high yields and/or growing dividends and is run by well-known investor and author Lowell Miller. It was brought to my attention by fellow writers Left Banker, Stanford Chemist and Thomas Hughes, and looked like a worthy portfolio addition, with its 10.9% distribution, 4.4% discount and impressive management team. Like any portfolio "newbie," we will watch it carefully to see how it settles in.
· Several other stalwarts in the portfolio that I am very happy with:
o Calamos Global Dynamic Income Fund (NASDAQ:CHW). I bought this at the wrong time a couple years ago, but the small paper loss I still have on it has been more than made up over that time by the generous monthly dividend of 11.5%. With a 12% discount, if I were a new buyer and didn't already own it, I'd snap it up.
o Pimco Dynamic Credit Income Fund (NYSE:PCI). Great fund managed by some of PIMCO's most senior people. I bought in at the wrong time a few years ago, but have more than made up with the 10% dividends. Sells at a 5.9% discount.
o I bought a number of MLP funds when that sector was being unfairly punished. (See list below for details on NYSE:KMF, NYSE:KYN, NYSE:JMF, NYSE:MIE and NYSE:NTG.) They will probably be good long-term income holds.
o I also hold some other PIMCO income funds NYSE:PFL and NYSE:PFN). All good funds, but I have to monitor them to see if they rise to premium prices, at which they may be candidates for rotation with other income funds at discounts and higher yields.
I have assembled this portfolio piece by piece over many years, as many readers know. For the most part it has done well, generating a cash yield in the 9% to 10% range for the last few years, while maintaining its market value (not without ups and downs.) But as readers know, my goal is to build as bullet-proof and all-weather an "income factory" as I can, so that the income stream will keep on coming regardless of what the market does in the meantime. As we face an uncertain financial, economic and geopolitical future, I think a portfolio like this is as good a blend of "battening down the hatches" and also "keeping the income flowing" as I can manage.
Many of the names on the attached list will look familiar and started out as ideas in other Seeking Alpha contributors' articles, like Left Banker, Douglas Albo, Stanford Chemist and others. Thank you, folks! I consider myself a portfolio manager, and the rest of the SA contributors are my "research staff."
Thanks also to the many readers and commenters who amuse and educate us, and keep us honest - and humble - with your comments.
|Savvy Senior Portfolio 7/20/2016||Symbol||Current Yield||CEF Premium/ Discount||This Holding As % of Portfolio Income||This Holding % of Portfolio Income 3 Months Ago||Increase/Decrease as % of Porfolio income|
|Eagle Point Credit Co.||ECC||14.20%||12.73%||17.11%||13.55%||3.56%|
|Eaton Vance Limited Duration Fund||EVV||8.97%||-8.91%||9.07%||9.53%||-0.46%|
|Cohen & Steers CEF Oppty Fund||FOF||8.84%||-10.90%||7.75%||7.74%||0.01%|
|Duff & Phelps Global Utility Fund||DPG||8.02%||-13.52%||6.62%||6.41%||0.21%|
|First Trust Specialty Financial Oppty Fund||FGB||10.86%||-4.43%||6.50%||6.50%||0.01%|
|Calamos Global Dynamic Income Fund||CHW||11.55%||-12.35%||6.12%||6.12%||0.01%|
|Pimco Dynamic Credit Income Fund||PCI||9.99%||-5.90%||5.70%||5.69%||0.00%|
|LMP Capital & Income Fund||SCD||9.14%||-15.24%||4.85%||4.84%||0.00%|
|Voya Global Equity Dividend||IGD||13.01%||-9.76%||4.20%||0.63%||3.58%|
|Blackstone GSO Strategic Credit Fund||BGB||8.65%||-11.19%||3.54%||3.19%||0.35%|
|Allianz Convertible & Income Fund||NCZ||12.26%||-1.57%||2.85%||3.22%||-0.37%|
|Pimco Income Strategy Fund II||PFN||10.34%||-0.86%||2.62%||2.62%||0.00%|
|Eaton Vance Tax Mgd Global Div Inc Fund||EXG||11.04%||1.07%||2.47%||2.47%||0.00%|
|Allianz Convertible & income II||NCV||11.87%||2.49%||2.47%||2.18%||0.29%|
|Nuveen Energy MLP Fund||JMF||10.98%||-6.50%||2.37%||2.37%||0.00%|
|Allianz Diversified Inc. & Conv. Fund||ACV||10.99%||-12.65%||2.23%||0.00%||2.23%|
|Miller/Howard High IncomevFund||HIE||10.93%||-4.44%||1.90%||0.00%||1.90%|
|Pimco Income Strategy Fund||PFL||10.45%||-1.05%||1.71%||3.92%||-2.21%|
|UBS ETRACS Leveraged REIT||MORL||22.05%||NA||1.61%||2.01%||-0.40%|
|Ares Dynamic Credit Allocation Fund||ARDC||8.75%||-14.33%||1.57%||0.76%||0.82%|
|Kayne Anderson Midstream Energy Fund||KMF||12.80%||-9.14%||1.24%||1.23%||0.00%|
|Cohen & Steers MLP Fund||MIE||8.80%||-13.05%||1.19%||1.96%||-0.78%|
|Kayne Anderson MLP Inv Co||KYN||11.88%||-0.36%||1.13%||1.13%||0.00%|
|Tortoise MLP Fund||NTG||8.96%||-6.04%||1.07%||1.06%||0.00%|
|Yield Shares ETF||YYY||9.93%||NA||0.91%||0.00%||0.91%|
|Cohen & Steers Infrastructure Fund||UTF||7.48%||-13.96%||0.69%||3.81%||-3.12%|
|Macquarie/First Trust Global Infra Fund||MFD||9.46%||-10.77%||0.51%||0.00%||0.51%|
|John Hancock Investors Trust||JHI||7.97%||-3.93%||0.00%||0.86%||-0.86%|
|Voya Risk Managed Natural Resources||IRR||12.89%||-9.91%||0.00%||2.76%||-2.76%|
|Pimco Income Opportunity Fund||PKO||9.61%||2.91%||0.00%||1.46%||-1.46%|
|Eaton Vance Tax Mgd Global Buy Write Fd||ETW||11.04%||-2.94%||0.00%||1.08%||-1.08%|
|Blackstone Lg/Sht Credit income Fund||BGX||7.92%||-10.27%||0.00%||0.88%||-0.88%|
Disclosure: I am/we are long FOF, EVV, CHW, FGB, AGV, NCZ, NCV, ECC, IGD, PCI, SCD, HIE, UTF.
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.