Making Money - An Alternative Strategy

by: Mark J. Grant

On November 8th I said a variety of things on CNBC. I said that Trump would win. I suggested buying equities and I said that yields would rise to the 10 year Treasury support/resistance line of 2.51%. That is what I stated.

I had determined that the days of the markets being dominated, controlled, by the Fed and the other central banks were over. The days of the central banks' "Wonderland" had just gotten Trumped and that Peter Pan was back in "Neverland." It also occurred to me that Mr. Trump, and his policies of less regulation, cutting taxes and "America First," were going to run the markets now and that new strategies should be implemented.

Since November 8 the DJIA has risen 11.2%, according to Bloomberg data. The 10 year Treasury yield rose and exceeded my 2.51% call by a few basis points and now stands at 2.36%, Bloomberg showed Friday morning, and it may be on track to challenge the lower end of the range which is 2.32%, in my calculations.

We have had quite a run in a little over three months.

Now all of this has been betting on the come. This is what we know. This is what we are used to in the markets as we look at either debt or equities and put our money down on the table. This is not, however, the only way to invest.

There is also, what I like to call, "Cash Flow Investing."

Let us suppose, for the sake of explanation, that a money manager has a client with one million dollars to invest. Here is an alternative game plan which I believe is safer, by design, than heavily betting upon the future. My alternative strategy differs significantly from any "appreciation plays" as yield is captured and locked-in, at the moment the money is invested.

So, you take one-half of the money, $500,000.00, and buy five to ten year investment grade corporate bonds. One reason you buy this sector is that most have yields, after taxes, that are higher than Municipal Bonds presently and liquidity is no real issue in this market. This is not true for every bond, I want to note, but it is generally true now.

Since I am using these bonds as a safeguard, as they have a stated maturity, against the rest of my alternative portfolio, I only want to buy these bonds at discounts. Here, in my opinion, you get some extra leverage as the closer they get to maturity, the price gap generally closes, unless the market inverts, which can certainly happen in recessionary times. However, this is not often the case.

Then I take the other half of the money, $500,000.00, and buy closed-end bond funds. This is the trickier part of my plan. There are some 1,500 of them, according to Morningstar, and if you don't know what you are doing you can make some serious mistakes. I also use some well-defined criteria here.

First, the fund must have a major sponsor. This is not the place to speculate on smaller firms, in my view. Second, the fund must be trading at a discount to the NAV. Closed-end bonds funds can go through re-organizations, like other securities, and I do not wish to find myself behind the eight ball. Third, the fund must be trading more than one hundred thousand shares a day as, while this is not the most liquid of markets, I want to make sure I can get in or out without any major consternation.

Then I look at Bloomberg and I do NOT use the twelve month yield, which is stated in most publications, but the "indicated yield" which is based upon past performance. Then I look at the leverage, almost all closed-end bond funds have leverage but it is the "fund's leverage" and not "your leverage" which is a key component of my strategy. The closed-end bond funds are generally borrowing at the short end of the curve and while the Fed has made all kinds of noise, with Mr. Trump's upcoming Fed appointments, I am not overly concerned.

Finally, I look at the fund's portfolio and decide whether I am comfortable with that is in it. Remember, a closed-end bond fund is generally traded as an equity, meaning no maturity, which is why I use the 50/50 concept with corporate bonds. Having said this, what is of critical importance in my estimation, given that you are buying a piece of a large bond portfolio after all, is what is contained in that portfolio. This must be examined very carefully.

I have spent hours and hours doing the homework on the closed-end bond bonds. There are around eight, that I like currently, and the average yield is around ten percent (10%). So, if you get, for the sake of this discussion, around 4.00% on one-half of the money and 10% on one-half of the money you get an average yield of about 7.00%. That is 4.64% MORE than the 10 year Treasury yield this morning.

There is also another important component here. All of the closed-end bond funds that I like currently pay monthly. This is Compound Interest 101. A 10% yield with a monthly check equates to a yield of 11.10%, in my calculations. Using this methodology, you get an average yield, between the funds and the corporates, of 7.55% which is 5.19% more than the 10 year Treasury yield.

The odd thing, which strikes many institutions, is that you are not really looking for appreciation in the closed-end bond funds. If they do appreciate in value significantly, then you are not making money on the money. When this happens, I sell the fund and find a new one, because any profit is not producing a return on the invested capital.

The other nice thing, in my judgement, about receiving money every month from the funds, unlike the corporate bonds which pay semi-annually, is that you can use the money to re-invest, put it some other place if the world goes haywire, or put it in another fund with a higher yield.

More and specific information can be obtained by clients, from me, upon request.

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